Decision Making in Marketing and Finance

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Decision Making in Marketing and Finance

An Interdisciplinary Approach to Solving Complex

Organizational Problems

Paul Sergius Koku

decision making in marketing and finance

Copyright © Paul Sergius Koku, 2014.

All rights reserved.

First published in 2014 byPALGRAVE MACMILLAN®in the United States— a division of St. Martin’s Press LLC,175 Fifth Avenue, New York, NY 10010.

Where this book is distributed in the UK, Europe and the rest of the world, this is by Palgrave Macmillan, a division of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS.

Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world.

Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries.

ISBN 978-1-349-47882-8

Library of Congress Cataloging-in-Publication Data

Koku, Paul Sergius, 1955– Decision making in marketing and finance : an interdisciplinary

approach to solving complex organizational problems / Paul Sergius Koku.

pages cm Includes bibliographical references and index.

1. Decision making. 2. Marketing. 3. Budget in business. I. Title.

HD30.23.K645 2014658.800199—dc23 2014006312

A catalogue record of the book is available from the British Library.

Design by Newgen Knowledge Works (P) Ltd., Chennai, India.

First edition: August 2014

10 9 8 7 6 5 4 3 2 1

Softcover reprint of the hardcover 1st edition 2014 978-1-137-37947-4

ISBN 978-1-137-44477-6 (eBook)DOI 10.1057/9781137444776

Dedicated to Aurelia, Ruth Violet, and Emma

Contents

List of Figures ix

Preface xi

Acknowledgments xv

Statement of Aims xvii

Chapter 1 Theory of the Firm 1

Chapter 2 The Customer Lifetime Value 19

Chapter 3 Strategic Marketing Plan 35

Chapter 4 Signaling in Finance and Marketing 49

Chapter 5 New-Product Introduction 69

Chapter 6 Sales Force Compensation and Management 83

Chapter 7 Marketing Communication 99

Chapter 8 Advertising 113

Chapter 9 Pricing and Sales Promotion 131

Chapter 10 Marketing Mistakes and Their Impact on the Firm 149

Appendix 1 Cases 157

Name Index 181

Subject Index 187

Figures

3.1 The customer-centered four-legged stool 373.2 The dual distribution approach 448.1 A simplified communication process 1158.2 The AIDA model 1189.1 Full-cost and variable-cost pricing strategies 132

Preface

Decision making in business does not take on the color or tenor of any one particular functional area; in fact, busi-ness decisions generally cut across disciplines. Yet, with the

exception of a few progressive schools, we continue to teach courses in business schools as though decisions are made in functional silos. Part of the problem, we think, is due to the fact that most of the text-books we use today are written that way. A textbook in finance hardly discusses anything related to marketing and vice-versa, this approach is far removed from reality where solving a marketing problem may require expertise in finance or operations management. This book is, however, different from other textbooks in the sense that we take an approach that is reality based. We take an interfunctional and cross-disciplinary approach, hence the title—Decision Making in Marketing and Finance.

We believe that turf protection and the so-called silo mentality are due to the fact that many people fail to see the company as an entity that works best when “all hands are on deck” or where people realize that everyone’s success or failure impacts everyone else. No one would be left behind, not even the best department, when a company fails and closes its doors. For that reason alone, if for none other, all the departments must work together for the good of each other.

This book stresses the interdisciplinary approach of decision making in organizations, and thus can be used as a textbook or reference book. It is written primarily as a strategy book, however, because it seeks to appeal to a broad audience; every care has been taken to express the con-cepts it discusses in everyday English without jargons and mathematics.

xii l Preface

Unlike many other textbooks, this book reviews both the classic and contemporary literature on the subjects discussed and relates them to the business decision being made or the business problem being solved. In this respect, it is suitable for use in both undergraduate and MBA courses.

Overview of the Book

Much has been said during the past three decades about the need for interdisciplinary approach to teaching business courses, yet very few text-books have been written for that purpose. This book is based on the belief that to teach across disciplines requires that we write books across disciplines.

This first edition of Decision Making in Marketing and Finance con-sists of ten chapters and an appendix with ten cases. All the cases have been created from scratch and only serve as platforms for further dis-cussing the concepts covered in the chapters. Chapter 1 discusses the firm as a composite of different departments, each of them necessary but incapable of steering the firm to success by itself, hence the need for interfunctional cooperation. The chapter draws on Coase’s 1937 seminal article on the theory of the firm and other popular and well-regarded articles on principal-agent relationships to motivate the discussions.

Chapter 2 discusses the Customer Life Time Value concept and uses it to make a case for relationship marketing and cross-selling.

Chapter 3 discusses usage of the 4Ps (product, price, place, and pro-motion) in strategic marketing planning; however, unlike the traditional textbooks, it takes an interdisciplinary approach and shows how each of the functional areas can and should make viable contributions to the plan.

Chapter 4 discusses signaling theory and its application in marketing. It reviews signaling theory from evolutionary biology through econom-ics and marketing by drawing on Michael Spence’s 1973 seminal paper on labor marketing signaling. This chapter also discusses the source of information asymmetry in marketing and how marketing variables such as advertising, new product introduction, warranties, and so on could be used as marketing variables.

Chapter 5 discusses new-product introduction. It relates new-prod-uct introduction to the product life cycle and signaling theory. It also

Preface l xiii

uses the new-product introduction as a topic to call for interfunctional cooperation.

Chapter 6 talks about sales force compensation and management. It nicely ties in agency problems that have been minimally discussed in marketing strategy textbooks. It also discusses the decision on whether a company should hire its own sales force or contract the selling activities to an independent agent.

Chapter 7 discusses the quintessential integrated marketing com-munication (IMC) strategy minus advertising, which is discussed in chapter 8. It ties the IMC to signaling and discusses the decision regard-ing which element of the communication mix to emphasize and when.

Chapter 8 focuses on advertising as a part of the communication mix. Because of the major role that advertising plays in the communication strategy of many companies and amount of money that is being spent on it, the chapter discusses seminal papers on the effectiveness of adver-tising campaigns and whether to view advertising as an expense or an investment. Again, an interdisciplinary approach is taken in discussing the issues.

Chapter 9 discusses the ever so important issue of pricing and sales promotion. It discusses the different forms of pricing techniques—from full-cost pricing approach to activity-based pricing approach. It also dis-cusses pricing as a signaling variable and the use of high price as an indicator of high quality.

Chapter 10 talks about marketing mistakes of all kinds, from product names to decisions regarding not recalling defective products from the market. The chapter uses the mistakes to highlight the need for cross-functional cooperation.

Acknowledgments

This book could not have been written without the help of sev-eral individuals. My past and present students have contributed indirectly to this book because I was able to “try” my ideas on

them. My colleagues, particularly Dr. Allen Smith, freely gave of their time. Allen often stayed to work in his office at school up to 2:00 or 3:00 a.m. so that I would know that there was someone else on the “floor” while I was “putting in my long hours.” Besides his time and intellectual contributions, he gave me unlimited access to his well-cataloged collec-tion of journal articles. Dr. Eric Shaw was also generous in lending me books from his vast collection of “out of circulation” books. I know few in the world who can match his collection. Ms. Selen Savas, my research assistant, was invaluable in her assistance. She was always there when I needed her.

The seed for the book was planted in December 1999 when I designed and taught a graduate course on Finance and Marketing Interface at Monash University, Melbourne, Australia. At that time, there was no suitable textbook on the market that I could use, so I cobbled together a collection of articles and cases. I started thinking then that I would write an interdisciplinary book that fills the void I perceived, but the idea simply remained just that—an idea. I wrote and rewrote this book in my head for over 14 years, but never wrote down a word on paper!

There are also many others who have directly or indirectly contributed to this book. Some people have contributed by challenging my thinking on certain issues—my nephew Dan an intellectual historian, with whom

xvi l Acknowledgments

I have had many long and vigorous discussions whenever I visited, is one of those. Some individuals have contributed by giving me uninterrupted time and space, and others by encouraging me—I wish to thank them all. While I view this book as a product of collective effort, I alone bear the full responsibility for all the mistakes of omission or commission.

Paul Sergius Koku

Statement of Aims

This book has three main objectives. First, the book shows how value could be created for shareholders and other stakeholders if managers or internal decision makers of a firm design solutions

with an interfunctional mind-set. Thus, the book approaches decision making within the firm using the critical links between finance and marketing. Second, by linking marketing and finance decisions, the book illustrates what many marketers have long argued, but seldom clearly demonstrated, that is, how marketing decisions directly affect the firm’s financial position. Third, the book intends to provide a much-needed teaching material for interdisciplinary approach for case analysis.

The continued use of cases to teach in business schools, especially the MBA programs, shows recognition of the superior outcomes of an interdisciplinary approach to solving business problems. However, functional departmental silos still exist mainly because of inertia and turf protection, and can only be eliminated through educa-tion on several fronts. Education of future internal decisions makers (business students at all levels) that shows not only the suboptimal solutions achieved in many instances through the “functional silo” method, but also the superior solutions that can be achieved, in many instances, through the cross-functional approach. This education to change a long-held mind-set should not be limited to only future decision makers (students), but current decision makers could also be persuaded through continuing education and the executive MBA programs.

xviii l Statement of Aims

For these reasons, this book is written for a very broad audience and does not make any assumption on possession of prior knowledge. In addition to being used as a teaching material, this book can also be read by the practitioners for background theoretical knowledge. It is also our hope that this book provides yet one more persuasive reason to break down functional silos.

CHAPTER 1

Theory of the Firm

There is a fable in many cultures of what an elephant looks like to six blind men. The first of the six men who felt the elephant’s tail with his fingers described the elephant to be as thin as a rope or a

snake. The second man who felt the elephant’s leg described the elephant like a huge pillar. The third man who felt the elephant’s tusk said the elephant was like a pipe. To the fourth man who felt the animal’s belly, the elephant was like a wall. To the fifth who felt the elephant’s ear, it was like a hand fan, and to the sixth man who felt the elephant’s trunk, the animal was like a tree branch.

While the origin of this story cannot be determined, it reminds us of the various definitions of the firm. It also, in a very practical way, demonstrates the imports of the bounded rationality theory. Our under-standing and knowledge of a phenomenon at any time, say t2, could be completely different and perhaps even superior to the one at time t1 because of availability of new and perhaps superior information at a later time (t2); and so is our understanding of the firm. A note of caution, while the “firm,” a “corporation,” and an “organization” could have dif-ferent meanings, in this chapter, we use the terms interchangeably in a generic sense to mean the same thing—the firm.

Corporations occupy a very special place in every modern economy regardless of whether the economy is characterized as an advanced, a newly developed, or a developing economy. Indeed, the contemporary firm can be referred to as the nucleus of a country’s economic engine and therefore deserving of special attention. The concept of the firm

P.S. Koku, Decision Making in Marketing and Finance© Paul Sergius Koku 2014

2 l Decision Making in Marketing and Finance

is not new even though it has, over the years, undergone several refine-ments. The fact that very few post-1937 academic discussions on the firm are held without any reference to Coase’s (1937) work on the nature of the firm is a testament to his insightful contribution to the theory. As alluded to by Coase, many macroeconomic analyses unintentionally but erroneously begin with an “industry” as the starting point because the concept of the firm, though not new, had not been clearly defined by economists. So what is the firm?

The importance of the firm as well as the brilliance in its “invention” can be appreciated when observed through the chain of changes that it has brought to the marketplace. First is the logic of specialization of labor. With specialization of labor, individuals get to work at or “pro-duce” what they can do best. So an individual A who is good at putting together automobiles may become a mechanic while individual B who is good at tilling land and tending to animals may become a farmer of some sort. Similarly, some individuals may choose to become accountants or lawyers while others may become doctors or marketing specialists.

Besides the intrinsic satisfaction that goes with doing what one enjoys best, specialization of labor also implicates several other issues. For example, with specialization comes cost advantage and high effi-ciency. Consumers enjoy lower costs when specialization occurs because there is less wastage in terms of material and time during production. However, if everyone specializes in what they do best, then how can one get the other things that one needs but cannot produce? To answer this question, we must introduce the concept of exchange or trade. So, one can argue that specialization necessitates exchange, which also comes with its own problems. For example, how much of product C should one exchange for product D? Economists refer to this problem as a problem of finding a unit of account or a numeraire, which for the sake of sim-plicity we will refer to here as the problem of “value.” So, in other words, how is C valued against D? However, there is another problem besides that of value.

Imagine the number of exchanges one has to make in order to get through the day. The mechanic may not just need to find a farmer who is willing to exchange food for his services, but also a carpenter, and perhaps teachers for his children and a doctor for his wife. The nature of the problem becomes easily evident. These bilateral exchanges come with enormous costs; for example, finding someone to exchange

Theory of the Firm l 3

products/services with. If the mechanic spends all day looking for indi-viduals to exchange services with, he will not have the time to work as a mechanic, and then, of course, he will have nothing to exchange.

The invention of money solved a major part of the problem; however, unresolved issues remained. For example, how does the farmer know how much to produce so that his produce does not go waste, and how does he ensure that he gets the best price for his produce? Most econo-mists before Coase (1937) assigned this problem and others like it to the market forces in a free market economy. However, as pointed out by Coase, the price mechanism or market forces do not always clear the market at the lowest cost. In other words, there are costs associated with the price mechanism’s clearance of the market. Coase referred to these costs as “transaction costs.” It can therefore be argued that the firm is an additional mechanism that facilitates clearance of the market in a more efficient manner. But how does the firm accomplish this? We will dis-cuss this later when we discuss features of the firm. In the meantime, we should discuss a few other noteworthy definitions of the firm.

Other Definitions and Objectives of the Firm

Coase (1937) was not alone in grappling with a realistic definition for the firm. It is noteworthy that in trying to come to a realistic defi-nition of the firm, Coase reverted to the two canons established by Professor Robinson (1932) in making assumptions. According to Professor Robinson, first, assumptions must be tractable; second, they must be realistic. Using these assumptions, Coase’s discussion on the firm intended, as he put it, to “bridge what appears to be a gap in eco-nomic theory between the assumption (made for some other purposes) that resources are allocated by means of the price mechanism and the assumption (made for other purposes) that this allocation is dependent on the entrepreneur- coordinator” (p. 389).

Behavioral Theory

Consistent with the canons used by Coase (1937), that is, making assumptions tractable and realistic, several other scholars including Simon, March, and Cyert (Simon, 1955, 1964; March and Simon, 1958; Cyert and March, 1963) proposed new definitions of the firm that draw


on the theories of human behavior and are different from those of neo-classical economists. According to these scholars, firms have not been created solely by the “entrepreneur-coordinator,” but instead emerge from coalitions and subcoalitions of individuals and groups such as managers, employees, shareholders, and lawmakers. This definition sets the groundwork for one of the most debated points between neoclassical economists and organizational theorists on the role of the firm.

It should come as no surprise (using Cyert and March’s (1963) defini-tion of the firm) that all the different coalitions and subcoalitions of the firm have different objectives that may be in conflict and impose dif-ferent constraints on the firm. According to this school of thought, the firm’s realistic objective therefore cannot be the maximization of share-holders’ profit since shareholders are only a part of the larger coalition or subcoalition. Furthermore, according to Simon (1964), because of com-putational limitations and the lack of perfect information, managers can only “satisfice” instead of maximize firm objectives.

To put things in context, it must be understood that up to this point in time, the neoclassical viewpoint of the firm—that the primary objec-tive of the firm was to maximize its profits—still prevailed. This view was clearly articulated by Friedman (1962) as follows:

The view has been gaining widespread acceptance that corporate offi-cials and labor leaders have a “social responsibility” that goes beyond serving the interest of their stockholders or their members. This view shows a fundamental misconception of the character and nature of a free economy. In such an economy, there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud. (p. 133)

Friedman’s more poignant indictment of corporate social responsibility, which was cited by Carroll (1999, p. 277), states, “Few trends could so thoroughly undermine the very foundations of free society as the accep-tance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible” (see also Friedman, 1970). It would appear that in Friedman’s world the managerial discre-tions that lead to expenditures on corporate social responsibility activities


are simply the result of agency problems (Lee, 2007), which will be dis-cussed in detail later in this book.

Pfeffer and Salancik’s (1978) definition of the firm contains elements similar to that of Cyert and March (1963). As in Cyert and March, Pfeffer and Salancik define the firm as a “coalition of interests.” These interests can be divided into two main factions, the internal and the external. The “internal” faction comprises union, managers, and the like, while the “external” faction consists of suppliers, regulators, legislators, environ-mentalists, and a pool of potential talents (potential employees). Because every firm generally intends to exist forever (an assumption that argu-ably formed the basis for accrual accounting, i.e., accounts receivable and accounts payable), the ability of the firm to draw resources as well as support from the external environment is important.

Thus, firms negotiate with their external environments to ensure and facilitate their survival. Part of “negotiating” with the external environ-ments involves taking steps to win the support of the community in which the firm exists. Some of these activities include donating in cash or kind to the community food bank to feed the homeless, buying sport-ing uniforms for the local little league, and the like. Activities such as these, of course, make many scholars question the objective of corporate social responsibility activities. Some wonder if the practice is not merely a public relations ploy designed to facilitate the attainment of resources for the firm and ensure its survival or a genuine recognition on the part of the firm that it needs to “legitimize” its existence by being a “citizen” of a community.

Modern Finance Theory

The usage of modern finance theory has also dramatically changed the definition of the firm. Differing from the neoclassical theory of the firm as a value maximizing entity, Fama and Miller (1972) have argued that firms exist over several periods, if not in perpetuity, instead of a single period. Furthermore, as a part of ensuring that they remain profitable and/or exist in perpetuity, firms frequently take on new projects and eliminate nonprofitable ones. Engaging in this process changes their risk levels; thus, it is not quite accurate to assume that the objective of firms is to maximize their value. Rather, the more accurate description of the objective of the firm under the modern theory of the firm, according to


Fama and Miller, is to maximize the firm’s present value. This objective/definition of the firm is different from the previous in two ways. First, it integrates into the definition of the firm the concept of present value of the firm’s shares. This step is an implicit recognition that owners of the firm do hold ownership of the firm by holding shares. Second, the definition also integrates the methods of estimating riskiness of projects, which not only make up the firm, but also determine its value.

Jensen and Meckling (1976) provide a new definition of the firm that focuses on the ownership structure of firms. The authors reechoed Coase’s (1937) observation that economists have failed to clearly define the firm; instead, what economists generally refer to as the theory of the firm is actually “a theory of markets in which firms are important actors.” Jensen and Meckling reviewed the definitions of the firm pro-vided by previous authors and concluded,

Organizations are simply legal fictions which serve as a nexus for a set of contracting relationships among individuals. This includes firms, non-profit institutions such as universities, hospitals and foundations, mutual organizations such as savings banks and insur-ance companies and co-operatives, some private clubs, and even government bodies such as cities, states and Federal governments, government enterprises such as TVA, the Post Office, transit sys-tems, etc. (p. 310)

Jensen and Meckling (1976) arrived at a new theory of the firm by inte-grating the three main theories: the theory of property rights, which was implicit in Coase’s view of the firm as a network of contracts; agency theory, which was also referred to by Coase when he discussed the conditions that could arise when the “entrepreneur-coordinator” hires someone else to manage the firm; and the theory of finance.

Because of agency problems, previous commentators on the “firm” including Adam Smith (1776) have attributed certain amount of inef-ficiencies to the arrangements that involve separation of owners from managers. In the words of Adam Smith (The Wealth of Nations, p. 700) cited by Jensen and Meckling (1976),

The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it


cannot well be expected, that they should watch over it with same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. (p. 305)

However, Jensen and Meckling (1976) characterized some of the problems with previous definitions of the firm as “special cases” of the theory of agency relationships and identified the components of agency costs as (a) monitoring costs incurred by the principal, (b) the bonding costs incurred by the agent, and (c) the residual loss. Assuming that a firm can issue only stocks and bonds, Jensen and Meckling examined how the principal and agent could arrive at an equilibrium contractual form given each party’s incentive to maximize his utility.

On property rights, the authors observed that the finer issues of the specification of individual rights are aspects of property rights that are critical for the definition of the firm. Such is the case, they argued, because individual rights determine the nature of contracts between individuals and organizations. They also determine the costs and rewards among people within organizations. Because firms are made up of a network of contracts with individuals that at times have conflicting objectives, firms often behave like markets in bringing the conflicting demands into equilibrium; thus, it would be misleading to personal-ize the firm in references such as its “objective functions” or its “social responsibility.”

Notwithstanding the above insights, Fama (1980) in explaining the nature of the firm suggests that the firm in which ownership is separated from management, despite the agency problems, functions much better than acknowledged by several commentators. He suggests that concerns over the seriousness of agency problems and the managerial propensity to shirk might be misplaced. In arriving at this conclusion, Fama also acknowledges the fact that to survive and thrive organizations need different expertise and different resources. The firm therefore acquires these resources in order to pursue the purpose for which it has been put together. Using the theory of property rights, Fama also argues along the


lines of other economists such as Coase (1937), Alchian and Demsetz (1972), and Jensen and Meckling (1976) that ownership of the skills and resources that make up organizations reside in those who possess them by ownership rights.

Reiterating the definition of the firm a la Coase (1937), Fama (1980) too suggests that the firm is a network of contracts between individu-als who have property rights to certain skills, expertise, or resources. However, unlike previous definitions of the firm as in Coase (1937) and Jensen and Meckling (1976), Fama argues that managers who are sepa-rate from owners might not necessarily shirk at the expense of owners because they are disciplined by competition from other firms and mana-gerial markets.

Competition from rival firms forces every firm to try to be effi-cient otherwise their cost of production will be unsustainably high and they will go out of business. Because shirking by managers is an inef-ficient use of resources, it will raise the cost of production, and because it is in the interest of every party in contract with the firm to see the firm remains in business, they will monitor the behavior of managers. Furthermore, a manager whose firm goes out of business will also have to look for employment elsewhere, and because the managerial market will not favorably view a manager whose firm goes out of business, it is in the managers own interest to be efficient or in other words cut down on shirking.

It is clear from most of the discussions above that most of the different conceptualizations of the firm revolve around the concept of separation of ownership from control that creates agency costs. The presence of agency costs in modern corporations with widely dispersed sharehold-ers was emphasized by Berle and Means (1932) in their seminal work. This point was revisited by several other authors including Coase (1937), Jensen and Meckling (1976), and Fama (1980). Demsetz (1983), how-ever, took a different approach to defining the firm. He argues that Berle and Means’s approach to defining the firm looks at the firm from two viewpoints that are completely different. The first viewpoint considers the firm during the pre-nineteenth-century era, as it existed before the corporate forms. The firm as it existed during that period approximated economists’ viewpoint of the firm that considers the firm as a device that allows profit maximization to take place and where managers do not consume perquisites on the job at the owners’ expense. The second


viewpoint, however, looks at the firm not as an efficient device to maxi-mize profit, but rather as an institution controlled by management that is interested in satisfying its own utility (which could be in the form of income and perquisites), and making only a minimum profit that will satisfy shareholders.

Demsetz (1983) cautioned, “It is a mistake to confuse the firm of economic theory with its real-world namesake.” In other words, there is a real gap in how economists see the firm and the firm as it exists in a layperson’s view. To Demsetz, the firm is not solely concerned with production for others because some level of consumption also does take place within the firm. This view is quite practical because it rec-ognizes managerial consumption of perquisites. Similarly, he does not view households to be concerned primarily with consumption because some level of production also takes place even within households. He gives an interesting example of a homeowner renting a room in his house to a boarder as a kind of production that could take place within households.

Looking at the firm and households this way, Demsetz (1983) pro-ceeds to address the preoccupation of previous economists with agency problems, specifically the problems associated with the separation of firm owners from managers. It is important to be aware that agency prob-lems can arise in other situations also, for example, a situation involving cooperative efforts involving two or more persons even though there is no clear principal-agent relationship involved (Jensen and Meckling, 1976).

Demsetz (1983) observes that it is unreasonable to assume that the diffused ownership of firms represented by stock ownership will militate against profit maximization motive of the firm, and that self-interest of owners will work in such a way that managers will have checks and bal-ances on their behavior. Furthermore, managers will not risk the many years they have invested in their training (“human capital”) and their reputation by shirking, since shirking could possibly make their opera-tions inefficient and put the firm in danger either of bankruptcy or of becoming a likely takeover target.

Citing empirical evidence, Demsetz (1983) argues that managers’ compensation not only in salaries and bonuses but also in stock own-erships correlates with stock performance. Furthermore, since signifi-cant number of managers do have ownership stocks, the said separation


between ownership and control is not “so separate as is often supposed.” The author concludes with an interesting observation,

The picture painted by management shareholdings, the importance of stock-based managerial income, and the size of minority share-holdings is that of a strong linkage between management and owner interests . . .

How could it be otherwise? In a world in which self-interest plays a significant role in economic behavior, it is foolish to believe that own-ers of valuable resources systematically relinquish control to managers who are not guided to serve their interests. (p. 390)

Features of the Firm

Having gone through the above discussions and the different viewpoints of the firm, we should now discuss features of the firm. Because these features, to a large extent, make the firm what it is, we revert to the ques-tion we posed at the beginning of this chapter for guidance: What is the firm?

There are legally many corporate forms that can be referred to as a firm, however, a simple generic view of the firm will suffice in answer-ing the question posed above. Examining features of the firm will help in understanding how it helps in clearing the market more efficiently in the world of Ronald Coase (1937). First, many economists including Salter cited by Plant (1932) and Hayek (1933) have argued that the “price mechanism” is the driving force that allocates resources in a free mar-ket. This price mechanism eventually clears the market, thus there is no need for a central planning authority that will coordinate resources. This argument is at the heart of the classical economic theory and consistent with Adam Smith’s (1776) invisible hands thesis. However, as argued by Coase, the firm, regardless of its size, unlike the market, by its very nature must have a coordinator. This coordinator is referred to as the entrepreneur in some contexts if he is also the founder of the firm, and by varying other titles such as the chief executive officer (CEO), the manag-ing director (MD), and so on, if he is hired to coordinate the resources in a large organization.

The main responsibility of the coordinator, quite naturally, is to organize the resources of the firm in an efficient manner to pursue the


goals of the organization. Hence, the coordination function of a central authority is key to the firm. Because coordination is vital to pursuing the organization’s mission, Marshall (1890) refers to it as the fourth factor of production, of course, the first three factors of production being land, labor, and capital. One of the objectives of the firm that is often glossed over in the discussions of the firm is to be as efficient as possible in pur-suing its goals. This has to be the case because firm AF will be driven out of business by firm BF in a free market system if firm BF can offer what firm AF is offering at a lower price, which can be achieved by producing what firm AF produces more efficiently or at a lower cost, given the same level of quality.

The coordination function of the CEO in the firm takes several forms and can be complex or simple depending on several factors including, but not limited to, what the organization “makes” and its size. One of the primary coordinating functions is decision making; thus, the CEO in course of coordinating the network of contracts makes several deci-sions on almost continual basis. Notice that in a market system the price mechanism drives how resources are allocated. Therefore, if resource E is in short supply in the market, it will in the short run command a higher price and consequently more resources will be converted into E until equilibrium is reestablished.

Take, for instance, the case of supply shortage of computer program-mers in the market. In the short run, the salaries of programmers will go up, as there is more demand for them (of course, that is why there is a shortage to begin with). This higher salary will attract more people who will switch from whatever they are doing or intend to do to computer programming so long as they have the aptitude for it. This movement will exert downward pressure on the salary for computer programmers until the supply is equal to demand. At that point, the higher salary will disappear. This process (the autonomous movement of resources from an area of low demand to that of high demand), however, does not occur within firms. The CEO dictates or controls this movement as a part of his coordinating responsibilities. This point was made by Coase in his seminal paper on the nature of the firm. However, as observed later by Jensen and Meckling (1976), Alchian and Demsetz (1972) disagreed with Coase’s (1937) point that the manager of the firm wields a coordi-nating authority over resources within the firm, and instead suggested that through property rights, contracts with resource owners serve as a


mechanism for “voluntary exchange.” Of course, the idea here is that the manager, in a free market, does not serve as a benevolent dictator.

The argument that the organization has to concern itself with the interests of other interested parties (the stakeholders in general), rather than only those of its shareholders, represents a significant development in the theory of the firm, which will be discussed later. However, it is well established that the CEO’s coordinating functions do not stop within the boundaries of his organization. Indeed, they extend beyond the boundaries of the firm as the organization also deals with its suppli-ers, forms alliances with other competitors, and deals with the immedi-ate community as well as the general society in which it exists.

Resource Allocation

As established earlier, because specialization leads to efficiency and one of the objectives of the firm is to be efficient, it makes sense after some point, for example, after having attained a certain size, to organize the firm into departments or specialized units. The economic and structural justification for the so-called functional departments has thus emerged. The four traditional functional departments within the firm are pro-duction, marketing, finance, and accounting. However, the functional departments of any firm in the contemporary business environment depend on the nature of industry in which it exists.

To have a purpose and direction, every good organization creates a mission statement. These mission statements are broken down into aspi-rational statements and measurable goals, some of which are couched in the units of certain departments. For example, a firm can create a measurable goal that states its goal as increasing the organization’s mar-ket share, using marketing terms, or attaining an X percent return on investment (ROI), using finance terms. Or yet still, an organization can express its goal in production terms such as attaining a certain capac-ity utilization rate by a certain date. All these efforts have led to some departments taking more prominence than others as organizations pur-sue strategic planning.

Managing the organization to attain its goals often calls for devising rules to allocate its resources, which are often limited, among its depart-ments. The departments that are prominent often get the lion’s share of the resources. This process, though logical, results in unintended


negative consequences. The various departments start competing with each other for scarce resources. To justify getting more resources, each department starts putting its interest above that of the organization and engages in processes inimical to the objectives of efficient use of resources. For example, in order to justify getting a budget similar or larger than what was allocated to them in the previous year, many departments go on wasteful spending of funds so that no budgeted funds would be left when the current fiscal year comes to its end.

The natural evolution of strategic importance of functional areas and the practice of allocating more resources to departments based on the departments “making a case for it” has led to the so-called silo mental-ity. The more pernicious part of the silo mentality is not so much as the departments working in isolation, but rather “working” indirectly against the attainment of the organizational objective. For example, if the marketing department fails to share all the relevant information that the accounting department needs in order to make a more realistic accounts receivable forecast then the firm as a whole is going to suffer. Similarly, if the marketing department fails to interface well with the finance department in order to derive a competitive pricing strategy for a product and make a realistic cash flow projection that could sup-port the company’s debt position, then entire firm is going to pay the price for the failure of the two departments. Can you think of a similar breakdown as a result of a failure of the marketing department to com-municate with the production department? The result is rather obvious and disastrous—for example, failure to accommodate demand, quality defects, and the like.

So, What Is the Firm?

We will close this chapter with a metaphoric illustration of the firm. One could argue that a firm is a team, pretty much like a soccer team operating in a league—a league of the marketplace. A soccer team is managed by the head coach, the equivalent of the CEO in a firm, and the head coach works with other coaches with a common objective, which is to make the team win. Similarly, the CEO of a firm should work with other managers and department heads to make the firm a success. Every player on a soccer team is skilled at playing a specific position. The goal of a team is to allow (1) each player to play to the best


of his ability, and (2) yet play with other team members so well that the team outwits the opposing team. By executing these two tasks, the team is positioned to win. No individual player out of the 11 wins a game. It is the team that wins.

In much the same way, no department of the firm can be successful individually. It is the firm that can be a success or failure. No one depart-ment can exist by itself when a firm files for bankruptcy. Thus, every department needs to coordinate with each other.

Current Trends

Many contemporary researchers of business strategy who have also examined the nature of the firm have either commented directly on the counterproductiveness of the silo mentality with which many modern corporations operate or have made a case for interfunctional cooperation as a better approach for “maximizing” the present value of the firm. We use the term “maximizing” as opposed to “optimizing” or “satisficing” because it is still the term used in finance journals and textbooks and defended by scholars of finance (Jensen and Meckling, 1976). Similarly, many commentators have argued against pedagogy in business schools that is conducted along the lines of “functional silos” under the guise of discipline-based department curricula. According to Behrman and Levin (1984 cited by Crittenden and Wilson, 2006), problems in the real world of business “do not yield to a single-discipline solution”; they are better attacked by multidisciplinary solutions. Thus, cross-disciplinary teaching is a must in business schools.

Business research during the past four decades is increasingly show-ing cross-disciplinary approach. For example, Anderson (1982) in lucid exposition explains (1) why it is better for all the functional areas of the firm to be involved in setting the goals of the firm, (2) reviews evolution in the development of theory of the firm, and (3) proposes a new theory of the firm that specifies the role of marketing and other functional areas in the “goal setting and strategic planning process.”

Anderson (1982) cited Hayes and Abernathy (1980) to support the proposition that short-term consideration of top management that led to dominance of financial and legal specialists in the management rungs in large US corporations led to the unfortunate “slighting of technologi-cal considerations in product development.” Against this background,


he argues that marketing department must form coalition with other functional areas that involve customer support to ensure the long-term survival of the firm:

For example, the long run investment perspective implicit in the marketing concept can be made more comprehensive if it is couched in the familiar terms of capital budgeting analysis. (p. 24)

Other interdisciplinary studies specifically involving marketing and finance include the works of Koku, Jagpal, and Viswanath (1997), which showed that new-product introduction decisions are both mar-keting and finance decisions as they involve not only cash flow implica-tions, but risk implications for the firm as well. Others such as Lovett and MacDonald (2005) reiterate similar views and show through dynamic modeling techniques that marketing activities do affect stock market measures. They showed through linkages that marketing activi-ties impact the consumption markets, which in turn affect the financial markets, and when these markets work in unison, they lead to long-run superior performance of firms.

Conclusion

The discussions above have not only illustrated the original thoughts that went into formulating the theory of the firm, but they also touched on some of the contemporary extensions to the original thoughts. While several lessons could be learned from this chapter, the arching theme that should come through is that as a network of contracts everyone is responsible for everyone else in the firm. In other words, the firm func-tions best as a true network and not in functional silos; for that reason, interdisciplinary collaboration is a must and not an option.

Knowledge Application Exercise for Chapter 1

Having now completed reading chapter 1, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing case 1, appendix 1, titled “Jack Gordon, CPA.”


References

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Behrman, J. N., and Levin, R. I. (1984). “Are Business Schools Doing Their Job?” Harvard Business Review 62 (January/February): 140–147.

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Coase, R. (1937). “The Nature of the Firm,” Economica 4 (16): 386–405.Crittenden, V. L., and Wilson, E. J. (2006). “An Exploratory Study of Cross-

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Jensen, M. C., and Meckling, W. H. (1976). “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics 3 (October): 305–360.

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CHAPTER 2

The Customer Lifetime Value

How much is a customer worth to my firm, and is the cus-tomer worth retaining? Calculating as these may sound, they are issues that today’s managers often have to wrestle with.

Common as the questions are, the answers are not simple, and the fact that such questions are now the norm suggests the following:

1. There are costs associated with getting and retaining a customer.2. Not every customer is desirable.3. There is a connection between having a customer and profits.

Commenting on the importance of customer loyalty, Reichheld states, “Experience has shown us that disloyalty at current rates stunts corporate performance by 25 to 50 percent, sometimes more. By contrast, busi-nesses that concentrate on finding and keeping good customers, produc-tive employees, and supportive investors continue to generate superior results. Loyalty is by no means dead. It remains one of the great engines of business success” (1996, p. 1).

It is not difficult to see the connection between customers and a com-pany’s profit; however, the connection between customers and cost to the company requires a little more probing. This chapter is therefore divided into three sections. The first two sections deal with how the company cultivates or wins over customers, the strategies used, and the associated costs. The third section deals with computations involving the customer lifetime value (CLV).



To get and retain a customer, many firms use a combination of ele-ments of the marketing mix (product, place, promotion, and price) and the communication mix (personal communication, advertising, sales promotion, publicity/public relations, instructional materials, and cor-porate design). It is clear from the list of elements (variables) that the marketing and communication mix are not mutually exclusive. Some elements, or variables as they are also called, are common to both the marketing and the communication mix. Below are some explanations on how these variables are used.

Marketing Mix Elements

Product

Many companies put significant efforts into designing their products/services so that they can appeal to the intended target market. The auto-mobile companies are well known for designing vehicles to appeal to certain demographic segments. However, automobile companies are not alone in trying to appeal to consumers through product design. Have you ever wondered why the shape of the Yoplait yogurt is unique? In addition to product design, many companies use free product samples to encourage consumers to try a new product. Samples are often smaller packages or versions of the actual product. In using samples, manu-facturers realize that many consumers suffer from inertia, which is the reluctance to change or try something new. With free product samples, companies try to nudge the consumer to, at no out-of-pocket cost, try the new offering.

Place

While the use of the “place variable” in getting the consumer to try the offering (product/service) is not always visible, it is nonetheless used. The objective is to make the initial offering (a sample or whatever) easily available to the consumer. Again, in designing its marketing strategy, the company realizes that not only are customers likely to suffer from inertia when it comes to trying new offerings, but they are also not likely to go out of their way to look for new offerings. Faced with this problem, the company tries to make the initial offering easily accessible to the potential target market. This is done through mailing the sample to the targets’ homes, freestanding-trial aisle displays, and the like.

The Customer Lifetime Value l 21

Promotion

Massive advertisements that stress the uniqueness of the new offering and attractive package designs and labeling are used to promote the offer-ing at the initial stage to “entice” consumers to try the new offering.

Price

Oftentimes companies subsidize consumers’ purchase price at the initial stages of product adoption. This is done by selling at a significant dis-count. The psychology of heavy price discounts at the initial stage is to try to overcome consumers’ unwillingness to purchase a product they might not like. However, with a heavily discounted price, customers feel that they would not lose a lot of money if the offering turns out to be something they do not like.

In addition to heavily subsidized prices, it is not uncommon, for example, in the services industry for the initial service fee to be waived to entice current or new consumers to try a new offering. Such exam-ples abound in the physical fitness industry where gym memberships are waived during the first month for new members. Similarly, it is not uncommon for credit card companies or financial institutions to waive the first year’s membership fee for new members in an effort to entice them with a new credit card.

The Communication Mix

Personal Communication

Personal communication as distinguished from impersonal communica-tion has been defined as “messages that move in both directions between two parties” (Lovelock and Wright, 2002, p. 199). As you may have already guessed, impersonal communication moves in only one direc-tion. Generally, it is from the company and directed to a large group of customers or potential customers. They can be identified by the “generic” tone, particularly in the salutation. They often begin this way—“Dear Customer,” “Account holder,” or “Sent from: XYZ, To: UVW.” Personal communication, in contrast, actually tries to address the specific needs of the recipient and the salutation is often individual specific. For example, they can begin as “Dear David” if David is the name of the customer or potential customer.


Clearly, it is cheaper for a company to use impersonal communication as a means to reach its customers or potential customers. However, tech-nology and availability of large databases have now made it inexpensive for firms to try to create the appearance of using personal communica-tion to reach their current and potential customers. The major issue now is for the firm to undertake a rigorous cost-benefit analysis in order to decide which approach to use.

Advertising

Advertising has been defined variedly by different people. Kotler and Keller (2009) define it as “any paid form of non-personal, presenta-tion and promotion of ideas, goods or services by an identified spon-sor” (p. 472). However, Mooradian, Matzler, and Ring (2012) suggest that “advertising entails communicating messages via paid-for, imper-sonal media (television, radio, newspaper, etc.) in which the sponsor is identified or known” (p. 300), while Ghewal and Levy (2006) define advertising as “a paid form of communicating from an identifiable source, delivered through a communication channel and designed to persuade the receiver to take some action, now or in the future” (p. 470).

It is evident from all the various definitions that advertising is a form of communication directed at an audience. Ghewal and Levy’s defini-tion goes a little beyond the other two definitions and tells us what we all know too well about advertising, that is, it is intended to get the tar-get consumers to take some action now or in the future. Several actions could be required from existing consumers. For example, they could be encouraged to consume more, refer others to try the product/service, or they themselves could avail its upgraded version. To potential consum-ers, the primary message is to overcome the inertia and try the product/service.

Sales Promotion

This is a short-term activity or incentive that is geared at stimulating pur-chase of the product/service. The objective of sales promotion is to get the current or potential customers to accelerate their purchase decisions. Thus, sales promotions are undertaken for only a specified, and generally


limited, time. They involve the use of samples, coupons, competitive events, and door prizes. It is evident from the discussions that sales pro-motions involve definite costs on the part of companies.

Publicity/Public Relations

These involve efforts designed to create positive image or favorable press/media coverage for the company. They are usually undertaken by a third party on behalf of the company and involve activities such as club spon-sorships, special events, adoption of highways, and visual displays of the company’s logo, symbol(s), or colors.

Instructional Materials

Though not necessarily used to win new customers, instructional mate-rials teach customers how to use new equipment and give information on new offerings.

Corporate Design

As a part of the communication mix, corporate design includes colors that are associated with the company, lettering, symbols, and logos. These are used to distinguish the company from competitors and to cre-ate a connection with the current and potential consumers.

CLV

CLV computations are actually the present-value calculations that are made based on projections of a customer’s lifetime expenditure. The pro-jected expenditure is treated as a stream of future cash flows from the customer, and therefore it becomes a lump sum in today’s dollar value. In simple mathematical terms, if i is the ith customer, t is the t th time, r is the discount rate, and n is the forecasting horizon, that is, the length of time that the customer remains with the company, the equation can be formulated as follows:

CLVi tt

n

r=

+=∑ ( )

( )Future gross profits Future costsit it-

11

The CLV gives managers a sense of how much a customer is worth to them in terms of dollars, and is thus helpful in the decisions on whether to undertake a certain level of expenditure to entice a potential customer


or how much the firm should be willing to spend to keep an existing customer.

While such calculations were not exactly welcomed in the past, they have now become a common tool in the tool kits of the practitioners as well as a common topic of research for academics. Several reasons have contributed to this change. First, accounting practices have undergone significant changes partly due to integration of technology that now allows them to do things quickly with spreadsheet calculations. Second, the use of spreadsheets has made it easier for managers to see a truer picture of a customer’s value to the firm. Furthermore, some scholars posit that relatively newer practices such as activity-based accounting also allow managers to evaluate the true value of a customer’s relation (Berger et al., 2006).

There are three important components to the CLV formulation accord-ing to many who have studied the CLV (Kerin and Peterson, 2013). The first step is to derive the per-period cash margin of the customer, which we will call here $X (X dollars). The per-period cash margin is the antici-pated revenue (purchases) from the customer, less all the expenses asso-ciated with the sale (discussed above, e.g., promotions, discounts, etc.) during a period. A period is a nonspecific term that could be specified by the manager. It could be a month, a quarter, or even a year. The next term is the retention rate; we shall call this term r, which captures the likelihood of retaining the customer. The third term, i, is the interest rate to be used in discounting the future stream of income. With these definitions CLV is algebraically specified as follows:

CLV X=+ −

$1

1 i r (2)

Equation 2 is a simplification of a slightly more complex formulation. It has been shown by Gupta and Lehmann (2003) that the more complex formulation reduces to equation 1 when the margin and retention rates are constant over time with an infinite time horizon.

Given equation 1 as it is, what does it mean in terms of numbers? Consider a popular mass merchandiser whose annual margin on a cus-tomer is $3,000.00. Note that we have chosen an annual margin to make the computations simple and straightforward. We could have very well chosen a monthly or quarterly margin, which we would need to


annualize, however, having chosen an annual margin at the outset we do not need to annualize the margin again. Let r, the retention rate, be 75% while, i, the interest rate, is 10%. Applying the formula with these values for the variables, we can compute the CLV as:

CLV 3000=+ −

$. .1

1 0 10 0 75

Sophisticated firms measure the rate of growth in the customer’s margin and can use that to estimate the customer’s CLV.

CLV = $3000 × 2.857

= $8,571.40

Can you think of how a firm could improve its CLV? A close exami-nation of the formula suggests a number of possibilities. What about increasing the margin? This could be done through a number of ways:

1. It can be done by decreasing costs associated with enticing or retaining the customer.

2. It can be done by holding down the cost of retaining or enticing the customer while the customer is encouraged to increase his/her spending.

3. It can also be done by increasing r. An argument can be made that the CLV can be increased by changing i also, but we must note that i is not within the control of the firm, hence in terms of strategic decisions, the company will take i as given.

4. A simultaneous increase in the margin and retention rate would also increase the CLV to the firm.

It is important to note that other factors such as competitive activity and the industry structure directly affect a firm’s margin. A consequence of monopolistic competition in an industry, that is, an industry in which there are many sellers and buyers and all the sellers sell the same things that are slightly different, all other things being equal, is a lower price level that will naturally affect a firm’s margin. Take for instance gas stations; because there are many gas stations as well as buyers in many towns, the margin on a gallon of gas is small. The opposite is theoretically true for


a monopoly except for the fact that they are generally regulated by the government, the utility companies being an example. Having duly noted what has just been discussed let us examine the effect of a change in the margin on the CLV as below.

If $X increases from $3,000.00 to $4,000.00 per year, then CLV becomes

CLV =+ −

$. .

40001

1 0 10 0 75

= $4000 × 2.857= $11,428.00 (an increase of about 33%)

What if the margin remains the same but the retention rate is improved, and therefore rises from 75% to 85%? In this case, the new CLV becomes,

=+ −

$. .

30001

1 0 10 0 85

= $3000 × 4= $12,000.00

Thus, it can be seen that by increasing the retention rate by approxi-mately 10%, that is, from 75% to 85%, the CLV increases by 40%. This suggests that increasing the retention rate is preferable to increasing the customer’s margin as far as enhancing the CLV is concerned.

Sophisticated firms measure the rate of growth in the customer’s mar-gin and can use that to estimate the customer’s CLV. Here let us assume that margin rate increases at a constant rate of j per year. In this case,

CLV X=+ − −

$

11 i r j

If we take j to be 5% per year with the variable values of r as 75% and i as 10%, as in the first case above, then

CLV 3000.10

=+ − −

$. .

11 0 0 75 0 05

= $3000 × 3.333= $10,000.00


As evidenced by this computation, a 5% constant annual growth rate in the firm’s margin rate leads to an increase of 16.66% or $1,428.60 in a CLV—a change from $8571.40 to $10,000.00.

In addition to the contributions from the accounting profession, for the past two decades the CLV has attracted the attention of aca-demics who have, through their research, shed more light on how the model works and how it could be enhanced. For example, it has helped to connect the dots between CLV and customer relationship marketing.

Relationship marketing has been variedly defined by several researchers. Kotler and Keller instead of providing a direct definition chose to describe it in terms of its objectives: “It aims to build mutu-ally satisfying long-term relationship with key constituents in order to earn and retain their business.” Baran, Galka, and Strunk (2008) also described it as “a focus on the relationship between the firm and its customers based on cooperation and collaboration. The ongoing process of engaging in cooperative and collaborative activities and pro-grams with immediate and end-user customers to create or enhance mutual economic value at a reduced cost” (p. 499), while Ryals and Knox (2005), citing Berry (1983), said it is “attracting, maintaining, and enhancing customer relationship.” We can conclude from these definitions that relationship marketing extols the virtues of a continu-ing mutually beneficial relationship in which the needs of both par-ties, the customer and seller, are satisfied. Ryals and Knox tied the CLV concept to relationship marketing and cited previous studies such as Reichheld and Sasser (1990) and Reichheld (1996), which showed, from the businesses they studied, that a 5% improvement in customer retention from 85% to 90% could lead to a significant improvement, from 35% to 95%, in the net present value.

We must, however, note that studies such as Carrol (1991) have criti-cized the CLV estimations of Reichheld and Sasser (1990) on method-ological grounds; nonetheless, the fact that improvement in customer retention rates leads to improvement in a firm’s profitability is not in dispute even by Carrol. However, notwithstanding the evidence from studies and the fact that even many practitioners seem to accept the customer relationship concept, Riyals and Knox cite studies such as Christopher, Payne, and Ballantyne (2003) that have shown that 80% of the 200 firms studied in the United Kingdom still overinvest in


customer acquisition and only 10% of the firms studied overinvest in customer retention.

Ryals and Knox (2005) argue that while single-period value cus-tomer profitability or forecasted CLV computations are commonly used attempts to capture the value of a customer and to give a dashboard view to the firm, they may not be the most appropriate metric for measur-ing the value of customer relationships or for managing the relation-ship marketing. They tend to overestimate the customers’ value to the firm because the values derived are not adjusted for the risks inherent in developing the relationships. The authors argued further that if the objective of the CLV is to measure marketing’s contribution to share-holder value, then the CLV should be measured for value instead of profit. This means that the CLV should be risk-adjusted; otherwise an activity such as investment in customer relationship could appear to be profitable, while it in fact provides minimal or even negative returns to shareholders.

How might this problem be solved? Ryals and Knox (2005) suggest that the problem could be solved through proper assessment of customer risk that takes into consideration risks in generating revenue streams, particularly from customers in whom the firm has made significant investments. The researchers call the combination of CLV with future customer risk the economic value (EV) and empirically show that it is a better metric of customers’ value to shareholders.

Reporting the outcome of the “Thought Leadership Conference” on CLV, which consisted of both academics and practitioners, Gupta and his coauthors listed three reasons why an increasing number of corpo-rations are adopting the CLV (Gupta et al., 2006). The authors made a number of arguments. First, they posit that the increasing pressure on marketing departments to show returns on marketing investments has caused many of them to look beyond the traditional metrics of brand awareness, attitudes, sales volume, and market share. Second, financial metrics, such as the stock price, are of limited use in holding marketing accountable because they reflect aggregated data and do not show customers that are not profitable, which a company should get rid of. Third, they argue that improvements in information technology have made large data collection on customers and subsequent analyses easier.


The authors further discussed the link between customer equity (CE), that is, the CLV of the current and future customers and its linkage to the stock price and then dwelt on the different mathematical models for com-puting the CLV and their associated econometric problems. They noted that the literature on customer relationship management (CRM) takes the firm’s perspective in modeling CLV and therefore uses terms such as “customer acquisition,” “retention,” and “expansion.” The literature on choice modeling, however, takes customers’ perspective and therefore uses terms such as “when,” “what,” and “where” the product can be purchased and “for how much.” It is clear that the two approaches come from differ-ent ends of the transaction spectrum; nonetheless, there are overlaps.

Berger et al. (2006), for example, proposed, what they termed, the “chain of framework” in which the CLV serves as a link, among other things, between the firm’s actions and shareholders’ value. In enhancing the CLV, they introduced the notion of “prescient” value of the CLV, which they called CLV-P.

The authors argue that a firm’s customer behavior includes other things such as customer acquisition, retention or defection, and devel-opment and their associated costs. Furthermore, they assert that like products, customers also go through a sequential product-life-cycle type of life stages with a firm. Even though not every customer necessarily goes through every stage, they begin from the acquisition stage through retention, and then go through either development or defection. The authors explained that customer behavior is guided by the customer’s mind-set toward a firm’s offerings (products/services) as well as those of its competitors and channels, and that the customer’s mind-set plays a role in how they perceive a product’s value and therefore in how brand equity is developed.

What might be the other components of a customer’s mind-set? According to Berger et al. (2006), other components of the mind-set are (i) awareness, (ii) association, (iii) attitude, (iv) attachment, and (v) advo-cacy. The authors explained awareness as the extent to which custom-ers can recall or recognize a firm’s offerings, association as the strength of benefits and “positives” attributed to the firm’s offerings, attitude as overall evaluation of the firm’s quality, attachment as the extent of the customer’s loyalty, and advocacy as the likelihood of the customer rec-ommending the offering to others.


Berger et al. (2006) have made several important points to improve the value of CLV as used and have provided the theoretical framework for doing so. First, they observed that even though an aggregate CLV is sufficient to estimate the link between the CLV and shareholders’ value, for strategic purposes, it is important to calculate the CLV on an individual basis. Second, to link the CLV to the sharehold-ers’ value, a 3-step process that uses “recency, frequency and mon-etary value data and various profits and cost measures” must be used. Third, the CLV must be related to marketing programs and strate-gies. In doing this, it is essential that the CLV is forward looking. What does a forward-looking CLV mean, and how is it estimated? According to Berger and his colleagues, a CLV could be estimated in the following two ways: (1) through the traditional maximization of expected CLV means, and (2) through the risk-adjusted measure. The latter requires an incorporation of “real options” valuation methods often used in finance and require probabilistic distributions of val-ues implied in marketing programs such as the benefits that would accrue to the firm in the future if it changes its business model or abandons unprofitable customers.

Tying everything together, the forward-looking CLV discussed above is referred to by the authors as CLV-P or the prescient value. The CLV-P is the highest value a firm is able to receive from a cus-tomer or a “complete real option value.” While the concept of the CLV-P sounds good in theory, it is not without econometric problems in practice; thus, the authors suggest some methods in overcoming these problems.

In a real-world example of how firms use CLV, Kumar and his col-leagues reported on how IBM used CLV to determine the level of mar-keting efforts to allocate to an account, given its CLV. The marketing contacts that were available to be used for each customer consisted of direct mail, telesales, email, and catalogs (Kumar et al., 2008). The study involved 35,000 accounts on which IBM implemented the CLV-driven resource allocation instead of allocating marketing resources based on past spending history. Fourteen percent of the accounts saw a reallocation in their marketing contacts with the implementation of CLV-driven allocation. This effort resulted in an increase in revenue of approximately $20 million (a tenfold increase) without any changes in the level of marketing investment. The increase in revenue realized


by IBM by changing the allocation of marketing resources alone is a clear evidence that CLV could be a useful tool in improving corporate profit, but like everything else in marketing and management, if used properly.

The phenomenal success enjoyed by IBM in using CLV to allocate marketing resources suggests that firms segment and profile their customers. Customers are segmented on factors such as CLV and size of wallet, and business customers on market share and firmograph-ics, which includes employee size, revenue size, industry, number of customers, and the like. IBM’s success also suggests that firms understand customer migration, that is, how customers move from higher to lower segments over time or vice versa in order to enhance retention.

Kumar and Rajan summarized the claims attributed to CLV in the following statements: “Loyal customers cost less to serve, pay more than other customers, and attract more customers through word of mouth” (2009, p. 1), and went on to argue that loyal customers are aware of how valuable they are to firms and therefore demand to be treated differently. Among their demands are lower prices and premium treatment. If this is the case, then why do firms pursue loyal customers, the researchers asked? The answer clearly lies in the fact that loyalty equals profitability according to Kumar and Rajan. However, as discussed earlier, focusing on profitability and CLV could be misleading; instead, focus should be on CLV and shareholder’s value.

As evidenced in the discussions in this chapter, there are, or should be, strong ties between marketing and finance to create shareholders’ value. Silo mentality, which fosters an independent operation of the two departments with little or no collaboration, at the minimum, hurts the value of the shareholders. It also hurts the very customers for whom the firm exists.

Conclusion

The CLV has become an important metric not only in marketing, but also for the entire business in light of customer relationship management. Even though CLV is heavily used by marketing folk, it is important that it be embraced by the entire organization. Marketing and finance folk are the most obvious users of the metric, but a reflection on what it


represents will suggest that its usefulness to the firm will be enhanced if every department contributes to it.


Having now completed reading chapter 2, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing case 2, appendix 1, titled “The Peoples Bank.”

References

Baran, R. Galka, R. J., and Strunk, D. P. (2008). The Principles of Customer Relationship Management. Mason, OH: Thomson-Southwestern.

Berger, P. D., Eechambadi, N., George, M., Lehman, D. R., Ross, R., and Venkatesan, R. (2006). “From Customer Lifetime Value to Shareholder Value: Theory, Empirical Evidence, and Issues for Future Research,” Journal of Service Research 9 (2): 156–167.

Berry, L. L. (1983). “Relationship Marketing,” in Berry, L., Shostack, G. L., and Upah, G. D. (eds.), Emerging Perspectives of Services Marketing. Chicago, IL: American Marketing Association, 25–28.

Carrol, P. (1991). “The Fallacy of Customer Retention,” Journal of Retail Banking 13 (4): 15–20.

Christopher, M., Payne, A., and Ballantyne, D. (2003). Relationship Marketing: Creating Stakeholder Value. Oxford, UK: Butterworth-Heinemman.

Ghewal, D., and Levy, M. (2006). Marketing, 2nd ed. Boston, MA: McGraw-Hill; Irwin.

Gupta, S., Hanssens, D., Hardie, B., Kahn, W., Kumar, V., Lin, N., Ravishanker, N., and Sriram, S. (2006). “Modeling Customer Lifetime Value,” Journal of Service Research 2 (2): 139–155.

Gupta, S., and Lehmann, D. R. (2003). “Customers as Assets,” Journal of Interactive Marketing 17 (10): 9–24.

Kerin, R. A., and Peterson, R. A. (2013). Strategic Marketing Problems. Upper Saddle River, NJ: Pearson; Prentice Hall.

Kotler, P., and Keller, K. L. (2009). Marketing Management, 13th ed. Upper Saddle River, NJ: Pearson; Prentice Hall.

Kumar, V., and Rajan, B. (2009). “Profitable Customer Management: Measuring and Maximizing Customer Lifetime Value,” Management Accounting Quarterly 10 (3): 1–18.


Kumar, V., Venkatesan, R., Bohling, T., and Beckmann, D. (2008). “The Power of CLV: Managing Customer Lifetime Value at IBM,” Management Science 27 (4): 585–599.

Lovelock, C., and Wright, L. (2002). Principles of Service Marketing Management, 2nd ed. Upper Saddle River, NJ: Prentice Hall.

Mooradian, T. A., Matzler, K., and Ring, L. J. (2012). Strategic Marketing. Upper Saddle River, NJ: Pearson; Prentice Hall.

Reichheld, F. (1996). The Loyalty Effect. Boston, MA: Harvard Business School Press.

Reichheld, F., and Sasser, W. E. Jr. (1990). “Zero Defections: Quality Comes to Service,” Harvard Business Review 68 (5): 105–111.

Ryals, L. J, and Knox, S. (2005). “Measuring Risk-Adjusted Customer Value and Its Impact on Relationship Marketing Strategies and Shareholder Value,” European Journal of Marketing 39 (5/6): 456–472.

CHAPTER 3

Strategic Marketing Plan

What is a firm’s strategic plan and what informs it? Several books have been written on how important strategic plans are to firms. Some of them even take their readers through

a step-by-step process on how to formulate and write a strategic plan, however, very few, if any, explicitly link strategic plans to shareholders’ value. Many seem to focus on resources and competition instead of the customer. Consistent with the theme of this book, in this chapter, we will work to establish linkages between the shareholders’ value, the fun-damental finances of the firm, and a strategic plan that focuses on the customer. The logic in focusing on the customer, even though obvious, seems to have eluded many firms; the truth is that without the customer there will be no company, but with the appropriate tools and the right customers, not only will there be a company but, in fact, there will be a successful company.

Because our discussion of strategic planning is customer centric, it is apparent that strategic plans are useful to both for-profit and not-for-profit organizations. It should therefore not be an unusual occurrence to hear not-for-profit entities such as state universities, public hospitals, public libraries, and museums also talk about strategic plans. Why not, one might ask? Well, they also exist because of their customers without whom they would have no justification for remaining in business. Thus, they too need a strategic marketing plan.

The strategic marketing plan should not become an issue to be dis-cussed or considered only when the organization is beset with a problem.



Formulating a strategic marketing plan must be a proactive process that is intended to accord the organization a sustainable competitive advan-tage; that is, it must offer the organization an advantage that cannot be easily copied or taken away by competitors. So how should it begin? First, it must be noted that we are not talking of strategic plans in general here, but rather about a strategic marketing plan. What is the difference one may ask? Michael Porter has this to say about strategy: “Essentially developing a competitive strategy is developing a broad formula for how a business is going to compete, what its goals should be, and what poli-cies will be needed to carry out those goals” (1980, pp. xvi). Drucker (1973), in contrast, says that strategic planning is “the continuous process of making present entrepreneurial (risk-taking) decisions systematically and with the greatest knowledge of their futurity; organizing system-atically the efforts needed to carry out these decisions; and measuring the results of these decisions against the expectations through organized, systematic feedback” (p. 125).

To strategize well, one has to use the things within one’s control in order to overcome things outside one’s control. The things outside one’s control include but are not limited to the behavior of competi-tion, cultural and demographic trends, economic conditions, and the like. In marketing strategy, one uses the marketing tools and resources that one has within his/her control. What might these tools/resources be? Typically, the 4Ps—product, place, promotion, and price—are the things that marketers have under their control and therefore can use to formulate their strategy; thus, the strategic marketing plan we discuss here will draw heavily on the 4Ps.

Because we emphasize the customer as the focus of the plan as well as all the firm’s activities, we adopt the metaphor of the four-legged stool as depicted in figure 3.1 to illustrate our points. The figure diagrammati-cally summarizes the discussions and arguments made in this chapter. It shows that the customer must be the focus of the 4Ps. In other words, the 4Ps must be made to answer the following questions: What does the customer want? What price(s) can the customer afford? Where and how does the customer buy? And, where does the customer get information on things that s/he buys?

In addition to the customer being the focus of the plan, the figure shows the interrelationship between all the 4Ps. This interrelationship displays a holistic approach to satisfying the consumer’s needs. All the

Strategic Marketing Plan l 37

questions posed above on the customer and the 4Ps should not be divided and assigned to individual departments; rather, they should be tackled together by representatives from all the functional areas. This approach eliminates the tendency of each functional area to solve only a part of the customer’s problem through the lenses of that department. For example, the finance department could be fixated on the price that could earn the firm’s ROI without much consideration of the quality of the product, or whether the target market could afford such a price. The team approach, however, allows each department to see things through the lenses that they might not traditionally use.

Even though we will develop our strategic marketing plan using the 4Ps, we take the view that a good strategic plan must begin and end with the customer. As such, marketing orientation of the firm should not be the job of the marketing department alone. It requires that every depart-ment in the firm be asked to view its functions through the lenses of the customer. This perspective will change the way many firms traditionally do business. To reorient focus to the customer with the strategic market-ing plan, it may be worthwhile to start the process with a question such as the following: Whose problems do we (as a company) want to solve? In other words, who are our customers, and which of their many needs do we want to satisfy? Better still, perhaps the question should be which needs are we capable of satisfying, instead of which needs do we want

Customer

PriceProduct

Place

Promotion

Figure 3.1 The customer-centered four-legged stool.


to satisfy? Framing the question in terms of capability introduces the awareness of competitors from the outset of the planning process. We will spend the rest of the chapter discussing each of the 4Ps and how they require all the functional areas of the firm to work together. However, because subsequent chapters, such as chapter 9, focus on pricing, we will only highlight the role of price in the interdepartmental planning process here.

4Ps

The Product

We used the term “product” here in order to be consistent with the 4Ps, but because what is being offered can be a service as well a product, per-haps the most appropriate term to use here is an “offering”; nonetheless, we vacillate between the two. So, how do we determine what to offer? Because what we offer is a solution to the consumer’s unmet needs, the best place to find an answer to the question is the consumer. This is one of the instances where the firm must employ “marketing research.” Because the answer does not lie within the organization, but rather out-side the organization with consumers, focus-group studies and surveys must be conducted. The firm does not need to conduct surveys in order to determine the appropriateness of every step it needs to take. It will be a waste of time and resources for the firm if that were to be the case even for routine decisions. However, finding out what to make is far from being routine. It is actually why the firm is in business, and hence studies must be conducted to find the right answer.

The business world is replete with several examples of firms that went into business not to satisfy an unmet need of the consumer, but to offer things (products and/or services) that the firm can and wants to make. Needless to say that such examples are not of success stories, but are of those who failed; Ford Edsel is one such legendary failure. The focus-group studies and surveys should be done in earnest and for the right reasons—out of a genuine search for the customers’ unmet problems and not a disguised effort to give “blessings” to a manager’s desires to make a new introduction. This means that the data collected from such efforts must be properly analyzed and prepared in a manner that lends itself to interpretation by decision makers who may not necessarily be quantita-tively inclined.


It is time for the firm to engage in a serious self-examination, once the customers’ unmet needs have been correctly determined. Which of the problems can we solve, what do we do best, and what can we do? These questions lead the firm to what most strategy texts refer to as the SWOT analysis—strength, weaknesses, opportunities, and threats. We must, for now, focus on the SW part of the SWOT, that is, the strengths and weaknesses. To answer the questions posed properly, the firm must enumerate its strengths and weaknesses. Does the firm’s strength lie in innovations? Does it have a large research and development (R & D) budget? Scaffolding the questions and answers can help in being system-atic and exhaustive in discussing the things that count. The outcome of this process could make clear that the firm might not have what it takes to maintain a competitive position as an innovator. Recent troubles of the company Research in Motion, which was lauded only a few years ago for its blackberry mobile phones, make these points clear.

It is far better for a firm to be a follower than to be an innovator, if it does not have the resources to support innovation on a sustained basis. To try to be an innovator without the resources to sustain that posi-tion simply makes the firm do all the hard work in charting a course in the uncharted world for his competitors to overtake and outrace him. A closer examination of the firm’s strengths will determine the consumers’ problems that the firm may choose to solve. For example, let’s assume that the consumers’ problem is a transportation problem. The consumers want to be able to get from point A to point B. How can the firm solve this problem? It will be unwise for the firm to immediately start thinking of making a car. A logical approach for the company is to examine its strengths in order to determine how it can best solve this transportation problem. This must be done with the awareness that in a free market it is more than likely that other firms may also be seeking solutions for the consumers’ transportation problem. This makes finding the correct answer to the question, what we do best, a matter of utmost importance to the firm’s success.

It may well be that the firm’s strength lies in making motorbikes instead of automobiles. If the firm, however, wants to make automobiles instead of motorbikes, then the next logical question is whether the firm can easily acquire the resources and expertise to make automobiles. If the answer is in the negative, then it might be a fool’s errand for the firm to embark on making automobiles at this time in its attempt to solve the


consumers’ current problems. However, the firm can think of a strategic reorientation that may allow it to acquire resources and expertise to make automobiles in the future. For now, to solve the consumers’ problems it must think of how best to use its strengths in making motorbikes.

Which segments of consumers can the firm serve well with its motor-bikes? Demographic factors assume importance here. They help the firm not only choose the appropriate consumer segments, but also the types of bikes to offer each segment. However, determination of the bike styles to target for each segment the firm may wish to serve might again require focus-group studies and surveys. It is easy to fumble the ball when the firm believes it knows what consumers want without asking them. While several factors contributed to the failure of Air Atlanta, which offered only first-class seats in the 1980s, one of the possible strategic failures is the fact that not every passenger wanted a first-class seat—recall that every seat on Atlanta was a first-class seat and meals were served with white linen, white china, and silverware.

A team approach between finance, marketing, and production folk is called for once the target market has been determined. Issues such as quality, style, and price that the target market would be willing to pay for the product are best solved by a team. Similarly, issues of whether the target market is large enough to generate a sufficient volume, break-even volume, the cost of capital to make the product, and payback analysis is best solved through the team approach. Besides bringing together diverse viewpoints, the approach allows every department to “buy into” the new project. Leaving these issues in the hands of one department would be a mistake since it would exclude the critical views of the “left out” depart-ments that could have had a bearing on the analysis. Similarly, it would be a mistake to compartmentalize the issues and have them handled by different departments.

The Price

The price at which the firm sells a product, or the motorbikes in our example, is as important as the motorbikes that are being sold. Because pricing is an essential factor for a firm’s success, it would be discussed in detail in chapter 9; however, we can say that it is important for the price to be consistent with the quality of the product. Furthermore, it is important that the price be such that the product/service can be afforded


by the target market. That is, while it is important that the price of the product be such that it covers the cost of making the product as well as some profit for the firm, it would defeat the purpose if the product were sold at a price beyond the reach of the target market. Doing so would be an open invitation for competition, which will try to underprice the firm’s product.

A team approach should not be limited to making the product/service but should be extended to pricing as well. The four questions that could call on the expertise from the different functional areas are as follows:

1. What is the product’s quality?2. How much did it cost to make?3. How much margin or profit do we require on it?4. Can the target market afford it?

No department is better equipped than the production department to answer the first and second questions. The finance department is better equipped to handle the second and third questions, most definitely the third, while the marketing department can handle the fourth.

Answer to the question for how much profit the product should be sold (i.e., pricing of the product) is often within the control of the product/service producer; however, there are instances in which price is controlled by external forces such as the government, even in a free market. The government may control prices through laws, and may do so only selectively in a free market in situations where there are only a few providers of the product/service. An example is the case of utilities that economists refer to as quasi monopoly. The government sets a limit to prices in certain other sectors also as a matter of policy, for example, rent control in certain areas of New York City.

The Place

The place or places where the product/service is offered for sale is another important factor that must be carefully examined by the firm. “Place” is actually a broader issue that encompasses distribution, which cannot be determined in isolation. Where are our customers, and how best can we reach them? These are the questions that the firm must seek answers to. The answer could either suggest that the firm consider several countries as


its market or, indicate that the firm’s customers reside in one geographic location. These answers as well as the firm’s ability will determine if the firm engages middlemen referred to in the literature as intermediaries in order to reach its target.

To effectively cover its market or reach the consumers, several options are available to the firm in the contemporary world of business. The firm can choose to completely delegate the movement of its goods/services from its factory to the final consumer to intermediaries. Who are these intermediaries? The intermediaries come between the firm and the final consumer and play an important role in the distribution channel. They are generally the wholesalers, the brokers, agents, and the retailers.

All the intermediaries, in their own ways, play useful economic service roles and do not exist simply to add to the distribution cost. To the extent that distribution costs are added to the prices at which consumers buy goods, producers would be reluctant to use the services of an intermedi-ary who does not add any economic value to the good but only increases price. This could make the product sell at an unjustifiably higher price and would make the firm vulnerable to competition that could sell at a lower price.

The differences in the intermediaries come from the roles they play. For example, the wholesaler buys the products from the manufacturers and sometimes repackages them to suit the needs of the retailers. Thus, some wholesalers further the production process through repackaging. Because they buy, and therefore own the goods they handle, they are described as carrying the title to the goods as opposed to brokers who do not own what they handle and therefore do not have title to the goods they handle. So who are brokers? Brokers can be called match-makers. They facilitate consumption by bringing sellers and buyers together.

Recall the local real-estate broker? S/he does not own the house that s/he sells, but simply facilitates the buying/selling process by bringing the buyer and seller together. Not too long ago, before the prolifera-tion of self-executing stock trading platforms, stockbrokers played an important role in stock trading (buying and selling of stocks), and their role was similar to that of the real-estate agent, that is, facilitating trade by bringing together those who owned certain stocks and wanted to sell and those who wanted to buy those stocks. For their facilitating


roles, brokers are generally paid a percentage of the selling price (i.e., by commission).

Agents also operate on commission basis, but unlike brokers who are neutral, represent one side of the transactional equation. That is, an agent could represent a seller in which case s/he is the seller’s agent, or a manufacturer in which case s/he is the manufacturer’s agent.

The retailers are the last link between the producer and the con-sumer. Sometimes a wide network of retailers is important to effectively cover the target market, but that is not always the case. Generally, the number of retailers used by the producer is contingent upon the image the producer wishes to cultivate. A producer who wants to cultivate the image of exclusivity and makes an exclusive product for a select group of consumers will select only a handful of retailers in a geographic location. Of course, this approach must be consistent with the other marketing mixes, and clearly, might not be suitable for a motorbike example.

A producer who, in contrast, does not have an exceptionally unique offering and therefore wants to flood the market with her/his offer-ings would wish to sell through as many retailers as s/he could possibly recruit, instead of being exclusive. Some producers may choose middle-of-the-road approach to distribute their offerings. They are not exclusive and yet they do not want products to be carried by any and every avail-able retailer. Such an approach might dilute their brand image. So, they selectively choose the retailers through whom they wish to sell. Tommy Hilfiger and Polo are brands that can be found in department stores, but not in other mass merchandisers such as Walmart or Kmart. This suggests that producers of these brands might be selectively choosing the retailers through whom they wish to sell.

The firm must also make a decision on whether it should try to sell directly to the consumer, that is, bypassing the intermediaries while simultaneously using them. This distribution approach is known as dual distribution strategy (dual is actually from duo meaning two in Latin). The diagram (figure 3.2) illustrates this approach.

The producer could also use more than two means simultaneously to reach consumers. In fact, the producer could also try to reach the consumer through the traditional intermediaries, through telephones, websites, catalogs, text messages, and emails. This approach is referred to as multichannel distribution approach (Rangaswamy and Van Bruggen,


2005). It is true the different channels compete with each other when a firm uses more than one means to reach the customer; therefore, a careful analysis ought to be done to see if using the different channels is worth it.

Even though distribution decisions are generally made within the marketing department, we recommend a team approach that involves all the functional areas. The finance department needs to be represented to contribute valuable inputs regarding the “numbers,” as the different distribution options could have a significant effect on the price. The operations/production department must also have a seat on the team. The different distribution options call for strategic allocation of ware-houses—and who has a better experience in designing critical paths and optimal location of warehouses than the operations/ production department? The strategic location of these warehouses can impact the

Producer

Wholesaler

Broker

Agent

Retailer

Customer

Figure 3.2 The dual distribution approach. The diagram has been kept simple; however, a relationship could exist between agents and retailers as in the case of pur-chasing agents as well as agents and manufacturers as in the case of manufacturer’s agents.


price as well as the speed of delivery, and consequently customer satis-faction. The lessons learned from Amazon and UPS are clear on this issue (Rodriguez, Comtois, and Slack, 2013).

Promotion

This section addresses the communication aspect of the strategic mar-keting plan. Specifically, it addresses how the firm plans to communicate with its target market. Because chapter 7 discusses communication in detail and chapter 8 discusses advertising, we will not discuss these topics here. It is, however, important to note that even though this is referred as “promotion” in the 4Ps, it involves more than “sales promotion” as far as the strategic marketing plan goes. In fact, this involves integrated marketing communication (IMC), which encompasses personal selling, advertising, sales promotion, public relations, and direct marketing.

A firm or producer should neither feel compelled to use all the ele-ments in the IMC, nor put equal weight on the ones being used. Take, for instance, our original firm that makes motorbikes, how should it use advertising, sales promotion, and personal selling? Because the motor-bikes are not necessarily expensive or complicated, we think the personal selling element should be used sparingly; instead, emphasis should be placed on advertising and to a less extent on sales promotion.

What is important here is that all the 4Ps must be consistent. In other words, they should not “clash” with one another. For example, an average-quality product should not be sold at a high price through per-sonal selling. Similarly, a high-priced product should not be sold through what might be perceived by the target group as a “cheap” communica-tion means. It would be “inconsistent” to sell an expensive wristwatch through a tabloid newspaper.

What about Existing Offerings?

Our discussions of the strategic marketing plan thus far have focused on new offerings; however, a good strategic marketing plan should address all the firm’s offerings, both the existing and the new. For a number of reasons, the SWOT analysis, in which the firm critically examines its internal strengths and weaknesses and external opportunities and threats, must be conducted as a forerunner of the strategic marketing plan. First,


it informs the firm, based on its strengths, the existing offerings it can continue to support and the ones it needs to eliminate. Second, it helps the firm to determine the strategic directions to take. For example, it helps the firm to determine how best to reposition an existing offering without running head-on into a formidable competitor. Third, it helps the firm to critically appraise the opportunities it can pursue given its strength. Fourth, it also helps the firm to prepare for oncoming changes that can threaten its performance or survival.

A good strategic plan not only spells out the goals the firm must achieve and the associated time frame, but also spells out the resources it will need to deploy as well as the manner in which they must be deployed. For goals, the firm could plan to increase its market share by 10% within the next 3 years. Or, it may plan to increase its ROI by 15% within the next 3 years. It may plan to increase capacity utilization from 60% to 70% in 2 years, and/or improve the quality of production so that defect rate could be reduced to 2% in 2 years. Note that the different goals are not mutually exclusive. In fact, they could be complementary and that is why we recommend a team approach.

By far, the most important part of the strategic marketing plan is how the firm intends to achieve the goals articulated in the plan. The “how” needs to be spelt out clearly, otherwise the plan might not be more than building “castles in the air.” By clearly addressing the “how,” the firm will realize whether its plan is realistic. For example, how does the firm plan to increase its market share by 10% in 3 years? Is it by cultivating new customers or by increasing consumption by the current users? (Can you relate the thought of increasing consumption by current customers to some of our discussions in the previous chapter?)

Closely related to the discussion of “how” is the implementation plan. The strategic marketing plan would not be complete without an implementation plan. This is a schedule indicating how the firm plans to translate the plan into action.

Conclusion

A good strategic marketing plan provides a detailed road map that a company needs to follow in order to accord itself a sustainable competi-tive advantage. While the plan involves the 4Ps, it should not preclude the involvement of the other functional areas of the firm. In fact, on


the contrary, we argue that the strategic marketing plan (even though it is called a marketing plan) is one obvious place where all the vari-ous departments could have a reasonable input that can make the whole firm successful. It would be illogical for the marketing department to determine the location of the company’s warehouse without taking sug-gestions from the production/operations management folk. Similarly, it would be unwise to locate the firm’s warehouse without taking into con-sideration its impact on the product’s price, something the finance folk can handle better.


Having now completed reading chapter 3, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing case 3, appendix 1, titled “Zingo, Inc.”

References

Drucker, P. F. (1973). Management: Tasks, Responsibilities and Practices. New York: Harper & Row.

Porter, M. (1980). Competitive Strategy. New York: Free Press.Rangaswamy, A., and Van Bruggen, G. H. (2005). “Opportunities and

Challenges in Multichannel Marketing: An Introduction to the Special Issue,” Journal of Interactive Marketing 19, 2 (Spring): 5–11.

Rodriguez, J-P., Comtois, C., and Slack, B. (2013). The Geography of Transport Systems. New York: Routledge.

CHAPTER 4

Signaling in Finance and Marketing

What is signaling, why is it used, and when is it used in market-ing? These are a few questions that usually come up, which we intend to deal with in this chapter. The term “signaling”

is used in many disciplines including, but not limited to, finance, eco-nomics, marketing, and evolutionary biology. Some scholars have argued that the term originated from evolutionary biology where scientists use it to describe a unique communication between male and female species—insects, animals, birds, and so on. Signals are different from “cues” and are intentionally emitted by the sender to communicate a specific intent. This intent is received by the receiver of the signal. For example, the male frog communicates its readiness to mate by emitting a specific signal to indicate its intent. This intent is understood by a female gray tree frog that receives the signal (Feldhamer et al., 2007). Similarly, peacocks sup-posedly signal their reproductive fitness with their large colorful tails (Grafen, 1990).

Signaling has, over the years, made its way into other disciplines including those that are not even remotely related to evolutionary biol-ogy. In the social sciences such as economics, finance, and marketing, signaling theory is used to explain communication between agents and principals in a market of information asymmetry (imperfect informa-tion), in which the market participants have different information. As in evolutionary biology both the signal sender and the receiver benefit from the signal. Spence in a seminal paper on labor market signaling argued that the labor market works more efficiently when potential productive



employees signal their productivity through the “amount” of education they have acquired, even if it is assumed that there is no intrinsic value to education itself (1973).

Even though the concept of signaling is simple, it is somewhat dif-ficult to fully express in words. This difficulty was expressed by Spence as follows:

I find it difficult, however, to give a coherent and comprehensive explanation of the meaning of the term abstracted from the contents of the essay. In fact, it is part of my purpose to outline a model in which signaling is implicitly defined and to explain why one can, and perhaps should, be interested in it. One might accurately characterize my problem as a signaling one, and that of the reader, who is faced with an investment decision under uncertainty, as that of interpreting signal. (1973, p. 361)

As in evolutionary biology, a number of conditions need to be met for signaling models to work. In other words, the model will fail without certain necessary conditions, that is, the signals will not be able to reveal the hidden information they intend to convey to the receiver. For exam-ple, three important conditions are necessary for Spence’s labor market model to work:

1. Education cannot be costless.2. The signaler must remain in the market for several periods.3. The marginal cost of obtaining more education decreases for pro-

ductive potential employees while it increases for nonproductive potential employees.

The above conditions are necessary to prevent cheating, that is, sending out false signals, and to prevent free riding, which Spence describes as follows:

If one believes that I will be in the essay market repeatedly, then both the reader and I will contemplate the possibility that I might invest in my future ability to communicate by accurately reporting the content of this essay. On the other hand, if I am to be in the market only once, or relatively infrequently, then the above-mentioned possibility deserves a low probability. (1973, p. 361)

Signaling in Finance and Marketing l 51

How do the above conditions ensure a separating equilibrium necessary for a signaling model to work?

First, the fact that signaling is not costless is a necessary but not a sufficient condition to prevent mimicking and free riding. Second, the fact that the signaler remains in the market for multiple periods prevents lying/cheating. If the signaler cheats in one period, it will be known in the second period, and the punishment associated with cheating out-weighs the benefits gained through cheating. Third, the fact that the marginal cost of education decreases for a productive potential employee, but increases for a nonproductive potential employee discourages the latter from engaging in deception, for example, by trying to obtain more education; hence, there is a separating equilibrium.

Following Spence (1973), several other scholars in business have argued that because information in the market is not perfect, insiders of organizations have better information on the value of the organizations than outsiders do. It is in the interest of these organizations to make this superior “insiders’” information available to “outsiders” because it could lead into an upward revision of the firm’s value. Furthermore, it is in the outsiders’ interest to have access to the insiders’ information because it makes them better informed and therefore they can make better deci-sions. Thus, the mutually beneficial condition for signaling alluded to earlier exists in the world of business and makes it worthwhile for firms also to signal.

Signaling in Finance

Scholars in finance have designed signaling models around corporate financial events or activities such as the financial structures of firms (Ross, 1977), initial public offerings (Leland and Pyle, 1977), dividend policy (Bhattacharya, 1979), declaration of higher dividends (Aharony and Swary, 1980), valuation of unseasoned new issues (Downes and Heinkle, 1982), stock repurchase by tender offers (Masulis, 1980), com-mon stock repurchase (Vermaelen, 1981), and the corporate structure (Myers and Majluf, 1984).

Ross (1977) conducted one of the earliest studies on corporate signal-ing. The study was based on the seminal paper of Modigliani and Miller (1958; also known as M-M, 1958) in which the authors developed the irrelevance of corporate structure theorem. Ross argued that Modigliani and Miller’s theorem is valid only in a world of perfect information


where both outsiders (investors) and managers (insiders or agents) have the same information on the activities of firms. However, the real world of business and investing is characterized by informational asymmetry in which managers have better information on the firm’s projects than out-siders. If corporate structures were irrelevant as argued by M-M, then the business world would be populated by firms that have been established solely by debt rather than equity since debt payments are excluded from corporate income in calculating income tax obligations. In such a world, the limit on the exclusive use of debt in financing a corporation could only be the possible offsetting costs and possible bankruptcy. Thus, an optimum ratio of debt to equity trades off the tax advantages that would come with increased debt against the costs of an increased probability of bankruptcy. Indeed, the fact empirical studies have shown that corpora-tions are not established solely by debt instruments suggests that corpo-rate structures are not irrelevant.

Ross (1977) argued further that the returns to the firm are deter-mined exogenously, however, managers face production problems as well as financing decisions that are driven by internally set criteria. This being the case, with better inside information, managers would choose an opti-mal production activity from any of the given options to maximize the firm’s value. In a competitive market, these internally generated deci-sions (choice of managerial incentive schedule and the choice of financial structure) signal inside information to the market, and inferences drawn by the market from these signals will be validated. The author furthered that an empirical implication of his argument is that cross-sectional val-ues of firms will “rise with leverage since increasing leverage increases the market’s perception of value.”

Leland and Pyle (1977) use Akerlof ’s (1970) argument for mar-ket failure to make their case. The authors argue that the market of entrepreneurs and investors is characterized by information asym-metry because entrepreneurs know more of the projects they want to undertake as well as their own abilities and capabilities than inves-tors do. Entrepreneurs have a vested interest to exaggerate the value of the projects they have on hand as well as their abilities to investors. Furthermore, because it is costly for investors to verify the informa-tion supplied by entrepreneurs regarding the value of their projects and their abilities, investors would simply consider new projects to be of average value. This being the case, many entrepreneurs could bring


below-average-value projects to the market to get the average value that the market is offering. If the supply of below-average projects is large relative to the supply of good projects, the market for venture capital may fail a la Akerlof.

To forestall the failure of the venture capital market and to attract the value they are worth, entrepreneurs of good projects must com-municate (signal) the “inside information” to outsiders (the investors). This information must be such that it cannot be mimicked by entre-preneurs with poor projects. According to Leland and Pyle (1977), the willingness of the entrepreneurs to invest in the project themselves (because action speaks louder than words) is a signal that the project at hand is a good one. Thus, investors will be willing to invest in a proj-ect based on information revealed regarding the value of the insiders’ investment in the project. Hence, the fraction of the equity held by the entrepreneur constitutes a credible signal to investors. Note the assumption here is that entrepreneurs with poor projects would be unwilling to invest in the project themselves, since poor projects are more likely to fail, and so, investors will not be willing to invest their money in it. The fraction of the entrepreneur’s ownership in the proj-ect could be a good indication of the cost to be borne by the entre-preneurs in the event of project’s failure. Therefore, an entrepreneur’s ownership of a significant fraction of a project indicates his/her confi-dence in the future cash f lows from the project. Hence, the entrepre-neur’s fraction of ownership will serve as a strong basis for investors’ evaluation of the project.

Bhattacharya (1979) extended previous works in finance on signaling theory by arguing that dividend payment also serves as a signal under information asymmetric conditions in which outside investors know less about the firm than the inside managers. Bhattacharya made the follow-ing assumptions:

1. The assets of firms in which people invest last longer than the planning horizon of investors.

2. The ownership of assets is transferred over time from one investor to the other.

3. Dividends are taxed as an ordinary income and the tax rate for an ordinary income is higher than that of capital gains.

4. Valuation of cash flows is done under risk-neutral conditions.


Under these conditions dividends signal credible information on the profitability of the firm and expectation regarding future cash flows from projects.

Why would insiders declare dividends that are more costly to investors who can sell shares? The author’s model assumes that finite number of investors will transfer assets of continuing projects to succeeding investors over time. However, the shorter the investors’ time horizon, the “higher is the equilibrium proportion of dividends to expected earnings.”

Do dividend announcements contain information over and above earnings? Even though this is an empirical question, in the 1970s, it generated a debate among researchers who subscribe to the efficient mar-ket hypothesis (EMH). This debate was settled by Aharony and Swary (1980) who conducted an empirical study comprising 149 industrial firms listed on the New York Stock Exchange. The researchers posited that even though dividend and earnings announcements are released by managers (insiders), the informational content of the two announcements would differ for several reasons. First, dividend announcements are com-pletely discretionary whereas earnings announcements are not. Second, because dividends are payouts that are not available for the firm to invest, announcement of changes in dividends will be a truer reflection of man-agement’s expectations of the firm’s financial prospects. Thus, under the EMH the stock should react to the signal conveyed in the announcement of changes in dividends. Aharony and Swary argued that because earn-ings announcements do not convey any additional inside information, their announcements should not elicit any reaction from the stock mar-ket. After correcting for confounding effects by dropping dates on which both announcements were released, the authors used the event-study technique to test their hypothesis. The results showed that the market perceives announcements of dividend changes to contain information over and above that contained in earnings announcements.

Based on the wide acceptance of signaling models in economics and finance, and the ever-growing number of signaling variables that are theoretically possible, in the 1980s significant research efforts have been directed at the empirical validation of the signaling variables. Downes and Heinkle (1982) conducted one such empirical study that specifically focused on dividend announcements and equity ownership of the entre-preneurs. As in the previous studies of Bhattacharya (1979) and Leland and Pyle (1977), Downes and Heinkle assumed the need for insiders


to signal their superior information using credible signals. The authors argue that as with any venture, insiders disclose pertinent information such as line of business, size of the venture, present form of financing, past sales, earnings, and so on. Entrepreneurs also disclose other discre-tionary information such as their fraction of ownership in the project and projected dividends.

Downes and Heinkle (1982) hypothesized, in light of the results of previous studies, the proportion of equity ownership and dividends to be positively related to the firm value as they signal to investors the unob-servable entrepreneurial features. They specifically tested whether the price of new issues is related to the level of the signal, and tested the hypothesis with pure primary and mixed primary and secondary issues of unseasoned companies. The prospectuses of 449 companies of firms that went public between 1965 through 1969 and filed papers with the Security Exchange Commission (SEC) were initially collected. Because there was no trading history of these companies, the authors assumed that any information learned by investors would come from the prospec-tuses that the firms filed with the SEC. Furthermore, because of the lack of public trading history, the researchers required that the firms included in the study have a minimum of three years of trading data and that the price-earnings ratio (P/E ratio) did not exceed 40. The empirical analyses from regression analyses supported the “entrepreneurial ownership reten-tion hypothesis,” but failed to support the dividend hypothesis.

In spite of the results of Downes and Heinkle (1982), the dividend signaling hypothesis persisted. The authors also surmised that the con-tradictory finding to the prevailing dividend hypothesis might be due to not “readily observable variables” being omitted from the valuation equation.

Vermaelen (1981) took a different approach to empirically validate insiders’ signaling hypothesis. His approach focuses on the behavior of securities pricing when firms repurchase their own shares. He argues that investors price securities in a manner that eliminates expected arbitrage profit opportunities and use signals such as the premium offered by firms to repurchase their stock, the target fraction, and the fraction of insider holdings. The implicit argument here is that the use of these variables by the firm signals positive inside information, hence the stock prices would be revised upward by the market on the day these announcements are released to the public.


Vermaelen (1981) outlined four possible arguments to explain why a firm’s purchase of its own stocks could lead to upward revision of its stock prices by the market when an announcement of stock repurchase is made.

1. Purchasing a firm’s own shares by itself is an ambiguous signal to the market. Why is that? The author argues that purchasing its own stocks could be an indication that a firm does not have any viable projects to invest its cash in, and, of course, this does not bode well for any firm that is supposed to be a continuing entity (refer to our discussions in chapter 1). However, the argument is different when a firm repurchases its stocks at a substantial pre-mium. The premium would be an indication that the manage-ment believes that the stock is undervalued and wants to pass on the information to the current shareholders.

2. A firm could repurchase its own stocks for tax reasons. By repur-chasing its shares with cash instead of declaring dividends, a firm confers on its stockholders the benefits of preferential tax treat-ments relative to dividends.

3. The author advanced the leverage hypothesis as the third argument for a firm to repurchase its own stock. This argument suggests that the repurchase could be made with debt, which implicates a tax subsidy.

4. Bondholders expropriation hypothesis suggests that a firm reduces the bondholders’ wealth and transfers this wealth to stockhold-ers through a repurchase of its shares. This wealth transfer occurs because a repurchase reduces the firm’s assets and therefore the value of bondholders’ claims. Furthermore, because this transfer was not anticipated at the pricing of the bond issues it was not reflected in the bond prices; as such, a transfer of wealth to share-holders occurs with repurchase announcements.

Vermaelen (1981) tested the hypothesis with data collected on open mar-ket purchases and tender offers since no public information was available on private companies. The tender offer data were from 1962 to 1977, and the data on open market purchases were covered from 1970 to 1978. To avoid confounding effects, data included in the final analysis consisted of announcement dates that had no other firm announcements within three


days, and tender offers that were not made in the maximum limit form were eliminated. The results of the analysis show that firms that repur-chased their shares experienced a permanent upward revision in share prices. This suggests, among other things, that repurchase announce-ments make the market more efficient because they allow firms to cor-rect mispricing of their shares through the release of inside information. Thus, the results also show that firms can engage in signaling superior inside information through firm-specific events.

Stewart Myers and Nicholas Majluf (1984) built an insightful model to explain how the structure of the firm and investment decisions could signal insider’s superior information. The model that came to be widely known as the Pecking Order Theory begins with the basic assumption in finance theory which posits that insiders will invest in any project so long as its net present value (NPV) is zero and that insiders know more about the value of the firm’s assets and the investment projects than outsiders. This being the case, managers would pass up certain opportunities to invest in case issuing stocks to raise money to invest costs the stock-holders more than the NPV of the project. However, managers would issue new stocks if they were overvalued. Knowing this, outsiders would undervalue the new stock issues, particularly if there are no clear profit-able uses for the funds. Thus, managers would prefer to use internal funds to finance projects. If there are no internal funds, then the prefer-ence will be to use debt, with the last resort being equity. This theory has implications for tax shields and suggests that changes in debt ratios are driven by the need for external funds rather than the attainment of an optimal structure.

We have thus far reviewed signaling and signaling scenarios in finance, next we will review signaling and signaling conditions in marketing.

Signaling in Marketing

Readers must have realized by now that information asymmetry is not limited to situations involving financing alone. How can consumers tell the quality of products before purchase? What about determining the quality of services before purchase? Are the two categories the same? These are a few examples of the marketing-related problems that are created from information asymmetric conditions. As problems that are consumer related, they are solved by marketing-centered signaling


variables such as pricing (Gabor and Granger, 1966; Klein and Leffler, 1981; Wolinsky, 1983; Rasmusen and Perri, 2001), advertising (Nelson, 1974; Schmanlensee, 1978; Klein and Lefler, 1981; Kihlstrom and Riordan, 1984), price and advertising (Milgrom and Roberts, 1986), warranties (Grossman, 1981; Wiener 1985), new-product announce-ments (Eliashberg and Robertson, 1988), new-product announcements and preannouncements (Koku, Jagpal, and Viswanath, 1997), corporate name changes (Koku, 1997a), and name changes of universities and col-leges (Koku, 1997b).

The nature of the differences between products and services are obvi-ous to any consumer who has had the occasion to purchase both of them, not necessarily at the same time though. Some of the basic differences are intangibility, simultaneity between production and consumption, and standardization. The intangibility difference is important to our dis-cussion on signaling because tangible products could be examined and sometimes even tested before purchase. For example, a consumer could test-drive a car in an attempt to verify its acclaimed capacity for quick acceleration. However, the consumer cannot test or objectively verify the speed with which the insurance company satisfies claims before pur-chase. Thus, while marketers have a general need to signal high quality to consumers, the discussion above shows that service marketers may, by the nature of their offerings, face a different kind of signaling problem.

Price as a signal

Even though price has long been known to influence consumers’ demand, other roles played by price in consumers’ decision to buy or “not buy” a product have been less popular in the economics or business literature prior to the 1960s. A seminal empirical paper by Gabor and Granger (1966) changed all this. In their article, the authors argued that contrary to classical economic theory of down-sloping demand curve, even with exception to Giffen goods and goods consumed for conspicuous con-sumption reasons, consumers do not always choose products that have the lowest prices in a product class even when the products are similar. Why should this occur? According to Gabor and Granger, this happens because the price of a product informs consumers on the cost of the product as well as the quality of the product; the former was intuitive, however, the latter was neither intuitive nor obvious.


Gabor and Granger (1966) furthermore argued that every consumer had a range of prices within which a product category must fall; that is, there is both a floor, a lower limit, and a ceiling, an upper bound, for every product category. One could interpret these limits as the consum-ers’ reference points. Consumers’ infer inferior quality for a product that sells below the floor and a higher quality for a product that sells above the upper limit. The results of investigations conducted by the authors in Nottingham in March/April 1963 on four categories of products (two foods, nylon stockings, two household articles, and Wilton carpet) con-firmed the authors’ hypothesis. Since Gabor and Granger several other studies have been conducted on the relationship between price and qual-ity and consumers’ utility functions that have, in the main, confirmed their findings (see, e.g., Ding, Ross, and Rao, 2010).

Price and Advertising as a Signal

An interesting interaction between high price and advertising to serve as information of high quality has been examined by Klein and Leffler (1981). Following the tradition of Hayek (1948) and Marshall (1949) who argued that reputation and brand names are private devices that ensure contract performance in the absence of a third party such as the government, Klein and Leffler argue that high prices and repeat purchase from consumers can assure private contractual performance without the intervention of a third party. The argument rests on the assumption that consumers know the production cost, and that prices of high-quality goods are sufficiently high above the salvageable pro-duction cost. Furthermore, the firms that try to cheat by selling low-quality goods at high prices would incur greater losses of future revenue from repeat purchases than the short-term gains they would experience from cheating.

Under these competitive conditions, high prices would enable pro-ducers of high-quality goods to invest in specific assets, which they would lose if these assets were not used to produce high-quality goods. Hence, celebrity endorsements, sponsorship of athletic events, elaborate and expensive commercials, and the like are used by companies not only to draw attention to the products, but also to indicate how much they could lose if they were to cheat; thus, these constitute credible signals of quality. Wolinsky (1983) also examined a situation in which high price


under information asymmetric conditions serves as a signal of high quality. He made the following five simple assumptions:

1. Consumers prefer high quality to low quality.2. Producers can produce at any quality they like, however, only the

firm knows the exact quality of the product that is produced.3. It is more expensive to produce high-quality products.4. Consumers can purchase repeatedly and obtain product- firm-

specific information from experience or infrequently learn some quality information from prepurchase inspection at the store.

5. Price signals are not randomly chosen.

If these conditions exist and the markup over the marginal cost of high quality signaled by the high price is sufficiently high, then the loss that would be incurred from loss of sales will outweigh the cost saved. Therefore at equilibrium, price signals will be such that each firm’s profit-maximizing quality will be signaled by its price. Several other researchers, for example, Rasmusen and Perri (2001), have extended Klein and Lefller’s model to include conditions where consumers do not know the cost functions of the firm.

Advertising as a Signal

Klein and Leffler (1981) referred to advertising in the context of high price serving as a signal of high quality, but could advertising alone serve as a signal of high quality? Nelson (1974) shows how advertising could, among other things, serve as a signal of high quality under information asymmetric conditions. First, Nelson makes a distinction between search and experience goods. Search goods are goods whose quality could be verified prior to purchase, for example, a car or a dress. Experience goods are goods whose quality could not be inspected prior to purchase, for example, a bottle of whiskey or a can of canned tuna. Because the con-sumer could verify the quality of search goods before purchase, adver-tising of search qualities will tend to emphasize the true qualities and exaggerate less (though exaggeration will not be completely eliminated). However, because of costs associated with misleading consumers and the loss of credibility, firms will curtail their tendency to exaggerate qualities of search goods that cannot be directly verified by the consumer.


Nelson (1974) specified two conditions under which advertisers for search qualities will not engage in deceptive advertising. First, con-sumers’ belief in the claims of the advertisement (ad) and acting on it does not increase seller’s profit on initial sales as opposed to repeat purchase. Second, it is possible for the advertiser to make true, as opposed to false, claims at no extra cost. If these two conditions hold, then according to Nelson advertisers of search qualities will maximize their profits by telling the truth if consumers believe that they are doing so.

The issue with experience qualities is, however, different. Because of the inability of the consumers to verify the quality before purchase, they rely on the volume of ads and celebrity endorsements as evidence of the fact that the product is a better buy. The implication here is mak-ing specific claims in ads for experience qualities does not matter in convincing the consumer to buy the product, what matters instead is the volume of ads itself. Consumers “read” the cost of ads for experience goods as a signal of high quality, Nelson (1974) argues. Schmanlensee (1978) argues that even though Nelson’s discussions of the role of ads on behavior of sellers and buyers in an imperfect informational market are interesting, Nelson did not formally model the market for such behav-iors. In a study that formally models the market for such behaviors, Schmanlensee observed that Nelson’s conclusions hold for some, but not all the parameter values.

In a further research on advertising as a signal, Kihlstrom and Riordan (1984) argue that even though much of advertising does not seem to con-vey direct credible information about product qualities, advertising itself may signal high quality if a mechanism exists in which there is a positive relationship between product quality and advertising expenditures. The authors developed two models which show that advertising does signal high quality in the short run. In the first model high-quality firms ulti-mately establish reputation for high quality regardless of whether they advertise. The implication of this model is that advertising can signal high quality “if and only if high quality production requires investments in specialized assets that increase fixed costs but not marginal costs.” In the second model, Kihlstrom and Riordan argue that nonadvertising “might signal quality even if marginal production costs are somewhat lower for low quality.” The conclusions made by authors parallel those made by Nelson (1974).


The advertising signaling models we have reviewed thus far did not distinguish between new products and established products. This, there-fore, begs the question of whether advertising can work for new products also. Milgrom and Roberts (1986) examine this question as an important extension to Nelson (1974) that captures the relationship of newly intro-duced experience goods and a set of equilibriums when multiple signals are used. In their model, which rests on repeat purchase, the authors argue that introductory price and the level of directly “uninformative” advertising or “other dissipative marketing expenditures” may be chosen by firms as signaling variables for initially unobservable quality of newly introduced experience goods. While some may disagree with our char-acterizations, the fact the majority of post-1974 articles on advertising as signal drew inspiration from Nelson’s article underscores its insightful nature.

Warranty as a Signal

There is hardly a consumer who has not come across the ubiquitous phrase “satisfaction guaranteed or your money back.” This phrase is now daily used by marketers of products/services to persuade consumers to overcome their reluctance or reservation in trying a new product or mak-ing a purchase. In reality, the phrase is an expression of a warranty. What then is warranty? A warranty is a promise. It is an assurance given by the warrantor to any party with regard to a specific condition or facts of products/services offered for sale. It can be written or oral depending on the jurisdiction. A warranty can also be expressed or implied. An expressed warranty as opposed to an implied warranty is specific in lan-guage with regard to the condition or fact to which the assurance applies. Grossman (1981) argues that warranties serve as a means through which sellers of high-quality products can distinguish themselves from sellers of low-quality products. The author first acknowledges that competition in the market serves to effect efficient allocation of resources through price mechanism. However, the price mechanism fails when only sellers know the quality of the items they sell, and they withhold that information from buyers.

Grossman (1981) explains that if there is no way for buyers to know the quality of the products being sold, then all the products will have to be sold at the same price. Sellers of low-quality products will find


it advantageous to hide information on the quality of their products. Of course, this is detrimental to sellers of good-quality products who will therefore withhold their products from the market. As the reader should have quickly realized, this is the classic case of information asymmetry—insiders (in this case sellers) have superior information than outsiders (buyers). The result of this condition, quite naturally, is the market failure—the classic “lemon problem,” as discussed by Akerlof (1970). To solve this problem, sellers can make statements that buyers can verify after they have purchased the product. For example, the seller of a gold ring can state that it is a 20-karat piece, which can be verified by the buyer after purchase. To convince the buyer that the information is truthful, the seller offers a warranty, a promise that the ring is what the seller claims it is. If the buyer finds out after purchase that the ring does not meet the stated quality, then the buyer can return the ring and claim the purchase price.

The scenario described above has several implications. Can you imagine a seller of low-quality products giving such an unqualified (general) warranty about quality? What do you think would happen if sellers of low-quality products give general warranty about quality? According to the Grossman’s (1981) model, this would lead to the return of many products after buyers realize the true condition of the product after purchase. This return is costly to the sellers of low-qual-ity products; hence, they would not offer such warranties. Similar to Spence’s (1973) argument in which education serves as a signal of the capacity of a potential productive employee whose interest is served by distinguishing himself in the job market through attaining higher level of education, warranty serves as a signal of quality from sell-ers of high-quality products whose interest is served by distinguish-ing themselves in the market. Unlike education signaling however, because it is in the public interest for consumers to be protected from unscrupulous merchants’ consumer warranty, signaling has public-policy implications. Should the government require quality disclo-sures? According to Grossman, if disclosure were costless, it would be in the interest of high-quality sellers to disclose; hence, there would be no need for the government to require disclosure under such conditions.

Other studies such as Wiener (1985) empirically tested the war-ranty signaling hypothesis on appliances and automobiles in view of


the Federal Trade Commission’s Warranty Improvement decision (see Federal Trade Commission, 1981). The author concluded after correct-ing for other cues that warranties indeed serve as accurate signals of quality.

New-Product Announcement(s) as a Signal

Firms need to continually innovate and introduce new products in order to sustain their growth or even maintain their existence. This is obvious under the “going concern” principle, which assumes that all business entities will be in existence ad infinitum or long enough to use up all their assets, and the product life cycle concept. However, new-product preannouncements themselves could serve as a cred-ible signal to the market under information asymmetric conditions. This observation was made by Eliashberg and Robertson (1988). The authors distinguished between new-product announcements and new-product preannouncements. Announcements were releases of informa-tion on new products that were made less than four weeks prior to the product’s arrival in the market, and preannouncements were releases of new-product information that were made more than four weeks before the product’s arrival in the market. Using this framework, the authors undertook an exploratory study that involved a survey of many mangers to explore the incidence and rationale for new-product preannounce-ments. The results, according to the authors, suggest that factors such as market dominance, company size, and customer switching costs provide satisfactory explanations for preannouncement signaling.

Koku (1994) and Koku, Jagpal, and Viswanath (1997) extended Eliashberg and Robertson’s new-product preannouncement signaling hypothesis by relating it to the share prices and concluded that only preannouncements on average have significant positive effects on stock prices. Furthermore, “firm-specific and informational variables do not any effect on market risk.” There are several other studies on new-prod-uct introduction that we have not discussed here. Some of them focus on the introduction as a means of improving the corporation’s cash flow and profitability, instead of the introduction as a signal, which is the subject of the discussions in this chapter. Some of those that focused on the introduction as a means to improve profitability will be discussed in the next chapter, which is devoted to new-product introduction.


Corporate Name Change as a Signal

There are potentially several other viable signaling variables such as corporate name change that are within the domain of marketing folk. Corporate name change as a credible signal was examined by Horsky and Swyngedouw (1987) and Koku (1997a; 1997b). Horsky and Swyngedouw argue that a company’s name is an integral part of its image; it is the public persona of the company similar to the quality of its products/services. The authors investigated whether a corporate name change has any effect on its profits performance. An event-study technique was used to examine the change in share prices of the 58 corporations that changed their name between 1981 and 1985. Based on the results of the analyses, the authors conclude that corpo-rate name change positively impacts the changing company’s profit-ability by enhancing its stock price. Furthermore, they suggest that the name change does not improve demand, but serves as a signal that other internal measures have been taken to improve performance.

Koku (1997a) agrees with the general hypothesis of Horsky and Swyngedouw (1987), but argues that the offerings of services organiza-tions are different from those offered by manufacturers of tangible prod-ucts, thus the signal implications of name change might be different. In the case of manufactured goods, the product could be tested before pur-chase while that might not necessarily be the case for services. Therefore Koku suggests that Horsky and Swyngedouw’s analyses could suffer from aggregation bias since they did not distinguish between services corporations and manufacturing organizations. Koku also intimated that the event-study technique might not be ideal for measuring impact of name change on profitability since it is susceptible to confounding effects. The author therefore used trend analysis and specifically focused on companies in the services industry that changed their names. He cor-rected results for mergers and other strategic alliances, and concluded that the results did show that name change signaling does work in the services industry too.

In an extension to the Koku (1997a), Koku (1997b) suggested that universities are a major part of the services industry and also change names routinely to signal major internal changes to their market (poten-tial students). However, no study had previously examined the effective-ness of these name changes. Using student enrollment as an indicator of


the effectiveness of name changes and correcting for size and national enrollment trends, the author concludes that compared to other universi-ties, enrollment in universities that changed name did not significantly improve, and suggests that university administration should instead focus on emphasizing internal changes made in the academic experi-ences of their students.

Conclusion

The above discussions, besides highlighting the information asymmetry that exists in the market between producers and consumers, and the fact that it is in the interest of both parties to bridge the information gap, show that both financial and marketing variables are equally effective in signaling insiders’ superior information. Because signals are not costly, it is important that management evaluate all the signaling variables, both financial and marketing, that are at its disposal at any particular time in the event of a need to signal. However, evaluating all the signaling vari-ables available to the firm may not be possible if there are functional silos that do not permit the marketing folk to talk to the finance folk. The overarching lesson in this chapter is consistent with the theme of this book—marketing folk need to talk to finance folk for the greater good of the company (employees and shareholders). Yes, employees also benefit supremely when the organization does well, because besides raises and bonuses they stand to be dislocated in the event of bankruptcy and other corporate financial distress.


Having now completed reading chapter 4, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing case 4, appendix 1, titled “Dixie Oil and Gas, Inc.”

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Wolinsky, A. (1983). “Prices as Signals of Product Quality,” The Review of Economic Studies 50 (4): 647–658.

CHAPTER 5

New-Product Introduction

Why should a firm introduce a new product/service, particu-larly in view of the abysmal failure rate of new products in the market? Regarding the grim picture of failure rates,

consider the following: some reports state that the failure rate of new products is between 80% and 90% (Crawford, 1987). However, differ-ent studies, depending on the methodology and analytical technique used, report rates between 24% and 98%. According to a report by Cooper and Edgett (2010), top- performing organizations experience a higher commercial success rate for their new products. The average success rate for this group is approximately 62% compared to bottom performers’ average success rate of 45%. Now, what do you think could account for this disparity in success rates? Of course, there could be numerous factors. The authors of the study offer two: (1) top performers have well-structured and applied innovation processes, and (2) they also have better gatekeeping and governance protocols. We can add a few more for this disparity in success rates, such as possibly flawed processes for market research of the need for the products/services, a rush to beat top performers, and/or be the first in the market.

Regardless of the staggering failure rates, there are justifiable, sound business reasons behind introducing new products. First, firms are engaged in a constant search to give the consumers a higher value and in the process increase their market share. Second, the concept of the product life cycle (PLC), regardless of its problems, is embedded in the mind-set of managers; hence the drive to find a replacement for the next



product that will “die.” Third, advancement in technology has made it necessary to innovate and introduce new products. Globalization of mar-kets has made it necessary to adapt some products/services that, though established in the first world, might not necessarily be suitable to condi-tions in developing markets.

The new-product development process is a very expensive undertak-ing that varies from one industry to the next. Some of these costs are not cleanly disclosed for competitive reasons and tend to be masked with other information. However, it has been reported that the average cost of introducing a new product in the agricultural industry rose from $160,000 in the early seventies to $40 million in 1993. Furthermore, nearly $400 million was spent in 1993 to introduce less than ten new products. On average, it takes 10–12 years of research and testing to bring a new product to market in the industry (anonymous, 1994). Gillette spent $200 million in advertising alone to launch its Gillette Fusion razor (Datamonitor, 2008), and the average cost of a new drug in the pharmaceutical industry, based on data covering the period between 1989 and 2006, has been estimated to cost $868 million (Adams and Brantner, 2006). These data when taken together with the high failure rate suggest that a disciplined approach must be brought to bear on the new-product development process.

A successful new-product development has several sequential pro-cesses. The product idea can be stopped as it makes its way through the different phases, thus management makes a series of go/no-go deci-sions. “Go” means the idea can proceed to the next phase while “no-go” means the idea must be dropped. Because these decisions are based on judgments that are not without error, a product idea that might be dropped by one company, say company A, might become the rainmaker for another company, say company B, at a different time.

Some marketing texts such as Kotler and Keller (2009) have as many as eight main steps while others such as Kerin and Peterson (2013) have as few as six steps. Because we wish to provide a comprehensive treat-ment of the new-product introduction process, which according to many commentators is important to the existence of every corporation, we will follow Kotler and Keller’s approach, discuss the eight steps, and highlight the steps that could benefit from more interfunctional involvement. The eight main steps involved in the new-product introduction are as fol-lows: (1) idea generation, (2) idea screening, (3) concept development

New-Product Introduction l 71

and testing, (4) marketing strategy development (5) Business analysis (6) Product development, (7) test marketing, and (8) commercialization. We provide below a discussion on each of the eight steps.

Steps in New-Product Introduction

Idea Generation

The primary question is, where do companies get new-product/service ideas? There is no simple answer to this question as new-product/service ideas come from several sources. However, we contend that the ideas must begin with a simple question that the firm must ask: How can the firm improve customers’ value, given what customers use the product/service for? Extending Kotler’s famous argument that the customer does not need a drill, but a hole, we can say that the customer does not need a phone, but needs to easily communicate electronically with others. This being the case, one can easily see how the customer’s value is enhanced with a mobile phone instead of the old black-rotary phone.

One of the better sources of new-product/service ideas is the com-pany’s employees. This is consistent with the view that employees are a company’s biggest resource. However, how a company harnesses new-product/service ideas is a challenge many companies still have to learn to overcome. The company 3M’s famous 15% “intrapreneurial” program that allows employees to spend 15% of the work hours on pet projects aimed at fostering innovation is a good example of idea gen-eration by employees that many companies can learn from. But we also hasten to add that this is not a one size fits all scenario; every company must carefully “take inventory” of its circumstances and strengths and devise appropriate means to harness employees’ creative ideas. Some may find the new-product ideas suggestion box approach useful while oth-ers might find new-idea contests more useful. However, whatever the circumstance, every company needs to make full use of its internal tal-ents in creating new products/services. Company’s encouragement for employees from different functional areas to interact and brainstorm on new-product/service ideas could be a good approach to foster cre-ative and cross-functional thinking that could lead to real innovation. Encouragement though must go beyond lip service. It means, among other things, that the company must provide the time and create the atmosphere that encourages cross-functional interaction.


Current customers and competitors are also a good source of new-product/service ideas. Current customers are able to see deficiencies in the product they currently use and are therefore in a good position to suggest improvements and/or alternatives. Knowing what competition is currently working on can also provide clues on possible new trends. The challenge though is how to legally get access to this information. Similar to current customers, the company’s channel members could also be a good source of new-product/service ideas.

Idea Screening

A good idea generation program must result in several ideas; the task then is to winnow the ideas down to a workable number. The idea screening process is not a foolproof mechanism for reducing a large number of ideas into a few that are likely to succeed. Some good ideas end up being rejected while some ideas that are not that great end up being retained. However, the two questions that must always be asked are: (1) Will the idea result into what the customers will value and therefore be willing to pay for, and (2) does the firm have what it takes to actually make the product and sustain it? Firms ignoring the first question run the risk of producing what customers don’t value or what they cannot afford. Carefully conducted focus-group studies are therefore sine qua non to the success of a new product. It will not only tell the firm what the cus-tomers value, but it will also give an idea of what price they are willing to pay. Of course, conjoint analysis and its associated techniques are also used to derive the price the customers are willing to pay, but they can-not replace a good focus-group study. Overlooking the second question could mislead a firm to make a product that it cannot sustain. Research in Motion’s recent flop of its newly introduced blackberry mobile phones is a good example of a situation where a firm can introduce a new prod-uct but fail to sustain its position. Other well-known examples of failure to sustain a newly launched product include Royal Crown’s diet cola and Clairol’s Touch of Yogurt Shampoo.

Concept Development and Testing

Product ideas are translated into a product concept with details at this stage. The questions, what the product will do, what its intended usage


is, and what the occasions for its usage are, must be addressed here. The product idea is fleshed with such sufficient details that the consumer is able to visualize it at this stage. The consumer can therefore tell whether s/he would buy the product and at what price—this would be the testing part of the concept development.

Marketing Strategy Development

This stage comprises the development of an initial strategy, based on the results of the concept development and testing phase, to introduce the product/service. Of course, this initial strategy would undergo several revisions; nonetheless, it serves as a rough draft that gives managers an idea of what to expect in terms of the long-term market share and profit.

Business Analysis

This phase focuses on the business aspect of the product in which important financial and marketing analyses are conducted; hence, it represents another important area where interfunctional coopera-tion works for the benefit of all. The projected sales volume must be worked out along with the break-even analysis, payback period, return on investment (ROI), and the internal rate of return (IRR). The break-even analysis is fundamental to the product’s success because it shows the number of units that must be sold before a profit is made given all the relevant costs involved in making the product. What might these relevant costs be? Generally, they include the fixed cost and the variable costs, such as labor and material costs. The payback period calculation involves working out how long it would take for the firm to recover all the relevant costs involved in making the product. Let us take the case of an individual taking a college loan that s/he must repay after college. If the individual pays a fixed sum of money each month or each year toward the repayment of the college loan, the period of time it takes the individual to completely pay off the loan is the rough analogy of the payback period. A firm may have a policy or expect to recover the costs within a defined period.

The ROI analyses should be conducted to help the firm decide whether it is better to invest in making product A or product B. Ideally


every product with a zero net present value (NPV) must be accepted for investment. However, because of limited funds, not every project will be pursued, hence a rank order that uses ROI as a criterion is used. The IRR serves a similar purpose. Given the cost of funds, every organization has a threshold that a project must cross in terms of its returns in order to be accepted—in a nutshell, this is what IRR is.

Even though not discussed in the business analysis stage, we sug-gest that the impact of the new product—specifically, cannibalization of existing products by a new product—be assessed during the business analysis stage, because it is then that the true contribution of the new product can be assessed.

Product Development

A project that earns a “go” at the business analysis phase makes it to the product development phase. This phase could also have a series of steps from developing a prototype to developing a “real functional” product that is ready to market. The research and development (R & D) folk constitute the lead team in the product development phase. However, the R & D folk cannot afford to get lost in the technical details and forget about the important roles the finance and the marketing folk have to play here. While the finance folk must ensure that there are no cost overruns, the marketing folk must ensure that the consumers can not only afford the price, but are also comfortable with the functionality and features of the product.

Test Marketing

This represents not only the last chance to nip the product in the bud, but also an opportunity to get the reaction of “real” consumers for whom the product is intended. The product is now in public domain, but not on a large scale. Perhaps a few more tweaks need to be made before the product is fully launched. While the test marketing phase is useful, it is a “double-edged” sword for the innovating organization. While seeking useful reactions, the product is also now available freely for competition to see, purchase, and study, and competition could very well launch a preemptive strike. Sometimes competition could leapfrog the innova-tor to the market based on information gleaned from the innovator’s


product while it is in the test marketing phase. Campbell’s Soup learned this lesson the hard way in its attempt to introduce natural fruit juice.

Commercialization

The product is finally launched to the general consumer public in this phase. However, it does not necessarily mean that the product is without defects. In the rush to beat competition to the market, many producers have launched products with significant manufacturing or other defects. This has led to product recalls that have been done voluntarily by the producer, or through the actions of an established administrative agency such as the Food and Drug Administration (FDA) in the case of drugs, or the Department of Transportation (DOT) in the case of automobiles. A study conducted by Jarrell and Peltzman (1985) on product recalls states that recalls, whether attributed to a third party outside the controls of the manufacturer in the pharmaceutical industry, such as the poison-ing of Tylenol capsules, or attributed directly due to the manufacturer’s error in the automobile industry, cost firms more than the costs incurred in direct recall. They damage the manufacturer’s reputation.

Decisions regarding when to launch a new product, depending on the product, is not trivial. Introducing an item that would be used by students in fall would be appropriate, but introducing such an item in winter might not be a good idea. Similarly introducing an energy drink might be appropriate in summer but not in winter. Decisions must also be made about activities to support the new-product introduction such as advertising blitz, special events, and other promotional activities. Of course, all these activities require funds to be earmarked for the intro-duction; however, it would be inaccurate to internalize these costs as solely the new-product costs.

Modern Finance Theory and New-Product Introduction

How do new products improve shareholders’ value? The idea that intro-ducing new products will improve cash flow and therefore improve shareholders’ value is intuitively appealing. However, since new-product introductions also come with high costs, it cannot be taken for granted without empirical evidence that their introduction necessarily improves shareholders’ wealth. Eddy and Saunders (1980) were one of the first


researchers to investigate this issue. They argue that if new-product introductions improve shareholders’ value beyond the current market prices, then the announcement of introduction of new products must result in increased share prices of the announcing firms. Implied in their argument are few assumptions: (1) the market is informationally efficient, and (2) market analysts and investors examine all publicly available information on firms in order to make investment decisions, and therefore the prevailing stock prices reflect all available public information.

Operating on the above assumptions, the authors further argue that new-product introductions would not result in stock price increase. Using asset pricing models, the authors argue that stock price apprecia-tion will be the result of the present value of the discounted streams of future income that the new product would generate and this would have already been anticipated by the market in pricing assets. The authors col-lected 76 new-product announcements between 1961 through 1969, and screened them to ensure that the announcements, in fact, carried new-product information. After screening, 66 observations were left, which were analyzed using the event-study method. The authors found no sig-nificant abnormal returns within the 3-day pre- and post-event days, and therefore concluded that their null hypothesis was confirmed.

Eddy and Saunders’s (1980) study was pioneering in its attempt to integrate marketing activities in modern finance theory; however, the study suffered from several shortcomings. For example, the authors made no attempt to segregate announcements by industries. Clearly, some industries are riskier than others and some (the pharmaceutical industry, for example) require more R & D expenditure in order to come up with new products. Therefore, without adjusting for risks, comparing the outcome of innovative activities across industries is the equivalent of comparing apples with oranges. Further, the results seem to suggest that there cannot be any signaling implications in new-product announce-ments since the market is already aware of the projects that insiders are working on. Of course, this also means that all the efforts and troubles that companies go through to hide the new products they are working on are either ineffective or useless.

Chaney, Devinney, and Winer (1991) sought to correct the short-comings in Eddy and Sauders’s (1980) study and collected data over a ten-year period between 1975 and 1984. The data comprised 1,683


new-product announcements released by 631 firms; this was reduced to 1,101 announcements released by 584 firms, after correcting for con-founding variables. The data were classified by industry using the stan-dard industrial classification codes (SIC), whether the announcement contained information on multiple or single product(s), and whether the product was new or an update of an existing product. The authors’ arguments for using the market model are the same as those of Eddy and Sauder’s and both studies used the event-study methodology. However, the results of Chaney, Devinney, and Winer’s study show that the stock market, as evidenced in the abnormal returns, does show significant upward price revision upon announcements of new products. The results also show that technology-based companies such as computers, pharmaceuticals, and chemical companies experience higher stock price appreciation. Furthermore, firm size is related to share price adjustment, and announcements of radically new-products experience higher returns than reformulations or update.

The implications of Chaney, Devinney, and Winer’s (1991) study of new-product introduction are clear. There are sound financial explana-tions for new-product introduction besides the explanations offered by the PLC that products that “die” must be replaced. It is important to note that Chaney, Devinney, and Winer interestingly did not assign sig-naling motives to new-product introductions. This was pointed out by Koku (1994), and Koku, Jagpal, and Viswanath (1997), who observed that a richer insight could be gained if the literature on signaling is inte-grated into the literature on new-product introduction, particularly in view of Klein and Leffler (1981) and Eliashberg and Robertson (1988). Koku (1994) and Koku, Jagpal, and Viswanath (1997) suggest that Klein and Leffler’s study suggests that firms that introduce new products more often and charge higher prices may be investing in product-specific assets and therefore are signaling the fact that they intend to or will remain in the market for a long time. Such firms will more likely attract consum-ers (final and industrial) who purchase durables and therefore want the company to remain in business to supply them spare parts.

Koku (1994) and Koku, Jagpal, and Viswanath (1997) argue that new-product information is not homogeneous. In other words, some new-product announcements are rather cryptic while some of them are detailed, and that there might be a strategic reason why firms choose to release cryptic or detailed information. They also argue that there is a


strategic reason for preannouncing and announcing new products to the extent that these signals reveal insider’s superior knowledge. Hence, the stock market will react differently to these information-releasing events (IREs). Finally, Koku (1994) and Koku, Jagpal, and Viswanath (1997) suggest that to the extent that IREs are received by competitors also, who will react to the information, IREs must affect the market risk—the risk that cannot be diversified by the firm releasing the information. The authors collected data over a period of ten years—from 1980 through 1989—and tested a series of hypotheses that built on their arguments using the event-study technique.

The results of their analyses confirm the signaling implications of Klein and Leffler’s (1981) study as well as their suggestion that it is incorrect to analyze the effects of preannouncements and announce-ments together. However, these results also did not show any signifi-cant effect on market risk that is caused by firm-specific informational variables.

The strategic implications of new-product preannouncements, announcements, and introduction to firm’s profits and shareholder’s wealth have been made less fuzzy by the studies we have thus far dis-cussed. How firms make profit by introducing, was however not discussed by these studies. Bayus, Erickson, and Jacobson (2003) illuminated this issue by studying three key drivers of firm value—profit rate, profit-rate persistence, and firm size—through growth of assets when new products are introduced in the personal computer (PC) industry. Because the PC industry is one of the most intensely competitive industry, the results of this study, though cannot be extended to other industries, would none-theless be instructive. The authors found, using various secondary data sources, that a total of 1,070 new products were introduced in the PC industry between 1974 and 1994. The results of the analysis, among other things, show that new-product introductions influence profit rate and firm size; however, no relationship was found between new-product introduction and persistent profit rate. The counterintuitive part of the study’s findings is that the effect of new-product introduction on firm’s profit actually results from reductions in selling and general admin-istrative expenditure (SG&A) that come with new products, and not from increase in gross operating returns. According to the authors, new products need less selling and less advertising intensity than their older counterparts.


First-Mover Advantage

What is the relationship between the firm’s order of market entry and market share? Contrary to popular belief, the first firm to enter the mar-ket does not necessarily equate to the firm being the market share leader. Several other factors need to be taken into consideration. Depending on the resources (human in terms of research talent and financial, for say, R & D budget) at the firm’s disposal, the firm might be better off being a follower than being the first to enter the market.

Studies conducted by Urban et al. (1983) on low-priced, frequently purchased consumer goods revealed a strong relationship between order of entry in the market and brand’s market share. The pioneer’s advantage was assumed to be due to the fact that consumers had more information on the pioneer as compared to subsequent brands. Further studies by Robinson and Fornell (1985) confirmed Urban et al.’s find-ings that order of entry plays a significant role in market share gained. The authors suggest that some of the pioneers’ advantages could be due to the entry barriers they may have erected. However, other stud-ies such as Robinson (1988) suggest that even though the relationship between pioneering brand and market share is as strong as the relation-ship between market share and the ROI, the first-mover advantage is determined in a large measure by the nature of the business and indus-try conditions. In convenience goods where pioneers have distribution advantages, they also enjoy higher market share. However, pioneers do not enjoy higher market share in industries where advertising is intense.

Conclusion

New-product introductions are important for the firm to continue to be profitable; however, all hands have to be on deck for a firm to enjoy all benefits that come with new-product introduction. First, it has to be an interdisciplinary process where finance folk interact with marketing folk and operations management/production folk. Anything short of a full cooperation will “cheat” the firm of benefits. Second, there are strategic and share price implications to information regarding new products; hence, the release of new-product information must be very well coordinated. Finally, though this has not been discussed explicitly


by any of the papers, Koku (1994) suggests that financing opportunities could be implicated in new-product IREs. If a firm’s share prices are revised upward, then it is possible that the firm could be worth more post-IRE than pre-IRE, and therefore a lesser credit risk. However, more work is needed in this area.


Having now completed reading chapter 5, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing case 5, appendix 1, titled “The Afriga.”

References

Adams, C. P., and Brantner, V. V. (2006). “Estimating the Cost of New Drug Development: Is It Really $802 Million?” Health Affairs 25, 2 (March/April): 420–428.

Anonymous (1994). “The High Cost of New Technology,” Successful Farming, Iowa Edition, 92,11 (November): SS8.

Bayus, B. L., Erickson, G., and Jacobson, R. (2003). “The Financial Rewards of New Product Introduction in the Personal Computer Industry,” Management Science 49 (22): 197–210.

Chaney, P. K., Devinney, T. M., and Winer, R. S. (1991). “The Impact of New Product Introduction on the Market Value of Firms,” Journal of Business 64 (October): 573–611.

Cooper, R. G., and Edgett, S. J. (2010). “Developing a Product Innovation and Technology Strategy for Your Business,” Research Technology Management 53 (3): 33–40.

Crawford, C. M. (1987). “New Product Failure Rates: A Reprise,” Research Management 30 (4): 20–24.

Datamonitor (2008). Gillette Fusion Case Study: Developing a US$1 Billion Brand. New York.

Eddy, R. A., and Saunders, G. B. (1980). “New Product Announcements and Stock Prices,” Decision Sciences 11 (January): 90–97.

Eliashberg, J., and Robertson, T. S. (1988). “New Product Preannouncing Behavior: A Market Signaling Study,” Journal of Market Research 25:282–292.

Jarrell, G., and Peltzman, S. (1985). “The Impact of Product Recalls on the Wealth of Sellers,” Journal of Political Economy 93 (3): 512–536.


Kerin, R., and Peterson, R. A. (2013). Strategic Marketing Problem: Cases and Comments, 13th ed. New York: Pearson; Prentice Hall.

Klein, B., and Leffler, K. B. (1981). “The Role of Market Forces in Assuring Contractual Performance,” Journal of Political Economy 89 (August): 615–641.

Koku, P. S. (1994). “The Effect of New Product Announcements and Preannouncements on the Value of the Firm,” Unpublished PhD Dissertation, Rutgers University, NJ.

Koku, P. S., Jagpal, H. S., and Viswanath, P. V. (1997). “The Effect of New Product Announcements and Preannouncements on Stock Price,” Journal of Market-Focused Management 2:183–199.

Kotler, P., and Keller, K. L. (2009). Marketing Management. Upper Saddle River, NJ: Pearson; Prentice Hall.

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CHAPTER 6

Sales Force Compensation and Management

The fallacy in the often-repeated statement “make the world’s best mousetrap and the world will beat a path to your door” is well known to every student of marketing, and more so to marketing

managers. The fact is the role of salespersons (salesmen and saleswomen) in the success of companies cannot be underestimated. Therefore, a good knowledge of their role and how to manage them is essential.

One of the basic decisions the firm needs to make is whether to hire its own sales force, that is, make the sales force a regular part of the employee pool, or contract the selling activities to independent agents. This is not a simple decision as it is fraught with several pros and cons. For example, the company is able to closely supervise the selling activi-ties of its salespersons as opposed to an independent agent. The com-pany can dictate to its own sales force how to allocate selling efforts and time. This can hardly be done to an independent sales agent. However, hiring its own sales force “ saddles” the company with the usual employee benefits—annual leave with pay, contributions toward retirement, healthcare insurance, and the like—none of these costs are to be borne if the sales force comprise independent agents.

The decision to hire a company’s own sales force or use independent agents—contrary to the mind-set that it is a marketing issue and is, therefore, best handled by the marketing department—in our opinion, is best handled through an interfunctional approach. The marketing and



human resources folk bring the company’s strategic interests to bear on such decisions while finance folk supply the figures. Simply put, there are qualitative and quantitative dimensions all of which need to be care-fully examined. Consider a situation where the marketing and human resources folk decide that it would be best for the firm to hire its own sales force if the costs justify it. Then, it would be up to finance folk to examine the figures. Essentially, the finance folk have to conduct a break-even analysis discussed below to determine the volume of sales that must be achieved for the company to break even on hiring its own sales force.

Consider the following case:

1. The company pays a base salary plus a 5% commission on sales to its internal sales force. Furthermore, the company spends $2 million on the base salary and fringe benefits paid to its internal sales force per year.

2. The company pays a 10% commission on sales to independent salespersons. Because these are “independent contractors,” the company does not incur any other additional costs on behalf of the external sales agents.

The information above results in the following algebraic formulation:

Total cost of internal sales force = 0.05 (X) + $2,000,000 (1)

Total cost of independent sales agents = 0.10 (X) (2)

where X = sales volume in dollars

For breakeven, equating the two expressions results in the following:

0.05 (X) + $2,000,000 = 0.10 (X)

$2,000,000 = 0.10 (X) – 0.05 (X)

$2,000,000 = 0.05 (X)

X2

5=

$ , ,.

000 0000 0

X = $30 million

Sales Force Compensation and Management l 85

This suggests that in pure financial terms, if sales volume is $40 million there are no cost savings or losses in maintaining company’s own sales force. It also suggests that if the sales volume is anything below $40 mil-lion, then it will be more expensive for the firm to maintain an internal sales force. In other words, it is financially better to use independent sales agents up to sales volume of $40 million, above which it is better for the firm to hire its own sales force. Note that these figures reflect no other strategic considerations (such as control over selling activities and atten-tion to nonselling efforts) for having its own sales force.

Sales Force Compensation

If the company chooses to hire its own sales force, then the next impor-tant issue is how to compensate its sales force. The compensation method is important because the problem of asymmetry, discussed in chapter 4, rears its head again particularly in the case of external salespersons. The problem is not completely eliminated even with internal sales force. Here the issue is, how can management ensure that the sales people are devot-ing their time and efforts to selling? Can they be sure that the sales per-sons do not just come in, sign for the company car, and drive off to the beach or to play golf when they claim to be calling on clients? Of course, the company can monitor their activities, but the cost of doing so will far exceed the benefits. To minimize these problems, companies have devised different compensation programs such as commission, commis-sion plus base salary, salary, salary plus bonuses, salary plus contest, com-mission plus contest, and commission plus bonuses.

Commission

Commissions are easy to administer and often used for independent agents; they are, however, used for company-employed sales force as well. The sales force is compensated as a percentage of the sales revenue under the straight-commission method of compensation. Generally, this percentage is predetermined and known to both par-ties. The single most-positive point of a straight-commission method of compensating salespeople is that the sky is literally the limit. Sellers of industrial goods can potentially make huge incomes when the economy is doing well. However, the assumption underlying the use


of the straight-commission method is that selling efforts lead directly to sales. This assumption ignores the fact that there are factors beyond selling efforts (in the case of industrial and end consumers) that go into making purchase decisions. Consider the economy, for example. Regardless of one’s selling efforts during a recession, it would be dif-ficult for a salesperson to sell to industrial buyers of a company that is cutting down on production. Similarly, it would be difficult for a car salesperson to sell cars during recession when consumers are uncertain about their prospects of continued employment. In this compensation method, such uncontrollable factors could, therefore, drive away some otherwise good salespersons.

Salary

This is a fixed, periodic compensation, specified in an employment con-tract, given to an employee in exchange for his/her services. An employ-ee’s salary is generally independent of his/her efforts; hence, a salary of a salesperson is independent of his/her sales. To the sales force, salary as a means of compensation removes the uncertainties that come with commission as a compensation method. An argument can be made that salary as a means of compensating sales force may not have incentive to expend their best effort toward making sales. However, an alterna-tive and equally persuasive argument also exists that by compensating salespersons through salary, the company shows that it trusts its sales-persons to do the right thing, and people will respond to this trust by doing their best for the company. This belief is consistent with Douglas McGreagor’s theory Y (1960).

Commission plus Base Salary

Combining a base salary with commission could be an attempt at solving the problem of losing risk-averse, good salespersons who cannot deal with the uncertainties that come with irregular income. Of course, the base salary is relatively low, but it offers the necessary safety net and still makes the salesperson “hungry” to earn commission. Offering a base salary also allows salespersons to spend some time on “missionary sales,” that is, on nonselling but important activities that make way for future sales.


Salary plus Bonuses

This combination of salary with bonus offers all the benefits of a regular, predetermined income. However, to encourage salespersons to expend as much energy as possible in generating sales, bonuses are given for achievement of a certain level of sales volume. The sales volume may or may not be predetermined.

Salary plus Contest

This compensation method is similar to salary plus bonus, but in place of a bonus, contests are held—for example, for the achievement of cer-tain sales volume within a certain period. Coveted prizes such as a paid vacation for two at a famous destination could be awarded to those who meet the sales goal. These contests create an additional impetus for salespersons.

Commission plus Contest

This compensation method is similar to salary plus contest, however, the contests are held for those on commission. This can include internal sales force as well as independent sales agents.

Commission plus Bonuses

This is a hybrid compensation method in which commission as described above is coupled with bonuses when salespersons achieve a certain vol-ume. As discussed above, the bonus may or may not be predetermined as well as the sales volume needed to qualify for the bonus.

Technology and Sales Force Management

Like everything else in the twenty-first century, selling to industrial and end consumers has also been impacted by the advancements in tech-nology. Sales force management in the twenty-first century is therefore completely different from what it used to be. Tools such as LinkedIn, Skype, company websites, and the like are available for networking and selling. In the face of modern technological advancements, geographic boundaries do not pose the challenge they once used to.


Online

Online selling is one of the areas where the impact of technology on sell-ing is marked. It is a small part of e-commerce that many companies can use to reach potential customers that hitherto could not be easily reached. To a large extent, online selling has rendered geographic boundaries irrel-evant. However, care must be exercised on how revenues generated from online sales are counted and to whom they are credited, particularly in instances where salespersons are still assigned territories and sales quotas. Furthermore, analysis must be done on the extent to which online sales would cannibalize company’s traditional selling methods, for example, brick and mortar or door-to-door sales.

Door-to-Door Sales

Even though this method of selling that is not extensively used today, its modification, “the house party sales,” is used rather successfully by industries, such as cosmetics, and companies, such as Tupperware. However, those who employ this method should also be aware of both local (i.e., state and federal) laws such as the 3-day cooling period that govern door-to-door sales (FTC, 2000).

Nonprofit Institutions and Sales Force

It is important to note that the use of sales force is not limited to for-profit organizations alone. In fact, many recruiters for schools, universi-ties, and colleges could be regarded as the sales force of the not-for-profit entities they represent, since their job, among other things, includes por-traying the entities they represent in a positive light such as engaging in activities that attract or convince potential students to enroll in the schools they represent. Even the “navigators” who are assisting people today to enroll in the affordable healthcare program could be considered as the program’s sales force to the extent that their job is to assist people to enroll in the program. The next issue we need to discuss pertains to management of the sales force.

How Does One Manage the Sales Force?

A complete treatment of this question can lead into yet another book; however, we are not going to subject the reader to another thesis. We deal


with sales force management issues here because this chapter is on sales force compensation and management; our treatment of sales force man-agement here though is not a substitute to a full-fledged course on sales and sales management. Rather, consistent with the theme of this book, we focus on the interfunctional issues that are relevant to managing the sales force. Underlying the effective management of the sales force are the following points: company ethics, company expectations, communi-cation processes, support, and training.

Company Ethics

It is important that the company have its ethics and code of conduct written in simple and understandable language, and distributed to all employees. Because members of the sales force, as indicated earlier in this book, are the public face and voice of the organization, they should be well educated, during their orientation sessions, not only on the accept-able code of conduct, but also on the ramifications when such codes are violated. Company policies regarding/prohibiting gifts, kickbacks, and bribes must be made clear because violating them may not only be vio-lating company’s policies, but they may also have legal implications that could negatively impact the company as well as the individuals involved. Salespeople who do business in foreign countries, for example, must be made aware of the Foreign Corrupt Practices Act (FCPA), which prohib-its US firms doing business outside the United States from paying bribes directly or indirectly through intermediaries.

Besides the laws, salespersons must be aware that most selling inci-dences whether to an end consumer or an industrial buyer, but par-ticularly industrial buyers, involve relationships. These long-lasting relationships are predicated on a number of personal factors, including trust, integrity, and reliability. Hence, conducts that will make custom-ers entertain doubts about any of these three characteristics in a sales-person will sooner or later hurt the salesperson’s ability to retain that customer. The value of a long-term customer over a short-term customer has to be shown in clear terms to the sales force using customer life-time value (CLV) computations (see chapter 2). Thus, pressure selling in which a salesperson will exert pressure on the customer to get a sale is not in the interest of the salesperson or the company, because such prac-tices engender negative word-of-mouth, which will definitely not lead to repeat purchases or references. While it will be expensive to monitor


each salesperson’s ethical conduct, it would be a good practice to require salespeople to make a formal written report to a specifically designated committee upon loss of an industrial account indicating the reason for the loss. This incident must be investigated by the committee charged to ensure that the loss was not due to ethical lapses.

Company Expectations

What are the company’s expectations of its sales force besides profes-sionalism? Of course, companies expect their sales force to sell, but how much and when? These are things that need concretizing. For example, the company must make it clear to its salespersons whether they are on a quota and are therefore expected to sell a certain amount monthly, quarterly, semiannually, or annually. This is important for the purposes of evaluation of salespersons as well as for determining the need for additional training for a salesperson.

How are quotas determined in instances where a company uses quotas to evaluate the performance of its sales force? While there are merits in using the quota system, it must be noted that the bases for coming up with the quotas must also be communicated to the sales team in order to establish credibility. In other words, the sales team has to understand that management did not just pull out the figures for the sales quota from thin air. Sales quotas must be realistic and achievable otherwise they will quickly demoralize the sales team. Also associated with how quotas are set is the issue of equity and fairness. Are newer salespeople expected to sell the same volume as experienced salespersons? Fairness and equity suggest that such should not be case. Furthermore, it must be noted that while quota sales goals are easy to evaluate and therefore popular, they detract from other activities such as missionary selling and cross selling, since such activities are often not properly captured in sales quotas.

Company expectations go beyond meeting sales quotas. Many com-panies expect their salespersons to make periodic “maintenance calls” on their accounts. These calls are not intended to lead to any immedi-ate sales, however, they can be an important part of future sales. They are a part of the company’s investments in the relationship. It is also not uncommon for a company to expect its salespersons to spend some weekends socializing with key customers. Such weekend social activities


include golfing, boating, fishing, or going to watch games (basketball, football, baseball, and the like).

Some companies also expect their salespersons to not only sell, but to also supervise the entire delivery process. This is done particularly for products/services requiring time-sensitive delivery to ensure that the cus-tomer receives the product/service at the promised delivery time. Failure to deliver on time could result in sales cancellations or loss of future sales.

Communication Processes

We chose the expression “communication processes” here to reflect the fact that several communications are taking place. First, there is a com-munication between the company and the sales force (internal commu-nication). This communication process takes place during training of the sales force and continues after training to reinforce policies, rules, and so on; it is also used for employee feedback. It is needless to say that these communication processes must be clear and unambiguous. Failure to do so might invite legal problems, for example, when a salesperson is to be terminated for failing to comply with rules and so forth.

The second part of the communication is between the sales team and customers. The sales team must be truthful in their communication to their potential customers. Truthfulness and full disclosure regarding what the products can and cannot do is important in building credibility with the potential and current customers. It must also be noted that not every communication with customers must be directed at selling; some communication must also be geared toward forging good relationships and not immediate sale. Above all a salesperson must be a good listener, particularly in the case of industrial sales. A good listener is one who is more likely to understand the potential or current customers’ problems and can, therefore, come up with acceptable solutions. A good salesper-son must regard him- or herself as a seller of solutions to problems and not a seller of products.

Support and Training

What kind and level of support does the company give the sales force? To be effective in selling, the sales force must be trained properly in all facets


related to selling. For example, those who sell to industrial buyers must be trained on making presentations and public speaking. They must also be very knowledgeable on the products they sell. If the product is for industrial buyers, the sales force must be given professionally designed PowerPoint slides. Many companies use sales engineering, that is, sales-persons with engineering degrees who are trained to sell highly technical products. Other companies use team-selling approach in which folk with engineering background or degrees partner with sales people from the marketing department to sell technical products.

The Use of Quotas as a Management Tool

The connection between selling and the success of an organization is obvious. This connection has somehow given way to the “simple logic” that the rate of success could be enhanced if sales efforts are properly harnessed or managed. However, is this simple logic correct, or is it simply one of those unsubstantiated myths? Given the importance of selling in the wider scheme of a company’s existence, it is not surprising that significant academic efforts have been directed at investigating the mode of managing the sales force and its success. Admittedly, success is an elusive term since it can be measured on several different criteria.

Setting sales quotas is a common managerial tool in sales. Some man-agers use sales quota as a forecasting guide, others use it as an evaluation tool or a motivational tool. But how does the quota level affect salesper-sons’ motivation, and better still their performance? These issues are less clear, nonetheless they must be understood if managers are to continue to rely on the use of sales quotas as motivational tool. Within this con-text, Chowdhury’s (1993) study was significant. The author developed a set of hypotheses on the motivational function of sales quotas using Locke’s (1968) goal-setting theory and Atkinson’s (1957, 1958) achieve-ment theory to conceptualize a role expectancy model. In developing his model, Chowdhury acknowledged the contradictions in expectancy theory as postulated by Vroom (1964) and the later works by Locke (1968), and Locke and Latham (1984).

The results of the model, which was tested in a laboratory experi-ment in which 113 undergraduate students assumed the role of sales-persons and negotiated with opponents whose roles were simulated by a custom-designed computer program, show that effort increases up


to a point as quota level is increased. Thereafter, effort decreases as quota level continues to increase. The results further showed a dispa-rate impact of increased quota levels on salespersons. Salespersons who were high on self-efficacy felt the increased quota levels more intensely than salespersons who were low on self-efficacy. Also, information on task-difficulty level influences the salespersons’ motivation to expend effort on the task.

Supervisory Control of Sales Team

Why is control, particularly supervisory control, of salespersons necessary? We alluded earlier to the effects of information asymmetric condition in selling, which provide a partial answer. However, a more detailed answer lies in what is accomplished through supervisory control. Anderson and Oliver (1987) identified two types of supervisory controls—output con-trol and behavior control, which were also considered to be information and reinforcement. Empirical studies on the effect of controls produced ambiguous results. While Jaworski, Stahakopoulos, and Krishnan (1993) found that output control increases end performance, Oliver and Anderson (1994), in contrast, found that it decreases relative end perfor-mance. Similarly, contradictory results were documented for behavior controls: Oliver and Anderson found that it improves job satisfaction, while Jaworski, Stahakopoulos, and Krishnan found no direct effect on job satisfaction.

Challagalla and Shervani (1996) reasoned that the conflicting results and the failure of previous empirical studies to observe hypothesized effects of output and behavior controls were, among other things, due to the restricted perspectives adopted on the dimensions of the controls, the types of controls examined, and the indirect effects of the controls. The authors also disaggregated behavior control into activity control and capability control and examined both the direct and indirect effects of control mechanisms. Challagalla and Shervani collected data from 270 salespersons, 5 industries, and 2 Fortune 500 companies, and tested their hypotheses using four regression models. The results show that information and reinforcement effects vary. These authors make a case for supervisors to distinguish between the information provided and the reinforcements given to salespersons. Furthermore, the results show that activity and capability controls have different effects; supervisory


control has indirect effects on salespersons’ performance, but direct and indirect effects on job satisfaction.

Selling, particularly industrial selling, given its long-term orientation has over time evolved into relationship management. A critical factor in this buyer-seller relationship is the salesperson’s knowledge, yet previous studies have glossed over how salespersons learn and its impact on their job satisfaction. Harris, Mowen, and Brown (2005) sought to empiri-cally address this knowledge gap in the following three ways:

1. How learning and performance influence a salesperson’s customer/selling orientation?

2. Whether there are any personality variables that influence the performance orientation, and if there are, what are they?

3. Whether goal and selling orientations influence work satisfaction?

The authors collected data from real-estate selling agents in six large real-estate firms. They reasoned that purchase and selling of real estate is a complex process that not only requires sellers to have good knowl-edge of what they are selling but also requires customers to trust the selling agent. The results of the analysis using linear structural equa-tion modeling suggest that, first, goal orientation is essential to customer orientation and “selling-oriented sales approaches” in the real-estate market. Furthermore, learning-oriented salespeople are more likely to exhibit customer-oriented selling behaviors. Second, learning orientation was found to be influenced by materialism, among other things, while materialism is positively influenced by performance orientation. Third, both customer and performance orientations influence work satisfac-tion. However, the results do not show that learning and selling orienta-tions positively impact work satisfaction. This relationship needs further study; it is possible that the nature of the real-estate market may have masked any plausible effects.

Team Selling

Selling need not be an individual effort. In fact, many organizations have selling teams. In spite of their presence, studies on the control of sales force have been generally focused on individual selling efforts (see Challagalla and Shervani, 1996; Weitz and Bradfrod, 1999; Ramaswami and Singh, 2003). To the extent that many organizations use selling


teams, understanding ways in which the effectiveness of these selling teams could be enhanced is also important. This point is more pressing in view of the results of a study conducted by Elling and his colleagues on the pharmaceutical industry, which shows that mismanagement of selling teams is not only common, but the industry could lose as much as $20 million per year on account of underperforming teams (2002).

Clearly, managing a selling team is much more complex than man-aging a salesperson. In addition to individual loyalties and goals being different in a selling team, different skills on issues such as conflict man-agement, setting team goals, and planning are needed. Lambe, Webb, and Ishida (2009) were among the first researchers to study the perfor-mance of self-managing selling teams. The authors specifically empiri-cally examined “the influence of empowerment and control on the degree to which selling teams engage in desired self-managing behaviors” and collected data from 124 sales representatives, who worked under 10 dis-trict managers and were employed with a large global pharmaceutical company. The results of the data analyzed using structural path analysis show that (1) self-management has a strong positive influence on team performance, and (2) empowerment results in the achievement of desired results by self-managing selling teams.

The authors surmised that their findings suggest that even though empowerment is positively associated with desired behaviors, “sales man-agement’s use of control can increase substantially the degree to which selling teams exhibit advantageous team self-management behaviors” (Lambe, Webb, and Ishida, 2009, p. 13). Thus, the “wrong form” of management can also have undesirable effects on the self-management of the team. While these findings are significant and important in the context of team selling, it ought to be noted that the study was limited to only the pharmaceutical industry.

Selling and New Products

How do salespeople behave with respect to new products? This is an interesting question given what we thus far know about new products—they are expensive to launch and some previous studies such as Bayus, Erickson, and Jacobson (2003) indicate that the profits from introduc-ing new products might not necessarily come from revenue improve-ments but rather from cutting down on operational support as well as selling and general administrative expenditure (SG&A). This knowledge


suggests that management would be concerned about efforts allocated by salespersons to selling new products. Ahearne, Rapp, Hughes, and Jindal (2010) hypothesized that managers may overmanage the sales force through behavior-based control systems in order to get them to behave according to management’s wishes with regard to new products. The authors collected longitudinal data from 226 salespersons along with external ratings from customers and archival measures of efforts and sale performance. The results of the analyses suggest that behavior-based controls rather constrain the ability of salespersons to appropriately allocate efforts across their customer base. As such, this negatively affects their customers’ product perception and ultimately affects new-product sales. Outcome-based control systems, in contrast, allow salespersons to “work smarter” on behalf of all products including the new products resulting in customers’ positive product perceptions, which have positive effects on the new-product sales.

Conclusion

Sales force management is more than hiring a group of individual sales-persons. From the discussions above and a review of previous studies, it is clear that the sales force management decision actually begins with an answer to the question of whether the company should hire its own sales team in the first place or contract the selling activities to independent agents. Because these decisions have serious financial implications, we argue that they are best handled by an interfunctional team involving marketing, finance, and production folk. By benefiting from several rel-evant viewpoints, decisions made are more likely to reflect the concerns of most internal stakeholders and less likely to be kicked around in a blaming game.


Having now completed reading chapter 6, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing case 6, appendix 1, titled “Honesty, Inc.”


References

Ahearne, M., Rapp, A., Hughes, D. E., and Jindal, R. (2010). “Managing Sales Force Product Perceptions and Control Systems in the Success of New Product Introductions,” Journal of Marketing Research 67:764–776.

Anderson, E., and Oliver, R. L. (1987). “Perspectives on Behavior-Based ver-sus Outcome-Based Sales Force Control Systems,” Journal of Marketing 51 (October): 76–88.

Atkinson, J. W. (1957). “Motivational Determinants of Risk Taking Behavior,” Psychological Review 64:359–372.

Atkinson, J. W. (1958). “Toward an Experimental Analysis of Human Motivation in Terms of Motives, Expectancies, Incentives,” in Atkinson, J. W., ed., Motives in Fantasy, Action and Society. Princeton, NJ: Van Nostrand, 288–305.

Bayus, B. L., Erickson, G., and Jacobson, R. (2003). “The Financial Rewards of New Product Introduction in the Personal Computer Industry,” Management Science 49 (2): 197–210.

Chowdhury, J. (1993). “The Motivational Impact of Sales Quotas on Effort,” Journal of Marketing Research 30 (February): 28–41.

Challagalla, G. N., and Shervani, T. A. (1996). “Dimensions and Types of Supervisory Control: Effects on Salesperson Performance and Satisfaction,” Journal of Marketing 60: 89–105.

Elling, M. E., Fogle, H. J., McKhann, C. S., and Simon, C. (2002). “Making More of Pharma’s Sales Force: Pharmaceutical Companies Have Lost Their Focus on Doctors. The Key to Higher Sales Is Regaining It,” The McKinsey Quarterly, Summer, 86–95.

Federal Trade Commission [FTC] (2000). “FTC Settlement Protects Door-to-Door Sales Consumers,” FTC Press Release.

Harris, E. G., Mowen, J. C., and Brown, T. J. (2005). “Re-examining Salesperson Goal Orientations: Personality Influencers, Customer Orientation, and Work Satisfaction,” Journal of the Academy of Marketing Science 33 (1): 19–35.

Jaworski, B. J., Stahakopoulos, V., and Krishnan, H. S. (1993). “Control Combinations in marketing: Conceptual Framework and Empirical Evidence,” Journal of Marketing 57 (January): 57–69.

Lambe, C. J., Webb, K. L., and Ishida, C. (2009). “Self-Managing Selling Teams and Team Performance: The Complementary Roles of Empowerment and Control,” Industrial Marketing Management 38 (1): 5–16.

Locke, E. A. (1968). “Toward a Theory of Task Motivation and Incentives,” Organizational Behavior and Human Performance 3:157–189.

Locke, E. A., and Latham, G. P. (1984). Goal Settings: A Motivational Technology That Works! Englewood Cliffs, NJ: Prentice Hall.

McGreagor, D. (1960). The Human Side of Theory Enterprise. New York: McGraw-Hill.


Oliver, R. L., and Anderson, E. (1994). “An Empirical Test of the Consequences of Behavior and Outcome-Based Sales Control Systems,” Journal of Marketing 58 (October): 53–67.

Ramaswami, S. N., and Singh, J. (2003). “Antecedents and Consequences of Merit Pay Fairness for Industrial Salespeople,” Journal of Marketing 67 (4): 46–66.

Vroom, V. (1964). Work and Motivation. New York: John Wiley & Sons.Weitz, B. A., and Bradford, K. D. (1999). “Personal Selling and Sales

Management: A Relationship Marketing Perspective,” Journal of the Academy of Marketing Science 27 (2): 241–254.

CHAPTER 7

Marketing Communication

To say that marketing communication is vital to the very exis-tence of a company is an understatement. According to Media Matters, a typical American adult stands to be exposed to about

600 to 625 such exposures per day. Approximately 272 of these expo-sures come from the traditional media such as TV, radio, magazines, and newspapers. These statistics, it is claimed, are more sound than the approximately 1,600 exposures attributed to Edwin Ebel’s (1957) remark on advertising effectiveness, which is often cited in books and papers but found to be baseless. Regardless of the true number, many people will agree that on a continual basis the sensory organs of the average American receive a fair amount of unsolicited or solicited prod-uct information from companies.

To cut through the clutter from competitors and reach their desired target audiences, companies communicate using a collection of modes known as the communication mix. In an integrated communication strategy, a company uses a communication mix that consists of adver-tising, sales promotion, public relations, personal selling, direct mar-keting, web-based information, corporate logo, company uniform, and instructional material. While the communication mix is usually dis-cussed as a matter entirely under the purview of marketing folk, we believe that limiting the decision to marketing folk on which commu-nication elements to use, at what time, and how much emphasis to put on each one of them could prevent other relevant views that should factor in such decisions from contributing to the analysis. For example,



besides the obvious cost-benefit analysis, how are the costs involved treated? Are they considered as sunk costs, which are irrecoverable, or as relevant costs to be recovered? If these costs are recoverable then how are they to be recovered? These questions would suggest that includ-ing finance and accounting people in the processes leading to decisions regarding the use of the communication mix is a wise idea, which we will explore further in this chapter. Because in our view advertising and sales promotions are topics that warrant in-depth discussions, we cover them in separate chapters, therefore they will not be covered again here. Thus, subsequent discussions will be on public relations, personal sell-ing, direct marketing, web-based information, corporate logo, company uniform, and instructional material as means used to reach a company’s targeted audience.

Marketing Communication Channels

Public Relations

Public relations popularly referred to as PR is a well-coordinated effort to cultivate favorable public image for the company. Even though it does not involve the selling of any of the company’s products, its long-term goal is to stimulate interest in the company’s offerings as well as in the company itself. Corporate PR activities are also geared to generate pub-licity for the firm. They involve activities such as special events, mak-ing press releases, and sponsoring newsworthy third-party community activities and events. An example of well-known PR activity that involves sponsorship of third-party activity is the US Post Office’s sponsorship of the United States’ cycling team in the past several Tour de France cycling competitions. Other equally well-known PR third-party sponsorship activities include Coca-Cola’s sponsorship of 2012 London Olympics; Nike’s sponsorship of 1996 Atlanta Summer Olympic Games, which were marred by the Centennial Olympic Park bombing; IMG Financial’s sponsorship of New York Marathon; and Vodafone’s, a British multina-tional telecommunication company, sponsorship of Ferrari Formula 1 auto racing teams and Manchester United soccer team.

The recent major thrust of many multinational companies in the public sphere of philanthropy is due to Corporate Social Responsibility (CSR), described by Bowen (1953) as “the obligations of businessmen to pursue those policies, to make those decisions, or to follow those lines

Marketing Communication l 101

of action which are desirable in terms of the objectives and values of our society.” However, many scholars such as L’Etang (1994), Markwick and Fill (1997), and Frankental (2001) have questioned the motive behind CSR efforts by many organizations and argue that companies could be using CSR activities simply as a PR tool. Thus, companies need to be careful about how they go about their PR activities. In an effort to cul-tivate goodwill and positive press, they may end up doing just the oppo-site. In spite of these possible negative perceptions, PR remains a potent tool in a company’s arsenal to stimulate public interest.

Personal Selling

Personal selling involves interpersonal encounters in which the sales-person or team tries to educate the potential buyer on the product. It is more often used in selling to industrial customers because it allows the sales force to give an immediate response to questions the potential buyer may have regarding the product. It is also permits cultivation of relationships, which are often important in selling to industrial buyers. Because relationships are involved, it is often argued that personal selling allows sellers to have the buyers’ best interest at heart. However, we think having the best interest of the buyer at heart should not be limited to personal selling alone; rather, it should be the focus of every interaction with a buyer whether through personal or impersonal means. Though expensive, the benefits of using personal selling could outweigh its costs. Hence, its use must be examined carefully. Its advantages include being able to explain complex aspects of the product being sold. Heavy-duty industrial equipment and other industrial machineries lend themselves to sales through personal selling, and more specifically, by a selling team. Personal selling also allows the sales force to deal with rejections or res-ervations that the potential buyer may have.

In addition to industrial equipment, personal selling is also used to sell low-margin, high-volume products such as encyclopedias and home-security systems; however, advancements in technology that have led to lower telecommunication rates have led to significant reduction in the use of personal selling for low-margin, high-volume items. Instead of selling such items through personal selling, one is more likely to see such items being sold through telemarketers. Can you think of other instances in which the use of personal selling could be beneficial to the company?


What about high-ticket and luxury items? Many consumers of luxury and high-ticket items such as fur coats, expensive wristwatches, and large carat diamonds want to be waited upon and the features of their expen-sive buys explained to them in person by a live person instead of bro-chures; hence, such items are also best sold through personal selling.

The quintessential question in using personal selling is, how many people should the firm hire? We don’t believe that there is much debate over the fact that the firm must hire enough staff “to get the job done.” This means that the personal selling team should not be under- or over-staffed. On the one hand, understaffing the team to cut on expenses is false savings, since the overtaxed team will be ineffective and will be quickly demoralized on failing to achieve company goals. This could also lead to “burn out” and job dissatisfaction of sales force. This issue has been investigated by several academics, and there seems to be a con-sensus that setting unreasonable and unattainable sales goals has a detri-mental effect on salespersons (Low et al., 2001; Lewin and Sager, 2007). On the other hand, overstaffing the sales team will cost the company unnecessary expenses and lead to inefficiencies. The best approach is to strike a balance.

Several approaches are used to hire approximately the right number of sales staff. One approach is discussed below. Consider the scenario where the company has a policy that salespersons must call on an account X number of times during a fiscal year with each call lasting T hours on average (including traveling time), the company anticipates servicing Y accounts, and budgets for Z total selling hours per salesperson during the fiscal year. With this information, we can calculate the minimum number of sales representatives, A, which the company needs to hire, as follows:

A =× ×X Y T

Z

Direct Marketing

When was the last time you received a spam message on your com-puter? When was the last time you got the so-called junk mail in your mailbox? When was the last time the churning of your fax machine at home woke you up in the night with a fax message from someone trying


to sell you penny stock? And when was the last time you received an unwanted telemarketing call that was trying to “sell you” a lower-rate mortgage? It is very likely that most of your answers to the questions posed above would be yesterday or today. This fact suggests the extent to which direct marketing aided by advancements in technology is a constant and an ever-present part of our lives.

Direct marketing, as the questions above suggest, obviously, has sev-eral components. It can be a direct mail from the seller (or sent on the seller’s behalf) to the consumer. It can also be done through the computer (Internet) or the telephone (by real or automated caller or text message). The advantage of direct marketing is its low cost. However, whether it obtains the desired results, which is to inform the consumer and stimu-late his/her interest in the product sufficiently to make him/her want to buy, is a different story. The term “junk mail” came into being because consumers actually considered unwanted and unsolicited mail as “junk.” However, technology and more sophisticated database management tools have enabled marketers to now narrowly tailor their use of direct mail so that they are directed to the target market that is more likely to find the sent information useful. In that case, “the mail” will no longer be considered junk, but rather a relevant piece of information.

With technology, marketers can now customize direct mail to not only address the customer by his or her name, but also to as much as feasible, speak to the customer’s needs. Also, thanks to technology, mar-keters who use direct marketing can afford to be flexible and current without incurring a lot of cost. However, advancement in technology also acts as a double-edged sword. With technology, consumers can afford to block unwanted messages. Also, laws have been introduced in the United States, at both the federal and state levels, so that telemarketers are not allowed to call consumers having their names on the “do not call reg-istry.” Similarly, consumers can opt out of receiving direct-marketing email messages by unsubscribing.

Web-Based Information

Companies with web presence use their websites for two main purposes: (1) to give information about the company, and (2) to sell. Even though the two objectives need not be mutually exclusive, the design of the web-site could vary depending on the primary objective. To give information


about the company, a company may use high-level content, videos as well as graphics, which can slow down loading time; however, slow-loading websites may put off potential customers who are time starved. The long loading time of a website could lead to loss of some impatient potential customers. Hence, websites whose objective is to sell must be easy to navigate, quick to load, and must liberally use headings or subheadings. They must also give customers the opportunity to skip from one place to the other.

How does the Internet impact the communication activities of the firm? This is a relevant question given how widely the Internet has permeated the lives of consumers. While there may not be a defini-tive answer to this question since application of the Internet is con-tinually evolving, at the minimum, the question forces companies to be thoughtful of how they use the Internet. In a study related to this issue, Lagrosen (2005) examined how marketers use Internet communication in marketing services and the effect of Internet on the other communi-cation channels by interviewing 19 companies in the service industry in Sweden. The author finds that three different types of communication strategies—mass communication strategy, mass relationship strategy, and personalized communication strategy—are used. These strategies are used depending on the size of the company. Large companies seem to favor mass-relationship or mass-transaction communication strategy even though operating in services industry, which requires extensive interaction with consumer, is best serviced by personalized communica-tion. It is not a surprise that the author finds that small or decentralized companies favor personalized communication strategy. Large compa-nies also use Internet communication to support the communication of other more-established integrated marketing communication (IMC) elements such as advertising, while small companies use personalized communication as a tool to network, considering their customers as their partners in networking.

Advertising through websites has become commonplace, hence the race now seems to be on how to catch the consumers’ attention while they are on the website. While some companies provide videos, games, and static banner advertisements (ads), an increasing number of them have resorted to the use of animation. Are these animated banners effective in arresting attention and persuading consumers? These questions were the subject of an experimental study conducted by Yoo, Kim, and Stout


(2004). The authors designed a 2 by 2 experiment consisting of anima-tion versus static banner, and low versus high product involvement. Fifty undergraduate students (29 males and 21 females) participated in the study. It is important to note that using students in this type of study is particularly relevant because students form a significant proportion of the Internet population.

The results of the study show that animated banner ads are not only more effective than static ads in catching the attention of website traffic, but they also generate higher recall as well as have more favorable and higher click-through intention than static banner ads do. Furthermore, the study finds that “effect of product involvement on attention was inde-pendent from animation effects” (Yoo, Kim, and Stout, 2004, p. 56). However, the study did not find any evidence of a hierarchy of effects in banner advertising. Even though these findings are based on experiments and therefore the results could be different from real-life results, they are interesting and worth the notice of ad managers.

What about background colors of websites, do they matter? It is not surprising that such questions have taken a new dimension given the constant search of companies for the “holy grail” that can accord them a competitive advantage on the web. A study investigating the effectiveness of background colors of websites on attitude measures such as attitude toward the ad, attitude toward the brand, attention to the commercial, and purchase intention was conducted by Stevenson, Bruner II, and Kumar (2000). The authors find in an experiment that manipulated the complexity of ads and background colors of web pages that more detailed web page backgrounds are not necessarily more effective on the attitude measures that count—purchase intentions and the like. However, simple background colors, in the case of the experi-ment, black, seem to be more effective in eliciting favorable consumer intentions.

Other Internet/Web-Based Means of Communications

Modern technology has widened the vista for direct marketing to include computers and mobile devices. The new means through which companies can provide company and product information to current and potential customers include the use of viral marketing, blogs, Facebook, MySpace, Twitter, YouTube, and the like. It must be noted though that the use of


modern technology is not without challenges. Some of the obvious chal-lenges involved in the use of computer-mediated means of communicat-ing are spam filters and blockers. In the next few paragraphs, we will briefly describe the above-listed means of communication and how they are used by marketers.

Viral MarketingViral marketing is also referred to as buzz marketing. According to Strauss and Frost, “Viral marketing is the online equivalent of word-of-mouth and referred to as word-of-mouse, which occurs when individuals forward e-mail to friends, co-workers, family, and others on their e-mail list” (2012, p. 292). Critical to the success of viral marketing is a preex-isting social network since the messages have to be forwarded from one person to the next. Viral marketing is used to send such items as text messages, video clips, interactive flash games, advergames, or web pages. One of the advantages of viral marketing is that the intended recipient need not necessarily be on the computer to be reached as he or she could be reached on mobile devices also.

The effectiveness of viral marketing is illustrated in an article writ-ten by Randall Eric in the September 1999 edition of Fast Company and reported in Strauss and Frost (2012). Randall reported that Hotmail’s promotion budget was $50,000 when it was launched, com-pared to between $50 and $100 million that would have been required. The company simply sent email messages to people telling them of its web-based email service. Within six months, the company regis-tered 1 million users. This number increased to 12 million users in 18 months.

BlogAccording to Blogpulse.com, reported in Strauss and Frost (2012), about 24,000 blogs are started every 24 hours. A blog is “personal diary” that is open to public and posted on a website. As a personal diary, it reflects the writer’s opinions and sentiments. BlogPulse is an automated search engine that monitors daily activities on blogs and generates trends and information. Because they are easy to start, blogs are usually used by individuals and small businesses to communicate with their audiences. A carefully written business blog could serve as a good communication device for the organization and draw readers to the company’s website.


Some blogs allow comments from readers; however, Wikis or Wikilogs are blogs specially designed for readers to participate by posting their comments or reactions to a posting on the blog.

MySpace

MySpace is one of the popular social networking websites, like Facebook, with emphasis on entertainment and music. Like Facebook, users can upload personal profiles, blog, photographs, and other infor-mation. Postings can be sent to all the members on one’s lists, or to a particular individual. Like Facebook, it is a great vehicle for companies not only to learn about individuals but also to send out information.

Facebook

Facebook is a social networking website that is in many respects similar to MySpace. Both are very popular with generations X and Y who are now in college or are about to graduate. Because of Facebook’s popular-ity with these age groups, it offers companies a great targeting vehicle as well as a means for companies to learn about individuals.

Twitter|

Twitter is a microblog and a social network that uses instant messag-ing. Because of its popularity, it offers a good advertising platform to companies.

YouTubeYouTube is a video sharing website that allows individuals to upload their videos for public viewing or sharing. Because of its popularity, companies could use it as a means to share instructional video clips on a product with the public. For example, a company that sells CPR (car-diopulmonary resuscitation) kits could demonstrate its use and post it on YouTube.

Corporate Logos and Colors

Corporate logos are identifiable shapes, objects, or marks that are unique to the corporations that own them. They are identity devices that are


meant to distinguish one company from the other and be recognizable by the public; as such, they represent the public face of the company. Besides adorning corporate head offices, stores, and vehicles, corporate logos are also used on corporate letterheads, uniforms, and in certain cases on products. Corporate logos link companies to the public, for that reason companies regard how recognized these logos are by the public as a measure of goodwill or a tangible asset. It is therefore no doubt that companies spend sizeable fortunes on promoting their logos and brands.

Logos are sometimes used together with certain colors to represent the company. For example, AT&T, the telecommunication giant, uses the color blue with its logo while McDonald, the fast-food king, uses yellow (the golden arches) with white letters on a red background; UPS is known for its brown and has even gone the extra mile to promote it in ads—recall “What Can Brown Do for You?” ads? It is not uncom-mon for companies to change their logos over time, sometimes ever so slightly. A change in logo occurs sometimes because of a merger or acqui-sition, with the new logo representing a fusion of the merged companies. However, a change in logo is also used by companies as a signaling device to communicate credible internal changes that are not directly visible to outsiders.

Company Uniform

Company uniforms are worn by company employees when they partici-pate in company activities such as going to work. Like logos, they are meant to identify employees’ employer (the company); however, some uniforms also have logos on them. Besides identification, company uni-forms say something about the companies they represent; this is particu-larly true in the services industry where uniform could be an integral part of the servicescape. Indeed, colors and designs of uniforms are not accidental; a look at the uniform of the employees of any of the major airlines makes this point clear.

Instructional Materials

Though not considered a part of the communication mix, instructional material can also be used to further a company’s cause. Besides educating


the consumer on products, instructional materials can also be used to promote the firm.

Integrated Marketing Communication (IMC)

What is IMC and what is it supposed to do? While different definitions may exist for IMC, a common theme that resonates through the dif-ferent definitions that we are aware of suggests that IMC is a process in which a firm uses all its communication variables in a coordinated and complementary manner to achieve its communication objectives. To use an IMC strategy successfully, therefore, requires the firm to have a number of things in place. First, it must have an objective. Most often this objective is to stimulate purchase. But, how would the firm go about stimulating purchase? This brings us to the second point, which requires the firm to have a target. Who is the target of the communication? Defining the target of the communication in turn requires the firm to determine the target’s communication or information needs. Is the target in need of reinforcement of the usefulness of the product? Or the target rather needs information on price, the product, or location? Where is the audience likely to get its information? Is it from friends, newspapers, online, or magazines?

Answers to the above questions not only greatly shape the nature of a firm’s IMC strategy, but also determine the relative weights placed on the different elements of the integrated communication mix. However, these questions also invite other departments, particularly the finance depart-ment, to participate in the firm’s IMC strategy, an area that has been traditionally reserved for the marketing department. The participation of the finance department will more likely force the firm to put into con-crete financial terms (money) what it expects to get back financially from the expenditures on the IMC strategy. There are no clear-cut practical methods for computing the return on investment (ROI) on IMCs; how-ever, different metrics could be developed to link the accomplishments of the IMC’s goals to financial accomplishments. Also, the models that we will discuss in chapter 8 on assessing the effectiveness of ads could be adapted to the broad mix of IMC.

There is still work to be done though. This work is promoted by this question: Should the IMC strategy aim solely at getting the consumer to purchase the product/service? An affirmative answer to this question


will be a rather myopic view of IMC. The answer therefore should be a resounding “NO!” Consumers’ reported regret or remorse after pur-chasing a product, also known as postpurchase dissonance, is real (see Rosenzweig and Thomas, 2012; Watson and Ruoh-Nam, 2013); hence, the case for reinforcement information for consumers after purchase. Furthermore, the increasing importance of word-of-mouth advertising in promoting products/services suggests that marketers must not neglect consumers after purchase; indeed, they should take the need for postpur-chase reinforcement information seriously.

How Widely Adopted Is IMC?

We believe the case for inviting other departments, especially the finance department, to participate in formulating the company’s IMC strategy is sold, however, the precursor question that should be asked is how widely adopted is IMC? Despite its intuitive appeal, it does not seem that many firms are practicing IMC. Low (2000) investigated the correlates of IMC and sought to find the factors that play a signifi-cant role in a company’s integration of its marketing communication activities. The study examined a cross-section of companies in differ-ent industries with a pragmatic instrument developed by the author to measure IMC, having first identified that the absence of consistency in defining and measuring IMC may have stif led research advancement in this area.

The results of the study have an interesting parallel to Lagrosen’s (2005) study of how firms use the Internet to communicate with con-sumers. Low (2000) finds that smaller, consumer-focused, and service-oriented firms tend to have their communication programs integrated; this is also common in manufacturing, agriculture, forestry, and mining industries. The author also finds a strong positive relationship between IMC and performance measures such as market share, sales, and profit. Furthermore, firms with greater integration seemed to have managers with more experience. It is interesting to note that in a survey of 421 executives, only 12 percent of the respondents indicated that communi-cation programs were fully integrated. This, of course, suggests that a lot more work has to be done by marketing folk. First, they must move to fully integrate their communication activities. Second, they should bring along finance folk as well.


Conclusion

What is the objective of marketing communication? How do we know that its goal has been accomplished? Reasonable people can differ sig-nificantly on the answers to these questions. However, one cannot deny that ultimately marketing communication activities should help the firm to make money. Thus, it would seem logical that the effect of IMC on the share price would be one of the good ways of evaluating its effectiveness. One could argue though that given the possibility that several other variables could affect a firm’s share price, an alterna-tive to evaluating the effect of IMC is to set its goal in financial terms. It is in this respect that we argue for the involvement of finance folk also in designing a firm’s IMC. They too have a role, indeed a valid role to play.


Having now completed reading chapter 7, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing case 7, appendix 1, titled “Golan, Inc.”

References

Bowen, H. R. (1953). Social Responsibilities of the Businessman. New York: Harper & Brothers.

Frankental, P. (2001). “Corporate Social Responsibility—A PR invention?” Corporate Communications 6 (1): 18–23.

L’Etang, J. (1994). “Public Relations and Corporate Social Responsibility: Some Issues Arising,” Journal of Business Ethics 13:111–123.

Lagrosen, S. (2005). “Effects of the Internet on the Marketing Communication of Service Companies,” Journal of Services Marketing 19 (2): 63–69.

Lewin, J. E., and Sager, J. K. (2007). “A Process Model of Burnout among Salespeople: Some New Thoughts,” Journal of Business Research 60 (6): 1216–1224.

Low, G. S. (2000). “Correlates of Integrated Marketing Communications,” Journal of Advertising Research 40 (May–June): 27–39.

Low, G. S., Cravens, D. W., Grant, K., and Moncrief, W. C. (2001). “Antecedents and Consequences of Salesperson Burnout,” European Journal Marketing 35 (5–6): 587–611.


Markwick, N., and Fill, C. (1997). “Towards a Framework for Managing Corporate Identity,” European Journal of Marketing 31 (5–6): 396–409.

Rosenzweig, E., and Thomas, G. (2012). “Buyer’s Remorse of Missed Opportunity? Differential Request for Material and Experiential Purchase,” Journal of Personality and Social Psychology 102, 2 (February): 215–223.

Stevenson, J. S., Bruner II, G. S., and Kumar, A. (2000). “Webpage Background and Viewer Attitude,” Journal of Advertising Research, January–April, 29–34.

Strauss, J., and Frost, R. (2012). E-Marketing, 6th ed. Upper Saddle River, NJ: Pearson.

Watson, M. Z., and Ruoh-Nam, Y. (2013). “An Exploratory Study of the Decision Processes of Fast versus Slow Fashion Consumers,” Journal of Fashion Marketing and Management 17 (2): 141–159.

Yoo, C. Y., Kim, K., and Stout, P. A. (2004). “Assessing the Effects of Animation in Online Banner Advertising: Hierarchy of Effects Mode,” Journal of Interactive Advertising 4 (2): 49–60.

CHAPTER 8

Advertising

Advertising is often discussed as one of the central elements of the integrated marketing communication (IMC). Of course, discussing it in a chapter by itself, instead of a chapter discussing

it along with other communication elements, does not change the fact that it is a part of communication elements. However, discussing it by itself gives us the opportunity to study it more in-depth than we would have done had we discussed it with the other communication elements. Furthermore, devoting a chapter to advertising is also consistent with the fact that significant research efforts have been devoted to it, as evi-denced in the number of academic and practitioner journals and articles specifically devoted to it.

There have been several major changes, over the years, in advertising as a communication element. Zinkham and Watson (1996) observed that at least five new forms of communication have been either wholly or partially created during the twentieth century and likened the changes that have taken place to a process of “creative destruction.” Not only has the century witnessed innovation and inventions such as the radio, television, videocassette recorders, and online media, but hybrid forms of those primary inventions are also available for advertising. While these inventions have brought with them a greater reach for produc-ers of goods/services, it is also clear that producers of goods/services in the United States continue to spend an enormous amount of money on advertising.



According to the eMarketer (2013), US producers spent $171.1 billion on advertising alone in 2013. This figure represents a 3% increase over what was spent in 2012; moving along its current trajectory, producers are projected to spend about $196.95 billion on advertising in 2017. Part of the increasing cost of advertising has been attributed to the increas-ing role being played by the digital media as a vehicle for advertising. There is not much argument that advertising expenditures have dramati-cally increased over the years even when corrected for inflation; what seems to be generating a heated debate, however, is whether advertisers are getting worthwhile returns on their dollars. The fact that this issue is being debated at all suggests that there is a well-founded belief that advertising should be treated as an investment that is supposed to gener-ate returns, just like investment in new products. The idea of assessing return on advertising expenditures is not new and has been discussed by commentators as far back as the 1960s and 1970s (see Britt, 1969; Campbell, 1969; Anderson, Barry, and Johnson, 1975; Reilly, McGann, and Marquardt, 1977). However, before we get to discuss the merits of this suggestion, we first need to discuss what advertising is and what makes for an effective advertisement (ad).

What Is an Advertisement?

Kotler and Keller (2009) defined advertising as “any paid form of non-personal presentation and promotion of ideas, goods, or services by an identified sponsor.” Noticeably absent in this definition though is what the average person thinks advertising is. Most people believe that advertising is a message “spread” on behalf of a corporate sponsor that is intended to persuade consumers to purchase the sponsor’s products. While an argument can be made that not every ad is intended to persuade con-sumers to purchase, to the extent that that is the goal of majority of ads, we will say that the average person is right in his/her belief of what an ad is. Indeed, it is the ad’s persuasion to purchase that gives us one of the most useful metric to evaluate its effectiveness.

Advertising is an interesting and complex communication process with many “players.” Hence, its success depends on the success of each player and each role. The principal players are the sender of the message(s), the receivers of the message(s), the symbols that are being used to communicate, and of course, the vehicle(s) used to convey the

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message(s). The interplay between these players is depicted in figure 8.1 in a rather simple model.

Also crucial to the communication process, though it does not itself play a role, is the communication’s goal. There is generally one sender at one time who sends the message, or on whose behalf a message is being sent; however, it is not unusual to have multiple receivers (targets), and even multiple messages and vehicles. Certainly, just as in personal conversations, the use of multiple messages could easily lead to confu-sion, hence senders who use multiple messages for the same purpose (objective) must guard against causing confusion. It is also important that both the senders and receivers share a common meaning of the symbols used to communicate, otherwise confusion could easily result. Many marketing blunders particularly cross-border and cross-cultural marketing problems have been traced to this problem (see chapter 10 for examples).

Advertising Vehicles

There are many vehicles available to advertisers. The list includes, but is not limited to, symbols and logos, print media, broadcast media, bill-boards, display signs, and packages. It is important to note that this list is not exhaustive and that the number of vehicles for advertising keeps growing, thanks to advancements in technology.

Symbols(Words, pictures, logos, etc.)

ReceiversMessage(s)Sender

Vehicle(s)(Cinema, print media,

broadcast media,billboards, etc.)

Figure 8.1 A simplified communication process.


Symbols and Logos

We have chosen to discuss symbols and logos first as advertising vehicles because we have already referred to them in chapter 7 on IMC, where we emphasized symbols and logos as means to distinguish the company in a crowded marketplace. Here, we wish to discuss symbols and logos a little differently. One of the important aspects in using symbols and logos as an advertising vehicle is that both the sender and the receiver(s) must share the same meanings for the symbols. For example, if a bank (a financial institution) chooses to use a lion as its symbol to convey its vigilance over clients’ deposits or its ability to safeguard clients’ money, then it is important that potential clients understand the symbolic mean-ing of the lion exactly as intended by the bank. If the potential clients take the lion to stand for royalty, instead of a symbol of security, then the bank may possibly lose some of its working-class potential clients who may think they do not belong to the royal class being targeted to deal with such a bank. This is an example of communication failure that all message senders must guard against.

Print Media

We put all the communication vehicles that involve print in this group. This category includes newspapers, periodicals, magazines, and journals. The choice of these vehicles, besides financial considerations (return on investments [ROI]), is driven by the advertiser’s target(s). Using a par-ticular print medium presupposes that the target market (audience) can read and is likely to avail that medium. It will make no sense if that is not the case. For example, it will be futile to use print medium to adver-tise a particular kind of powdered detergent aimed at poor illiterates in developing countries. However, it is perfectly appropriate for an airline to pitch its business class in newspaper (a print medium) that is popular with businesspeople.

Broadcast Media

Broadcast media as a vehicle for linking messages, senders, and message receivers has taken on a new dimension with podcasting. Traditionally, broadcast media include radio and television (i.e., both audio and visual). Because radio is strictly audio based, advertising on radio relies on listen-ers’ imagination to complete the picture that the sender is trying to paint.

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However, the absence of visuals is probably compensated by the flexibil-ity that comes with radio advertising. Not only can the ads be repeated several times, but spots can also be easily changed. Furthermore, they can be narrowly targeted to specific audiences, for example, listeners of radio theater, sports, and so on. An additional advantage in using the radio lies in its reach, since it is suitable to reach both urban and rural dwellers.

Billboards

Billboards have been classified by some organizations such as Zenith Optimedia as an important advertising vehicle along with television, radio, newspaper, magazines, Internet, and cinema. Whereas billboards used to be stationary and outdoor, creativity and technology have now made mobile billboards possible. It is not uncommon to find billboards on cycles that are used to carry passengers in some developing countries. Similarly, finding billboards on moving trucks and municipal buses is now commonplace even in advanced countries. Billboards could be nondiscriminating in terms of the people who see them, for example, those placed by the highways. However, the ability to place them is select communities is a big advantage. Furthermore, the ability to use pictures on billboards makes them particularly useful in reaching tar-gets that may not necessarily be able to read. According to a study by Taylor, Franke, and Bang (2006), businesses use billboards as a means to advertise because of their visibility, media efficiency, local presence, and because of the tangible responses they receive. They also identified factors that contribute to billboards’ success as an advertising medium as name identification, location of the billboard, readability, clarity of mes-sage, use as a tool of IMC, powerful visuals, clever, creative, and provider of information.

Display Signs

Display signs are becoming an important advertising vehicle with the advent of digital signage. The advantages of digital display signs lie in their flexibility, cost, and customization; being flexible, different mes-sages can be used in sequence on the same “board.” Different messages can also be used for the same product and at different locations depend-ing on demographic factors. Display signs can be used both indoors and


outdoors. Also, their location indoors can be changed easily—they can be displayed at point-of-purchase or anywhere else depending on product and traffic.

Packages

When was the last time you closely read a package? Besides product information, packages are also used as an advertising vehicle. Even though they are generally designed and intended to contain a product, packages also serve as an advertising vehicle that may be used to create or augment the product’s image (as in the case of expensive perfumes) or convey information on the product’s prestige (as in Rolex watch).

How Is Advertising Message Processed?

Although it is fairly old, has been criticized by some scholars (cf. Weilbacher, 2001), and does have alternative models such as Colley’s (1961) DAGMAR (Defining Advertising Goals for Measured Advertising Results) and Ehrenberg’s (1974) ATR (Awareness, Trial, Reinforcement), the hierarchy of effects model (Lewis, 1908) can still be a useful frame-work for marketers. The model popularly referred to as AIDA comprises four main levels as shown in figure 8.2.

Attention (or cognition) is the logical starting point of the commu-nication process, when the product or firm is new, or when the firm is going after a new target (i.e., a new audience). For a new product, the

A (Action)

D (Desire)

I (Interest)

A (Attention)

Figure 8.2 The AIDA model.

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firm has to get the consumer’s attention either to itself or to its offering. Similarly, the firm has to get the attention of its new target. Because this entails getting through a crowded “information space,” it implicates heavy advertising (blitz) through several different media (vehicles) and/or sales promotion.

Interest is the second level in the four-step process. Clearly, it is not sufficient for the firm to capture the attention of the potential buyer. Neither attention nor interest will translate into a sale; however, it is a step toward the firm’s ultimate goal. Hence, the firm must go beyond awareness and retain the interest of this audience (target). To retain inter-est, the firm must not only come up with creative ways, but it must also provide the target with reasons for wanting to buy the product. This means that the firm must provide the product’s attributes or features, compare the product with competition, and show how it is a superior “buy,” if it is. Websites retain visitors’ interest by providing rich content, information, relevant and interesting videos, and even games. Interest could also be maintained via the use of direct mail, which can serve as a frequent reminder. To some extent, personal selling could also be used, where cost effective and appropriate.

Desire (or affect) is the third level in the hierarchy that seems to logically f low from interest. There are unlimited and creative ways in which a firm could make the potential customer desire the product. Some firms emphasize how easy the product is to operate and main-tain. This technique is used well by the Shark company for its vacuum cleaners. Others emphasize how easy it is to acquire the product. The current “signthendrive” advertising campaign by Volkswagen, the German automobile manufacturer, is a nice demonstration of this tech-nique. Of course, narcissistic feelings are also used to whip up desire. Examples of such use involve ads with a catch phrase such as “Go ahead and treat yourself,” in which the seller invites the customer to “treat” him- or herself.

Action (or conation) is the last step in the four-step acquisition pro-cess. Here the potential customer becomes a “customer.” The seller has given enough reason to persuade the consumer to make the purchase. Certainly, information through the different IMC elements informing the consumer about the product’s availability is useful. Sometimes con-trived “scarcity,” in which the seller tells the customers about the limited number of the products available, gets the consumer to take action.


Other Advertising Models

As indicated earlier, the field of advertising has, over the years, attracted significant research efforts leading to a wide range of output in theo-ries and models that deal with how consumers process information or how advertising gets the desired results. While these theories and mod-els are important, it is not our intent to discuss any of them in detail here. Instead, we simply wish to draw readers’ attention to some of them and direct them to detailed information, if they wish to read on them further.

In addition to the hierarchy of effects, the DAGMAR, and the ATR models mentioned above, other often-discussed advertising models include the information-processing model (IPM) and the elaboration-likelihood model (ELM). The IPM (McGuire, 1978) classifies the antecedents of advertising effects into several factors following the classic-communication model. The identified factors are the source (the sender), the message (the message being sent), the receiver, the chan-nel (referred to in the communication model above as the vehicle), and the destination. The IPM also posits six hierarchical steps of advertising effects including (1) presentation of the communication, (2) attention to the communication, (3) comprehension of the arguments and conclu-sion, (4) yielding to the conclusion, (5) retention of the new attitude, and (6) behavior on the basis of the new attitude (cf. Scholten, 1996).

The ELM (Petty and Cacioppo, 1983) posits that consumers’ attitude toward an advertised brand occurs through (a) elaboration on arguments, which is a central route, or (b) heuristics, which may have inferences to brand quality through information obtained as a function of mere expo-sure to the brand, processed through the peripheral route (cf. Scholten, 1996). The likelihood of using either route depends on the consumer’s motivation and ability.

Humor, Absurdity, and Interestingness in Advertising

Humor

Advertisers, it would seem, want to ensure that they are pulling the right plugs given the enormous amount of money spent on ads. One of the issues that has attracted the attention of scholars during the past two decades is the use of specific cognitive and affective factors such as absurdity,

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humor, and fear in ads. Do these factors detract from the message being conveyed, or do they enhance it? It is also possible that they enhance consumers’ perception of brand, recall of an ad, as well the effective-ness of an ad. Because they are commonly used in ads, humor has also attracted academic efforts to examine the relationship between the use of humor in ads and viewers ability to recall, how they process humor, and their attitude toward ads with humor (Krishnan and Chakravarti, 1990; Scott, Klein, and Bryant, 1990). However, the questions, such as what makes an ad humorous and what makes viewers perceive some ads as more humorous than others even though they were intended to be just as humorous, remained unanswered. Alden and Hoyer (1993) set out to investigate humor in television ads.

The authors coded and analyzed 497 ads collected over a 3-day period in November 1990 from 3 national television networks—ABC, NBC, and CBS. Using Raskin’s (1985) semantic theory of contrasts and per-ceived humorousness as an analytical framework, the authors found that ads that use a “contrast between everyday life and the unexpected were generally perceived as more humorous” than those that use a “contrast between everyday life and the impossible.” The authors’ findings “sug-gest that the type of cognitive structure within an ad may play an impor-tant role in determining consumer perceptions of humor.”

Absurdity

As in the case of humor, the effect of absurdity on consumers’ percep-tion of ads is of immense interest to managers—do they detract from or enhance ads? Arias-Bolzmann, Chakraborty, and Mowen (2000) inves-tigated the effects of absurdity in advertising. They defined absurdity as “incongruously juxtaposing pictorial images, words and/or sounds that viewers perceive as bizarre, irrational, illogical and disordered. For example, ads for Camel cigarettes portrayed a dromedary, a cigarette dangling from his mouth, participating in sports and wearing fashion clothing” (p. 35).

The authors tested two competing predictions based on the princi-ple of evaluative consistency of cognitive elaborations (Chattopadhyay and Basu, 1990) and the distraction theory (Petty, Wells, and Brock, 1976) by manipulating the presence or absence of an absurd image in a simulated print ad for a nonexisting brand of a wine cooler. The results


of the study suggest that consumers’ prior attitude toward wine coolers moderate the effectiveness of absurdity in advertising. Those who viewed the ad with an absurd image with prior negative attitude toward wine coolers showed more positive attitude toward the ad and brand than those who viewed an ad with nonabsurd image. However, viewers with prior positive attitude toward wine coolers who viewed the ad with an absurd image showed no difference in attitude toward the ad and brand than those who viewed an ad with nonabsurd image.

The study also shows that absurdity positively affects consumers’ ability to recall brand names similar to the results of studies involv-ing persuasion. These findings support the mediating role of cognitive responses to absurd effects in advertising messages. It must, however, be noted that absurdity may have many dimensions; hence, the authors recommend future studies that investigate the construct validity of absurdity as an important further contribution. Similar to absurdity, the effects of interestingness of TV commercials have been examined by researchers. These days, when competition for consumers’ atten-tion by companies is intense, consumers are time starved, and using TiVo and channel surfing are almost the norm, it is important that the commercials aired by companies grab and sustain the consumers’ attention in order not to be “cut.” Thus, topic of interestingness of TV commercials is an important one.

Interestingness

Alwitt (2000) studied the interestingness of TV commercials by first developing the characteristics of interestingness based on a review of the literature. According to the literature, an interesting commercial has (1) an unexpected ending, (2) the brand may not be identified until late in the commercial, and (3) the message cannot be comprehended until late in the commercial. In essence an interesting commercial must have an information gap that must be filled by the viewer. The author then developed a series of hypotheses tested by data collected from domestic and international television commercials.

The study concludes on the basis of its results that interestingness of TV commercials is like sense-making in which viewers want to know “about the outcome of the execution, identification of the brand,” and in instances where they already knew the brand, they would want to

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“know the message that is being communicated.” Furthermore, the study found that an interesting commercial not only maintains viewers’ attention, but it also elicits more positive attitude from viewers toward the ad and the brand. What are the characteristics of an interesting commercial? The study suggests that an interesting commercial creates unexpected events. Therefore, advertisers need to create commercials with unexpected events if they intend to maintain viewers’ attention in this crowded space.

The Bottom Line and Accountability

Finding a way to determine the effectiveness of advertising is not a new problem, but has taken on added urgency given the large sum of money being spent on advertising in the United States alone. As indicated above, eMarketer (2013) estimates that $171.1 billion was spent on advertising alone in 2013. Grappling with the same problem over half a century ago, Lavidge and Steiner (1961) surmised that the problem of measuring advertising effectiveness may have been compounded by a mind-set in which the development and selection of research designs are absorbed in technique orientation; therefore, the authors decid-edly took an alternative, more pragmatic approach. They argued that designing a method of measuring advertising effectiveness must begin by asking what advertising is intended to accomplish. In answering this question, the authors suggested that regardless of how the answer might be parsed, the goal of advertising is to increase sales; however, this result cannot always be immediate, hence advertising does have a long-term orientation.

The authors outlined three major functions of advertising as follows: (1) to create awareness and provide knowledge, that is, advertising must provide information and ideas, (2) to create favorable disposition in consumers toward the product, and (3) to produce action, that is, get consumers to buy the product. These steps were related to the three psy-chological stages of (a) cognition, which refers to the intellectual or the rational state, (b) affection, which refers to the emotional or the feelings state, and (c) conation, which refers to the motivational or the striving state. Because all potential consumers are not necessarily at the same level, one of the tasks of measuring the effectiveness of advertising is to adopt the stepwise model of product acquisition and measure the


number of people at each stage and the number of people that moved to the next stage.

Britt revisited the question on advertising returns by asking whether the so-called advertising campaigns are really successful and how adver-tising agencies could confirm the outcome. In his quest to find answers to these questions, the author analyzed 135 advertising campaigns exe-cuted by 40 advertising agencies by outlining the following criteria:

1. Did the agency set specific objectives for the campaign, that is, objectives specific enough to be measured?

2. Did the agency attempt to measure the effectives of the campaign by clearly stating how the campaign fulfilled the previously-set objectives?

3. Were there any differences in results . . . in either specificity of the objectives on in fulfillment of objectives in terms of (a) size of agency or (b) product classification? (1969, p. 385)

The results show that only 2 campaigns out of the 135, or less than 2%, met the first criterion. Of the 135, 42 campaigns, or 31%, met the second criterion. Because of diversity of product classes represented by the 135 campaigns, assessment using the third criterion was hin-dered; nevertheless, it was found that about “sixty-nine percent of the campaign statements did not relate proofs of success of the advertising campaign to the stated objective of campaign.” Of course, the state of affairs with regard to advertising effectiveness and its assessment has dramatically changed since Britt’s (1969) study.

Anderson, Barry, and Johnson (1975) took up the issue of return on advertising (ROA). They suggest that clear decision criteria need to be established before an attempt to evaluate ROA is made. With regard to using quantitative techniques, the authors express the view that there is a need to specify objective criteria within the two frameworks in exis-tence at the time, namely, evaluation of advertising using communica-tive effects measurements and measurement of changes in sales method. Furthermore, there is also the need to state the preadvertising require-ments of the advertising efforts. One of the assumptions in these efforts is that effect of other IMC variables is held constant. Even so, there are enough criticisms of each approach. For example, the communicative effects approach has been criticized for its lack of empirical proof of

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attitude-behavior change relationships while the sales analysis approach has been criticized for ignoring the effects of the other IMC variables in contributing to improvement on sales.

The quantitative approach suggested by Anderson, Barry, and Johnson (1975) with emphasis on statistics includes experimental variable manip-ulation and nonexperimental post-facto analysis. This includes multic-ity testing, matched area testing, and time series analysis. While these techniques are reasonable, they are deficient on the account that they do not provide insight into future endeavors on the basis of past experi-ences. According to the authors, a method pioneered by Palda (1966) and extended by Simon (1971) that uses the delayed effects of advertising expenditure eliminates the effects of past advertising effects on current advertising, while it maximizes the future benefits of current advertising efforts by incorporating advertising retention rates, which are essentially carryover effects. Through these approaches, the effect of advertising expenditures on current and future sales could be measured.

According to Anderson, Barry, and Johnson (1975), the DAGMAR concept proposed by Colley (1961) is a communicative effects concept, which captures both principles and mental processes in a consumer’s acceptance of a product. The principles aspect of the concept separates the ads effect from the other IMC variables and distinguishes between marketing goals and advertising goals. The questions that must be answered in order to coordinate and converge decisions, according to the authors, relate to merchandise, markets, motives, messages, media, and measurements—dubbed by the authors as the 6Ms. With the DAGMAR framework, the effectiveness of an ad in moving consumers’ attitude from one level to the other could be measured with a pretest that measures the current level of attitude, the goals regarding the movement of attitudes, and posttests to determine the level of attitude after the ad. The problem with this measurement scheme is that it assumes that “attitude-behavior-purchase correlations” are sequential movements.

How Many People View the Ad?

The number of people who will view an ad is one of the common con-siderations for an advertiser in selecting a vehicle—the more the better. However, the number of persons who will view an ad is also used by media owners (TV or radio) to determine the cost of a 30-second spot,


which is expressed as Cost Per Thousand (CPM). The popularity of sporting events such as soccer in Europe and Football in the United States have contributed to steep rise in the cost of 30-second spots on TV for their championship games. However, the importance of website advertising has made click-through (defined as “number of visitors com-ing [from] different sources, such as google or referring sites,” Strauss and Frost, 2012, p. 301) rates also an important consideration. Other relevant metrics are “website page views and registration” defined as “number of visitors viewing the pages and number of visitors registering at the site,” and “volume and origin of site traffic” defined as “number of visitors coming from different sources, such as Google or referring sites” (p. 301).

A visit to a website may not necessarily lead to a sale, however, if a person stays longer at a website, it may be an indication that some-thing at the website is of interest to the viewer. Based on this logic, interest has been shown in keeping track of how long viewers remain at a website—web stickiness. For sites that advertise products, the longer a viewer remains, the more likely s/he is to buy something.

The Relationship between Advertising and Finance

The review of the literature shows that interests in assessing the ROA have been expressed more than half a century (cf. Anderson, Barry, and Johnson, 1975) ago, however, to the extent that folk in charge of adver-tising do not interface with folk in finance to determine an acceptable way of computing ROA, suggests that much more education on the interrelationship between the two is needed. It does not help matters that even most academic institutions where advertising is offered as a degree do not seem to be doing much to bridge the divide between advertising and finance folk. One possible reason might be the errone-ous perception that advertising is only concerned with creative stuff while finance people are concerned with only numbers.

Arguing that most of the previous works on assessing the wealth effects of advertising were theoretical in how they relate sales to earn-ings, Reilly, McGann, and Marquardt (1977) examined the relationship between advertising expenditure and stockowners’ wealth through stock price movements. The researchers gathered data on firms identified as top national advertisers by Advertising Age. Data of 71 firms collected

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over a 9-year period, starting from December 1964 through December 1972, were analyzed for variations in advertising expenditure during the period under investigation, and firms’ performance measured against the Dow Jones Industrial Average (DJIA) and the Standard and Poor’s 425 Industrial Index (SP425).

The results of the analyses show that (1) portfolio of large advertis-ing firms experienced between two to four times more annual returns than the aggregate market with firms of equal risk, and (2) consistent advertisers enjoyed higher sales growth and stock price appreciation than inconsistent advertisers. To the best of our knowledge, this study is the first that links advertising expenditure to stock performance and hence shareholders’ wealth.

Similar to the Reilly, McGann, and Marquardt’s (1977) study, Mathur and Mathur (1996) also analyzed a company’s stock perfor-mance when news was released that it had initiated a relationship with an advertising agency. The authors argue that announcement that a firm has initiated a relationship with an advertising agency may be a signal to investors or may reflect a change in strategy, and may, all the same, have implications for investors. Mathur and Mathur collected data from January 1989 through December 1994. The sample con-sisted of 173 announcements of new accounts that were tested for clus-tering and found to be “cluster” free. The presence of clusters would lead to overestimation of significance tests in regression analysis due to correlated residuals.

The authors formed three subgroups based on the information in the announcement. The first subgroup consisted of regular announcements that an account has been assigned to an ad agency. The second sub-group consisted of announcements involving an ad agency with whom a firm already had a relationship, for example, was previously produc-ing regional ads for a product, but would now be creating a national ad for firm’s another product. The third subgroup involved announce-ments on new activities by firms. The data were analyzed using the event-study technique. The results reveal the following: (1) negative wealth effects were associated with the first and second subgroups and (2) significantly positive wealth effects were associated with the third subgroup. Announcements involving prestigious ad agencies resulted in positive wealth effects, and announcements involving firms that were doing relatively poorly had relatively poor wealth effects. These results


do have implications for how firms strategically release information. It would seem that while more information is better than less information, how the information is parsed seems to be more important.

If information on initiation of a relationship with an ad agency leads to negative wealth effects, then what happens when information is released on termination of relationship with an ad agency? This issue was researched by Hozier and Schatzberg (2000) who concluded that the results were mixed. It would seem as though termination would be called for in the face of poor performance; however, the question is, are industry trends or factors responsible for the poor performance, instead? It might appear from signaling model viewpoint that the termination might also be considered as positive news. Why? It may be indicative of changes in the offing. However, the wealth effects may not be registered because the information may have been already anticipated and used previously in asset valuation models.

Conclusion

It is clear that the increasing expenditure on advertising cannot go without accountability. As a popular ad tag stated, “Where is the beef?” In other words, what are advertisers paying for? The answer to this question, though, throws us back almost 50 years to Britt’s (1969) study. What is the goal of advertising? Surely, it is supposed to impact consumers, but at the end of the day it should move sales. The ques-tion then becomes, “by how much?” It does not make financial sense to spend $10 million dollars to realize additional sales of $4 million. But how do we know how much ROA we want? It is not an absurd idea to get finance folk involved. In fact, that may be the best way to move the firm forward. Financial returns cannot be sacrificed at the altar of creativity.


Having now completed reading chapter 8, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing case 8, appendix 1, titled “Healthcare America Medical Center.”

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CHAPTER 9

Pricing and Sales Promotion

The price at which to sell a firm’s offerings, for several reasons, is one of the most important decisions for a firm. Price is the only variable that generates revenue for the firm, therefore it is the

engine or, better still, the gasoline in the engine that keeps the firm run-ning. A mistake in pricing could easily make the firm go bankrupt or out of business. Several books have been written on pricing and economists have devoted a significant effort to the study of pricing, yet our under-standing on how consumers use price is incomplete because there is a big psychological component to it. Though the psychological aspect of price still remains a black box to some extent, our current understanding can be useful to organizations particularly in terms of how they strategize to meet the consumers’ unmet needs, and also deep enough not to use price as a strategic variable because it can be easily copied by competition. We also know that price can be used as a signaling variable to convey nonob-vious information on quality (as discussed in chapter 4).

It is safe to say that regardless of other issues or objectives that might be associated with pricing, the basic pricing objective is to maximize profit. Of course, others along the veins of Simon (1972) will argue that the objective is to optimize profit. However, because the concept of profit maximization is intuitively appealing and simple, and for practical pur-poses not wrong, we will, in this discussion, stick to that concept.

There are two basic types of pricing strategies that are often used: full-cost pricing strategy and the variable-cost pricing strategy. Full-cost pricing strategy is based on the logic that the price paid by the cus-tomer should reflect not only the costs incurred in making the product/



service but also a “profit.” Diagrammatically, price can be shown to contain three strands (fixed cost, variable cost, and margin) as depicted in figure 9.1.

Every item made must bear some percentage of the fixed cost incurred in running the factory. To some extent, the greater the volume of items made the smaller the percentage of the fixed cost borne by each prod-uct. Let us take, for example, that the fixed cost in running a factory is $100.00 and only 20 items are made. Since the fixed cost would be allocated over the items made, each of the 20 items would bear $5.00 as its share of the fixed cost. However, this would decrease to $4.00 if 25 items were made, and to $2.00 if 50 items were made. Of course, this does not go on up to infinity since diseconomies of scale would set in after a certain point.

On the income statement, the variable cost is referred as the “cost of goods sold.” The variable cost consists of the direct cost incurred for labor and materials used in making an item. Sometimes, firms sell certain offerings at the cost of making it. Note, however, that would be a short-lived strategy designed to achieve certain short-term goals. Consider this strategy a little more for a minute. Selling at the variable cost simply means that the offering is not “paying its full way.” It is neither contributing anything to the overhead (the fixed cost), nor it is contributing anything to profit. So, why must the firm sell anything at the variable cost albeit for a short time?

Firms sometimes, for a short time, sell offerings at variable costs in order to stimulate traffic and boost sales for their other offerings. Sometimes the decision to sell at or close to the variable cost is driven by the desire to utilize idle capacity to produce an item on contract. For example, a beverage company that is operating below capacity could contract with a retail store and make a private label for the retail store

Full-costpricing

Fixed cost

Variable cost

Margin

Figure 9.1 Full-cost and variable-cost pricing strategies.

Pricing and Sales Promotion l 133

using its idle capacity. An argument could be made that there is no rea-son to charge the retail store for the fixed cost because that part of the production cost had already been allocated, and the idle capacity would have gone waste had the beverage company not gotten the contract.

As per figure 9.1, if the fixed cost is not charged to the customer, only two pricing strands remain, that is, pricing to the customer now comprises only the variable cost and the margin. However, the beverage company may not even charge the retailer the “full weight” of the mar-gin in a competitive environment.

Information and Value

Skimming and penetration pricing are also used when a firm introduces a new product. In skimming strategy, the producer sets an initial high price when the product is introduced. This initial price is, however, lowered over time. The logic behind the skimming strategy is that it allows the firm to quickly recoup its investment in the product before competition sets in, or before its patent expires. One therefore expects skimming strat-egy to be used with products such as high technology or pharmaceuticals that require huge R & D investments (Adams and Brantner, 2006).

Penetration strategy is the opposite of skimming. In this case the company introduces the product with an initial low price that is revised upward over time. Generally, most products are introduced this way since the firm initially subsidizes consumption in the hope that the consumers will “pay their own way” once they grow to like the prod-uct. Penetration pricing sometimes acts as a deterrent to competition. Competition may find it very difficult to match profitably, or sell under the current price. Skimming pricing, in contrast, invites competition. With the price of the product being high, competition could easily assume that a huge profit is being made and would therefore want to “get in on the act.”

As indicated earlier on, pricing more than any other issue calls for col-laboration across all the company’s departments because it is important for the company not to price itself out of the market, that is, selling at a price beyond the reach of its target market. With the finance, market-ing, and production management folk working together, not only could such a catastrophe be prevented, but also steps could be taken so that the price reflects the quality and the product is within the price range of its target market.


Value is another notion that cannot be overlooked in pricing. Many authors define value of product a as follows:

Valuea =Perceived benefits of product a

(1)Price of product a

Thus, the value of product a depends on the ratio of the perceived ben-efits of product a to the price of product a. This definition suggests that value is subjective and could vary depending on the consumer. Others have, however, defined value as follows:

Valuea =Perceived benefits of product a

(2)Price of a substitute of product a

They argue that the most appropriate way for a consumer to determine the value of a product is by comparing it with its closest substitute. Thus the numerator of equation 2 should be “the perceived benefits of product a,” and the denominator should be the “price of the closest substitute of product a.”

Gabor (1977) argued there are other pricing options such as (1) maxi-mization of the markup rate, (2) maximization of rate of return on the net worth of the firm, and (3) maximization of the rate of return on the total assets of the firm. However, as pointed out by the author, these options though theoretically possible are not really practically attractive. Why not? Let’s discuss a simple case he makes for the impracticality for “the maximization of total profits over any period.” This, he suggests, theoretically means that capital should be reinvested in the firm until the marginal rate of return is equal to the cost of the investment. In other words, the managers should disregard other investment opportunities even if they would yield higher returns. We have yet to see any manager who will do that.

Elasticity of Demand and Other Pricing Options

Elasticity of Demand

Economists define elasticity as the degree of responsiveness of quantity for a given a unit change in price.


Algebraically, elasticity is,

E

Q QQ Q

P PP P

1 0

1 0

1 0

1 0

=

−+

−+

2

2

(3)

In the equation 3 above, E is the elasticity; Q0 is the quantity at time t1 (the initial quantity sold); Q1 is the quantity sold at time t2; P0 is the price at which quantity Q0 was demanded; and P1 is the price at which quantity Q1 was demanded. The elasticity is said to be price elastic when degree of responsiveness in quantity given a unit change in price is greater than 1, unit elastic when it is equal to 1, and inelastic when it is less than 1. It is important to note that for the value of E to make sense, it is expressed as an absolute value, that is, −30 is the same as 30.

The basic notion of elasticity has given rise to some important pricing strategies. For example, if the demand is price elastic, then the producer could increase his total profit, in some cases, by lowering his per unit profit by decreasing the unit price. Let us take the case of a producer of beach slippers, for example, with the information provided below. For the sake of simplicity, let us assume that the producer sells directly to the public.

Beach Slippers Incorporated

Total fixed cost $100.00Number of units produced 100Allocated fixed cost per unit $1.00Material cost per unit $1.00Direct labor cost per unit $2.00Total variable cost per unit $3.00 ($1 in direct material cost per unit

+ $2 in direct labor cost per unit)Total cost per unit $4.00 ($1 in allocated fixed cost per unit

+ $3 in total variable cost per unit)Unit selling price $5.00Number of units sold 100


Based on the information provided above, we can say that allocated fixed cost to each unit produced is $1.00 hence profit per unit is $1.00. At the current selling price, the producer is able to sell 100 pairs of slippers, making a total of $100.00 in profit (total revenue [$500] − total fixed cost [$100] − total variable cost [$300]). Note that the break-even vol-ume is 50 units (i.e., 50 pairs of slippers). Now, the producer decides to lower the selling price to $4.50. At this price, he has essentially decided to lower per unit profit, that is, reduction in per unit profit from $1.00 to $0.50. However, at $4.50 selling price per unit, he is able to sell 200 pairs of slippers. Thus, his total profit is now $200.00 on units sold (total revenue [$900] − total fixed cost [$100] − total variable cost [$600]), that is, an improvement of $100.00. This is possible because demand for the slippers is price elastic in this example.

One of the interesting nuances about price elasticity as far as the pro-ducer is concerned is how the product is consumed or used. For exam-ple, if the product is consumed jointly with another product let us say product B that the manufacturer makes, then it is important that the producer take the effect of the price change on the quantity of product B that would be demanded. Economists refer to such price effects as cross elasticity. Let us take a hypothetical example of a producer of a special computer printer known as the Zee printer. The producer also makes a high-quality Zee ink that the Zee printer owners prefer to use, even though there are substitutes. While the computer printer is pur-chased once every couple of years, the Zee ink is purchased several times a year depending on how much printing the owner does. Armed with this knowledge, the manufacturer of the Zee printer could decrease the price of the Zee printer, which is equivalent to giving up some of his per unit profit on the Zee printer in the hope of making the printers more affordable—this might slightly increase the quantity of the printers sold. But, he could make up for the printers’ lower profitability by increasing the price of Zee ink.

Activity-Based Costing

As indicated above, because the price of a product/service under the full-cost pricing approach is impacted by the amount of the indi-rect cost allocated to the product/service, it is worthwhile to discuss other approaches that are used to allocate the indirect cost. One such


approach we discuss here is the activity-based costing (ABC) approach. The activity-based costing was promoted in the 1980s as an alternative to the traditional approach to allocation of indirect costs because of arguments that the traditional approach does not do a good enough job of allocating all the indirect costs. The activity-based costing therefore allows for a more complete allocation of indirect costs actually incurred in making a product/service (Kaplan and Cooper, 1988). However, even the activity-based costing approach seems to be out of favor now.

Other Issues on Price

Other issues that could be useful to the producer in pricing his products are (1) a good knowledge of price of the available close substitutes, and (2) the per unit profit on these substitutes. A more intimate knowledge of their cost structure would be useful, but hard to get. However, armed with knowledge of (1) and (2) above, the producer would be in a better position to compete because he would know how much unit profit to give up and still remain profitable. Other products that the producer makes could also determine how a particular product is priced, since many producers maintain a price line.

To maximize revenue generated from a product, many produc-ers sell the same product at different prices to different consumer groups. This pricing strategy is known as price discrimination. For example, in-state students in a public university pay significantly lower tuition fees than out-of-state students. Similarly, senior citizens pay less for several services such as public transportation and even privately owned cinemas (in many cities) than nonsenior citizens. What about the entertainment industry? Do we have examples of price discrimination? Well, the seats closer to the stage of a concert of a popular performer may go for significantly higher price than the seats that are far away in the rafters (the so-called nosebleed sections). Similarly, the seats closer to the basketball court or the box seats go for much higher price than the seats in the rafters. All these are good examples of price discrimination. Consumers select where they want to sit at the concert, based on their ability to afford the ticket. Thus, one of the important keys to price discrimination is information on the price affordability of the consumers in the different segments of the target population.


Quite contrary to what many people think, as shown above, price dis-crimination per se is not illegal. What is illegal is discriminating on the basis of impermissible standards, such as race, gender, and religion.

Pricing and the Law

United States has a relatively extensive consumer protection laws at both the federal and state levels. Federal laws that regulate pricing activi-ties intended to prevent the emergence of monopolists date back to the 1800s. First, the Interstate Commerce Committee, which ultimately led to the enactment of the Sherman Antitrust Act (1890), was formed. The Sherman Act contains two main sections, Section 1 and Section 2. It can be argued that Section 1 deals with activities while Section 2 deals with persons. For example, Section 1 states,

Every contact, combination in the form of trust or otherwise, or con-spiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal.

While Section 2 states,

Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part or trade or commerce among the several States, or with for-eign nations, shall be deemed guilty of a felony.

Anyone who has followed how legislation is used to fix societal ills would have noticed that it is not a onetime activity. Several iterations maybe needed to plug loopholes in previous versions and so was the Sherman Antitrust law. The Clayton Act was passed in 1914 with the Federal Trade Commission Act to plug the loopholes in the Sherman Antitrust law. Subsequently, the Robinson-Patman Act was passed in 1936 to extend the Clayton Act to limit the power of buyers as well as sellers. The Wheeler-Lea Act followed in 1938. Again, this was intended to fix the shortcomings in the previous laws. Wheeler-Lea Act amended Section 5 of the Federal Trade Commission Act. Finally, “unfair and deceptive acts and practices” as well as “unfair methods of competition” have been pro-scribed. The details of these laws are interesting and could offer several


insights; however, because we do not intend this to be a law book, we will skip the details.

What does the truth-in-lending law have to do with pricing? The answer is a lot; the truth-in-lending laws also known TILA is under Title 1 of the Consumer Credit Protection Act. Because many consumers pur-chase high-ticket items such as washing machines, Hi-Fi, and the like on credit, and interest rates can be regarded as the price for borrowing money, it is important that both merchants and consumers know how TILA operates. Because this is not a law text, we will not discuss TILA extensively. However, it is important to observe that there are several conditions that must be met for TILA to be implicated and one of them is that the loan must have finance charges and must be payable in more than four months in installments. Because many instances in which entities were prosecuted involved pricing and advertising, we will leave discussion of those instances to be treated under promotion, the next section of this chapter.

Predatory Pricing

Predatory pricing is not a pricing strategy but a tactic (possibly illegal) in which the producer prices the product at an unreasonably low level such that it is impossible to make profit. Why then will a producer sell at unprofitably low price when the basic objective of pricing is to make profit? Several plausible explanations are given for this practice, but it is generally believed that the intent behind this tactic is to drive out com-petition. This intent, of course, makes the practice illegal and violates Section 2 of the Sherman Act stated above. Collusion and price fixing also fall in the same illegal antimonopoly acts that good competitions must avoid. The legal costs, fines, and the possible damage to reputation that a firm could suffer as a result of engaging in any of these conducts make any possible short-term gain look pale.

Price leaders are producers who because of their size enjoy a unique position. Generally, they dictate the prices of the products.

Product-Line Pricing

To discuss product-line pricing, one first needs to define a product line. Product line is defined by Monroe as “a group of products sold by an


organization to one general market. The products have some character-istics, customers, or uses in common and may also share technologies, distribution channel, prices, and services” (2003). Producers who offer several different lines of product differentiate the lines by different price range. This is logical because the different lines may have different cost structures and features. Note that a product line generally comprises sev-eral different products. Take for an example, a fictional firm Zeze, Inc., which makes products A, B, and C. Product A comprises A1, A2, A3, and A4; product B comprises B1, B2, and B3; and product C comprises C1, C2, C3, C4, C5, and C6. Products A, B, and C therefore represent distinct product lines that could be priced along different price ranges. Product A’s price range may be from $99.00 to $150.00, B’s could be $199.00 to $249.00, and so forth. Technically, A, B, and C are referred to as the width of the firm’s offerings while the lengths of A, B, or C, that is, the number of offerings in a line is referred to as the depth.

To make the point clearer let’s take a company in real world of business—Mercedes Benz. The car manufacturer offers different lines. There is a line called the C-class, then the E-class, and another called the S-class. The C-class has several models, for example, C-220, C-230, and C-250. The price for the C-class might start from $29,900.00 and go up to $41,000.00. The price for the E-class might start from $40,000.00 and go up to $66,000.00. The S-class price might start from $65,000.00.

Another good illustration of price line is exhibited by Apple, Inc. We know that Apple offers a wide range of products. Let us just focus on iPhones, iPads, and Macs. Apple sells several iPhone models with a 2-year contract, for example, the iPhone 3 might sell at $100.00, the iPhone 4 for $150.00, and iPhone 5S, the most expensive one, for $200.00. These prices represent a range. Similarly, Apple’s iPads sell over a price range. The same argument goes for the Macs.

Price Bundling

Almost every student of marketing has come across the concept of price bundling in the introductory course in marketing. However, the con-cept is worth reviewing since many concepts in the introductory courses often seemed fuzzy to those who did not have much background in the real world of business. So, what is price bundling? Some scholars have argued that price bundling is a special case of product-line pricing (see


Monroe, 2003). It involves related products being sold as a package and can be as simple as four T-shirts being sold together as a package by the local retailer, or some basic and often-used computer software programs such as Microsoft Word, PowerPoint, and Excel being sold together with the computer.

There are several types of bundling, for example, pure bundling, mixed bundling, mixed-joint bundling, add-on bundling, and tie-in sales. The consumer does not have the option of selecting individual items from the bundle that is being offered for sale. So, in an all-inclusive vacation package being sold in a pure bundling strategy, the customer does not have the option of buying the accommodation alone without meals or the air travel alone without the accommodation as separate indi-vidual items. It is a “take it [all] or leave it.” However, in mixed bundling, the customer has the option of purchasing the items individually or as a bundle. Hence, in the vacation package example, the customer could purchase the all-inclusive package as offered or purchase the air travel and hotel accommodation separately. The customer could even purchase hotel accommodation alone without meals. It must be noted though that the pricing approach in the mixed bundling strategy makes it such that customers could enjoy cost savings by purchasing the bundle to the extent the required items are being offered together as a bundle and then further customize individually as per choice.

The mixed-joint bundling case is a hybrid between mixed bundling and pure bundling. Here, two premium products/services are offered separately at the same price. For example, Microsoft Word software program and Excel software program might be offered separately for $100.00 each, but Excel might be offered as an add-on to individuals that have purchased Microsoft Word for $75.00. Thus, the consumer enjoys savings by purchasing the two premium products together.

Add-on bundling is a practice in which a discount on another offering (product/service) say product/service B that could very well be purchased by itself is offered only to buyers who buy a certain offering say product A. An example could be a furniture store selling a center table (B) at a discount to buyers who buy a dining set (A). Note that the dining set could be bought without the center table and vice versa. While add-on bundling looks like the mixed-joint bundling, it must be noted that neither the dining set nor the center table is a premium product unlike Microsoft Excel and Word.


Tie-ins are not really a pricing strategy but rather a controversial sell-ing tactic that is often discussed under pricing strategy. Tie-ins involve a secondary product that the producer sells together with a primary product or requires the consumer to buy with the primary product. For example, a seller of a computer may tie certain software packages to the purchase of the computer. Obviously, such a practice could run afoul with antitrust laws.

Other Techniques

There is still a vast collection of pricing techniques that producers could adopt. It is often argued that a logical pricing technique that producers could adopt is to price a product/service differently along the product cycle. “Playing” along the product life cycle by offering the product/ser-vice at different prices at different stages of the products life cycle makes sense, and could in a way be considered an extension of either penetration or skimming pricing. However, a major practical problem with pricing along the product’s life cycle is the inability to clearly identify the stage the product is in until the stage is perhaps over. How does a producer know for sure that the product/service is in declining stage, for example, and not simply experiencing a bad spell?

The advancements in technology have made auctions, for example, no longer the domain of auction houses, but a technique that could be used by any producer or seller if the process has been properly thought through. eBay, for example, has made auctioning an everyday experience and a process that is open to everyone. Priceline has also creatively used this approach (technically a reverse auction) to price discriminate—a process in which different buyers pay different prices for the same prod-uct/service. For example, different consumers pay different prices for an airline ticket from the same origin to the same destination. Each buyer pays what s/he could afford for the same airline ticket by bidding for it. The interesting aspect of reverse auction is that the consumers “name” the prices at which they can afford the product, instead of the seller fix-ing the price.

The fact that still there are vigorous discussions on issues such as the Just Noticeable Difference (JND) and the effects of odd and even pricing on consumers underscores the role of psychology in marketing, and in this case in pricing. Some scholars argue that the way the human mind processes information or figures makes consumers discount the cents


associated with the whole number. Thus, the consumer is likely to think of the price of $1.99 in terms of a $1.00 instead of $2.00. Of course, others strongly disagree with such an assertion, consider it irrational, but argue that context does matter (Kamen and Toman, 1970; Stopel, 1972). Some recent studies have introduced culture as a relevant factor that influences how consumers perceive and respond to odd and even pricing (Nguyen, Heeler, and Taran, 2007), and others suggest that this psychological pricing phenomenon is not limited to pricing of consumer goods/services but could be observed even in the arena of mergers and acquisition (Agarwal and Zeephongsekul, 2013). Regardless of which argument prevails, psychological pricing is alive and well, as a cursory look around the reader would attest.

Pricing to Business Customers

Our discussions thus far focused on producers pricing items to be pur-chased by the final consumer (e.g., households); however, there is another pricing strategy that is not intended for the final consumer. These strate-gies are intended for other producers, thus we can refer to them as B2B (business-to-business) pricing strategies. They include strategies such as volume or quantity discounts, early payment discounts, trade discounts or functional discount, pricing based on geographic location, and pricing based on special orders.

Volume Discount

Volume discount is a common price reduction offered to a buyer, gen-erally a business entity, based on the quantity, in volume or dollars, purchased. It is designed to encourage large purchases, but it also often attracts a legal scrutiny. The producer/seller offering the discount must ensure that the same discounts are offered to buyers who are similarly situated otherwise the discount could be violating the law, specifically the Robinson-Patman Act (Monroe, 2003).

Early Payment Discount

Under accounts receivable and accounts payable programs, buyers with credit privileges with a seller or producer could purchase now and pay later. However, to encourage early payment, the producer/seller uses the early payment discount to encourage buyers to pay early and thus make


funds quickly available to the producer/seller. These discounts are gener-ally indicated on invoices in short-handed ways such as 3/10 net 30. This means that the buyer could take 3% off the invoice price if the price is paid within 10 days, however, the invoice price must be paid if payment is effected later than 10 days but before 30 days. Of course, this also sug-gests that late payments may be added if payments are made later than 30 days.

Trade Discount

Trade discounts are also referred to as functional discounts. They are offered to members of the distribution channel based on the functions they perform. Thus, a wholesaler would enjoy a discount that is different from the one extended to the retailer as they occupy different levels in the distribution channel and perform different functions.

Pricing Based on Geographic Location

Transportation and insurance costs could be significant depending on the location of both the vendor and the buyer. Hence, it is not unreason-able for sellers/producers to charge a higher price for shipping goods over a significant distance. However, to free themselves from the responsibili-ties as well as the cost related to shipping over a distance, sellers use the free on board (FOB) terminology to indicate where their responsibilities terminate. Hence FOB origin means the buyer is responsible for the trans-portation from the seller premises whereas FOB destination means that the seller is responsible for transportation to the buyer’s premises. Sellers seldom use FOB origin in instances where competition is intense.

Pricing Based on Special Orders

Special orders by definition require some form of deviation from what the seller generally does—either a special production setup that may result in the loss of economies of scale or an expedited delivery. Hence, special orders attract special, generally higher, prices. There are also instances where idle capacity could be used to fulfill a special order in which case the special order could be priced at a lower cost since all the fixed cost involved in the production may have already been allocated.


Sales Promotion

Sales promotion is an important short-term marketing program that is designed primarily to stimulate sales, though, some sales promotional activities might be designed to create awareness, generally to a newly opened retailer. Sales promotion consists of several different tools and activities such as raffles, free trials, free samples, special events, heavy advertising, special discounts, coupons, rebates, and across-the-board price cuts. To stimulate purchase, the seller must first attract buyers’ attention and/or draw them to the seller’s premises; therefore, some retailers, especially automobile dealers, have a reputation for creating a carnival-like atmosphere with balloons, free drinks, popcorns, and other giveaways during a special event. These events are usually held to introduce new-year models and/or to facilitate movement of inventory of models that are about to be replaced with newer models.

Other retailers especially in the services sector are prone to using free trials during sales promotion. It is not unusual to see a gym or a local cable company advertising free trials during their sales promotion. Because of their focus on the end consumer, most of the activities used in sales promotion are “pull”-strategy driven. Pull strategies are “customer oriented” in the sense that they “induce” the customer to purchase or try the offering whereas “push” strategies focus on the intermediaries ( channel members) and incentivize them to sell the product.

Coupons

These are documents generally issued by manufacturers of packaged consumer goods and retailers during sales promotion that entitle the holder to a reduction in retail price. Coupons either have the amount or a percentage of reduction in the purchase price that the holder is entitled to stated on them (e.g., $2.00 or 10%). They are distributed through a variety of means, for example, through print media, through the mail as well as the Internet. Coupons are often redeemed at a retailer who subsequently presents them to the manufacturer (in case of a manufac-turer-issued coupon) to be reimbursed. Since there could be significant processing costs associated with couponing, therefore a seller or man-ufacturer planning to use coupons must ensure that the cost-benefit analyses have been done prior to embarking on the program.


Theoretically, coupons are supposed to be used by price-conscious individuals who could not afford the item at its full cost. Thus, it is a form of discriminatory pricing in favor of those who could less afford the product. However, anecdotal stories in the news and on the Internet seem to suggest otherwise.

Rebates

What is the difference between rebates and coupons? Are the same things called by different names? Even though both coupons and rebates are similar and used during sales promotion, the form of rebates gener-ally used in the United States are mail-in rebates. A rebate is generally a refund of a portion of a purchase price to the buyer. Mail-in rebates usually require the buyer to send the receipt of purchase and a barcode in order to receive a refund.

Across-the-Board Price Cut

Unlike coupons that entitle only the holders to a price discount and therefore a selective price reduction, across-the-board price cut reduces the purchase price by the same amount for everyone; it is a kind of a “blunt sword” used to stimulate purchase. Its effectiveness in raising revenue though is unclear. Consider A and B as two consumers who wish to buy xGadget, the latest smart phone. The consumer A could afford the product at the current selling price of $400.00, but B could afford the product only when it sells at $350.00, so B decides to post-pone his purchase. Suddenly, the maker of xGadget decides to reduce the price and sell the product at $350.00. Now even though A was pre-pared to pay $400.00 for the product s/he also gets to enjoy the $50.00 discount. Since both A and B buy the product now, but at $350.00 each, A’s $50.00 is lost to the seller. Even though we do not know the seller’s margin, we can guess that unless a sufficient number of consum-ers respond favorably to this price cut, the sellers might be worse off in terms of profit than without the across-the-board price cut.

Some commentators think that because of the “bluntness” of across-the-board price cut, sellers try to play games, that is, the price cut is actually a phantom price cut. They suggest that some sellers deliberately increase the selling price on the product soon before the price cut so that the so-called price cut simply brings the price down to where it was


originally. Of course, that would be a deceptive practice; therefore across-the-board price cuts have attracted the attention of attorneys general in different states. The state of New York had some of the most publicized cases when its attorney general was Eliot Spitzer. One of the cases that caught attention in national news was a lawsuit brought against Federated Department Stores, Macy’s parent company, in early 2006 for deceptive marketing and advertising (Koku, 2009). The lawsuit, which was settled without admission of guilt, alleged that Kaufman’s, one of the upscale stores owned by Federated Department Stores, offered Braun Tassimo Hot Beverage System on sale at a price of $169.99. Its regular price was allegedly $219.99. However, it was discovered that the manufacturer’s suggested retail price (MSRP) for the product was actually $169.99, and the product was being sold by Kaufman’s competitors at $169.99 (the MSRP) (The Consumerist, 2006). In short, there was no discount at all, and the claimed discount was merely a ruse. Federated settled the suit without admitting fault and paid $725,000.00 in penalties and costs (see New York State Attorney General’s Press Release, 2006).

Conclusion

Pricing is a complex but important issue. Its judicious use can make a company profitable while its reckless use can bankrupt a company. As much as its careful use can attract consumers, its careless use may not only drive consumers away, but it may also attract lawsuits. Because it directly affects a company’s bottom line and its ability to meet its finan-cial obligations, we argue that finance folk should be involved in pricing decisions. Furthermore, even though we have not heard this argument made by other marketing strategists, because improper pricing could eas-ily attract a lawsuit, we recommend that the legal folk also be involved in pricing decisions. It could save the company a lot of money and negative press.


Having now completed reading Chapter 9, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing Case #9, in the Appendix, titled Vincent’s University.


References

Adams, C. P., and Brantner, V. V. (2006). “Estimating the Cost of New Drug Development: Is It Really $802 Million?,” Health Affairs 25 (2): 420–428.

Agarwal, N., and Zeephongsekul, P. (2013). “Psychological Pricing in Mergers and Acquisitions Using Prospect Theory,” Studies in Economics and Finance 30 (1): 22–30.

Attorney General (2006). “Leading Department Store Chain Agrees to Reform Advertising Practices and End Fake Sales,” Press Release, March 14.

The Consumerist (2006). “Spitzer Settles False Advertising Suit against Macy’s,” March 15.

Gabor, A. (1977). Pricing. Cambridge: Cambridge University Press.Kamen, J. M., and Toman, R. J. (1970). “Psychophysics of Prices,” Journal of

Marketing Research, February, 27–35.Kaplan, R. S., and Cooper, R. (1988). “Measure Cost Right: Make the Right

Decision,” The Harvard Business Review, September, 96–103.Koku, P. S. (2009). “Which Law Do Your Marketers Know? Some Legal Issues

on Price Discrimination,” The Academy of Marketing Sciences’ Biennial Conference—C.D. ROM, July.

Monroe, K. (2003). Pricing: Making Profitable Decisions, 3rd ed. Boston, MA: McGraw-Hill; Irwin.

Nguyen, A., Heeler, R. M., and Taran, Z. (2007). “High-Low Context Cultures & Price-Ending Practices,” The Journal of Product and Brand Management 16 (3): 206–214.

Simon, H. (1972). “Theories of Bounded Rationality,” in McGuire, C. B., and Radner, R. (eds.), Decisions and Organizations. Amsterdam: North-Holland Publishing, 161–176.

Stopel, J. (1972). “‘Fair’ or ‘Psychological’ Pricing,” Journal of Marketing Research, February, 109.

CHAPTER 10

Marketing Mistakes and Their Impact on the Firm

There is no doubt that marketing decisions are not limited to the marketing department alone, but instead affect the firm in general. In fact, to be specific, marketing decisions impact the

firm’s value, which is the overarching message in this book. However, marketing mistakes are the obvious instances in which the effects of marketing on the firm’s value are felt. Marketing mistakes could occur in variety of ways and could be caused by limitless number of factors; however, we limit our discussions to decisions of the firm to enter a for-eign market, introduce a new product, name a new product, and recall a defective product.

Expanding into a New Market

Why should a firm expand into a new market and how does that deci-sion concern the finance folk? The answers to these questions are not difficult to find, and interestingly, these questions must be answered almost on daily basis by many firms. Firms must enter new markets for a variety of reasons. First, similar to introducing new products, firms enter new markets as a means to increase their revenue. However, again, like introducing new products, expanding into new markets, whether domestic or foreign, involves risks; hence, it is important that a firm



that is contemplating entry into new market(s) carefully evaluate mar-ket attractiveness and the associated risks.

The attractiveness of the market is often evaluated using Market Attractiveness Framework. This framework consists of inventorying the market features against the firm’s strengths. For example, answers need to be found to questions such as how big is the market, and how fast is it growing? How many competitors are out there? How badly does the market need the product? And how foreign-business friendly are the regulations as well as the business climate? What are the rele-vant industry regulations if the firm is going across borders? However, industry regulations might be relevant even in domestic markets such as the pharmaceutical industry or the telecommunication industry. What price is the market prepared to pay for the product? Of course, the list is not exhaustive, but these factors must be weighed against what the firm can do well, how fast the firm can get these items to the market, how much it will cost the firm to make the product, and the additional costs that must be incurred to bring the product to market.

Market risks, which generally refer to the likelihood of loss be it in domestic or foreign market, are not as easily assessed as market attractive-ness. Nonetheless, they must be assessed in order to give decision makers some sense of what to expect. Estimating the riskiness of a market could be done through the use of econometric models that take factors such as the industry structure into consideration. However, there are many sources from where country risk estimates could be obtained. Sources such as Euromoney Country Risk Survey and Economist Intelligence Unit are particularly useful.

Introduction of a New Product

Most of the major mistakes made by marketing folk severely impact-ing the firm’s financial position and therefore the shareholders’ wealth occur with new-product introductions that fail. Several reasons could be offered for such mistakes. Perhaps the new product failed because in haste to be the first to introduce the new product in the market, the firm ignored some of the steps necessary to ensure success. It could also be that there was no need for the product in the first place, and the product was introduced only because of a manager’s hubris. The world of

Marketing Mistakes and Their Impact on the Firm l 151

marketing is full of stories of new-product failures that could fill a book. Below are few examples:

The Ford Edsel of 1957 is a classic new-product failure that many ●l

marketing texts refer to although the reason for its failure is not entirely clear. Some commentators suggest that the Edsel’s fail-ure might be due to failure in positioning strategy—it was neither priced as a luxury car nor as an economy car; however, others blame its failure on poor design/appearance. No matter what the cause, Edsel’s failure did not help Ford’s bottom line or its shareholders’ wealth.After spending $325 million on developing a smokeless cigarette, ●l

R. J. Reynolds launched the Premier smokeless cigarette in 1988. However, the product was withdrawn in 1989 after barely a year in the market. Smokers complained of the cigarette leaving a bad aftertaste in the mouth. The question is, where was test marketing done?The New Coke could not buy success in the market with a $4 mil-●l

lion expense on taste test. Coca-Cola in an attempt to vanquish its rival Pepsi-Cola introduced the New Cola, a sweeter tast-ing drink, that was to replace the then existing drink in 1985. However, instead of stirring consumers’ interest, the New Coke stirred consumers’ anger. It was reported that there were more than 400,000 angry letters and phone calls to the company’s head office in Atlanta. Can you imagine what would have happened if email messages were in use at the time? Coke had to reverse its decision.New services also fail if the studies are not done properly. United ●l

States Football League (USFL) was launched in 1982 but folded in spring 1985 after spending $163 million.

Other notable new-product failures include Sony’s Betamax video-cassette tape, Apple’s Newton, which spent five years on the market (1993–1998), Frito-Lay’s Olestra, which is now being sold under a dif-ferent name, and Sony’s eVilla, which was supposed to be an Internet dedicated machine, spent only two months on the market before being pulled back.


Naming New Products

Many companies have learned the hard way that mistakes with a prod-uct’s name can also be costly and could lead to a product’s failure in the market, particularly in the case of foreign markets. Examples of name snafus include the following:

Mitsubishi had to change the name of its Pajero in Latin America ●l

as “Pajero” translates into something else that is undesirable in the local slang.The “Kiri” brand of French cheese had to be renamed in Iran ●l

because “kiri” in Persian refers to a female body part that cannot be mentioned in polite company; the name was changed to “Kibi.”

Sometimes it is not a name, but an ad or tagline that comes out badly when translated into a foreign language. Examples include Coors’ “Turn it loose,” which comes out “Suffer from Diarrhea” when trans-lated into Spanish. KFC the finger “licking” giant’s “finger licking good” translates into “Eat your fingers off” in Chinese. Even Pepsi and Coke could not escape “translation” problems. Pepsi’s “Come alive with Pepsi Generation” came out as “Pepsi will bring your ancestors back” in Taiwan and the name Coca-Cola reportedly when initially translated into Chinese came out as “Bite the wax tadpole” or “female horse stuffed with wax” depending on the dialect, and Coca-Cola did not realize the mistake until thousands of signs went up (“Marketing Translation Mistakes,” 2009).

Product Recall

By itself, recalling defective products or products that have been tam-pered with by a third party results in loss of money, but the manner in which the recall is handled could either mitigate or exacerbate the problem. Several products are recalled each year for a myriad of reasons. Some products are voluntarily recalled in order to fix a minor problem or some are pulled off reluctantly under pressure from an appropriate regu-lating body. Johnson and Johnson is often cited for exemplary conduct for voluntarily pulling out its Tylenol capsules from the market during the Tylenol tampering episode in 1982. Unfortunately, that cannot be said for every company involved in the unfortunate situation in which its products have to be taken off the market.


One of the most infamous and contentious product recalls occurred in the United States in May 2000. This incident involved Ford Motor Company’s Ford Explorer SUV and Firestone’s 15” tires. This recall was almost the opposite of the preemptive manner in which Tylenol poisoning episode was handled. Because of the contentious manner in which the recall was handled some of the casualties of the epi-sode included loss of an almost 100-year relationship between Ford and Bridgestone and the resignation of Ford’s CEO. In 2009, Peanut Corporation of America also reluctantly pulled off its peanut butter when it was initially suspected and later confirmed that a certain batch of its product was contaminated with salmonella.

While some of the incidents that precipitate the necessity to take a product off the market could be avoided through proper inspection of the production process and proper testing of the final product, some cannot be avoided. Instances such as tampering are orchestrated by third parties outside the control of the firm. However, it is in the interest of the firm to be perceived by the public as dealing honestly with the situation and trying its best to resolve it.

Studies on product recalls (Jarrell and Peltzman, 1985; Hoffer, Pruitt and Reilly, 1988; Davidson III and Worrell, 1992) have shown that in addition to out-of-pocket expenses involved in rectifying the recall, there are also significant costs incurred in goodwill loss when the public believes that the cause of the defect was due to the producer and doubts the sincerity of the producer in accepting culpability and in remedying the situation. In fact, Davidson III and Worrell in their study found that wealth loss is more significant when the products are replaced or the purchase price returned as opposed to when the products are fixed; there was only limited evidence that government-ordered recalls produce more negative wealth loss than voluntary recalls. Nonetheless, according to some commentators, goodwill and appreciation of the openness in which Johnson and Johnson handled the Tylenol episode helped to propel Tylenol back to the top of the analgesic market when it was relaunched.

While there are no simple solutions to these problems, we believe that first, there should be more deliberate effort on the part of com-panies to do things right once and for all, as a start. Second, when mistakes are made, they should be handled in a frank and forthright manner. Unfortunately, most of the companies seem to lean on the advice of their attorneys when things go wrong. Rather than dealing


with the public in a frank and open manner, for liability reasons, they start being evasive and turn on their public relations (PR) machine. Third, more information is generally better than less even within the firm, hence interfunctional decision processes must be encouraged and even formalized.

Conclusion

Marketing mistakes make an interesting read; it is even funny and yet there is a serious side to it. In the short term some of the individuals connected with mistakes do lose their jobs, however, in the long term others who may not be connected with the mistakes could also lose their jobs. Why is that? First, the hard fact is that any cent that is wasted on mistakes is a cent that is not available to be invested in an otherwise productive project, all else being the same. Second, additional funds are often spent to remedy the mistake that has been made. These funds could also have been invested in other productive projects had the mis-take not been made. Third, some of these mistakes, particularly those involving product recalls, could cost the firm in terms of goodwill. For these reasons, it is better to work toward decreasing, if not eliminating, marketing mistakes.

The fact that these mistakes are generally referred to as marketing mistakes suggests that the existing perception is that they are caused by the marketing folk. This needs to be changed, because such mis-takes do not just impact the marketing department, rather they impact the whole firm. One way in which they can be changed from being “marketing mistakes” to “company mistakes” or “business mistakes” is by making the decisions interfunctional decisions. While the role of every department in advertising decisions is not clear, the role that the finance department plays should be clear because advertising programs also must be evaluated on the basis of their returns.


Having now completed reading Chapter 10, it is recommended that you test your understanding of the materials covered in the chapter by analyzing/discussing Case #10, in the Appendix, titled Sunco Appliances.


References

Davidson, III, W. N., and Worrell, D. L. (1992). “The Effect of Product Recall Announcements on Shareholder Wealth,” Strategic Management Journal 13 (6): 467–473.

Hoffer, G., Pruitt, S., and Reilly, R. (1988). “The Impact of Product Recalls on the Wealth of Sellers: A Re-examination,” Journal of Political Economy 96:663–670.

Jarrell, G., and Peltzman, S. (1985). “The Impact of Product Recalls on the Wealth of Sellers,” Journal of Political Economy 93 (3): 512–536.

“Marketing Translation Mistakes,” at http://www.i18nguy.com/translations.html, accessed on January 20, 2014.

http://www.i18nguy.com/translations.html

http://www.i18nguy.com/translations.html

APPENDIX 1

Cases

Case 1: Jack Gordon, CPA

It was a cold December 2013 morning with Christmas festivities in the air when Jack called yet another family meeting, the second in a month over the same issue. These meetings also doubled as business meet-ings since all the employees of Jack’s accounting company are his fam-ily members. The meeting room was decorated in red and green colors with a good-sized Christmas tree. Underneath the tree were gift-wrapped boxes, empty boxes really, just serving as props.

The five-person business is owned by Jack who serves as its presi-dent and sole proprietor. Amy, Jack’s wife, serves as Jack Gordon’s office manager. She answers the phones, replies to mail from clients, and does other jobs around the office as needed. The twins John and Johanna (often referred to as “J and J” by friends), Amy and Jack’s only children, and a cleaner named Davis comprise the remaining three staff of the firm. Both John and Johanna are 23 years old and have graduated with accounting degrees from the local university the previous year. They have been “working” with the firm practically all their lives. They “gradu-ated” from stuffing and sealing envelopes for tax returns, when they were in grade school, to doing accounts reconciliation and auditing when they got to college. They enjoy accounting and count themselves very lucky to be able to work with their parents as staff accountants.

Unlike their friends who had to struggle in order to get summer employment, which was not necessarily enjoyable, for John and Johanna, since high school, there was always a predictable relatively easy summer

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employment. Also, unlike their other classmates in college, there were no uncertainties regarding finding a good job after graduation. Even though Jack and Amy did not make John and Johanna feel privileged, both kids knew that they were extremely lucky and did not have to worry about financial issues while going to college. Thus, they dedicated themselves to their studies and graduated with honors. Both John and Johanna were literally “each other’s keepers”; they got along well. The joke among their friends was what would happen when any of them married.

Though their opinion is not binding, Jack often gives the impression that he values the input of John and Johanna. This meeting was the second to discuss the possibility of expanding the company beyond the family. This issue seemed to preoccupy Jack quite a bit of late; thus, the fact that he convened a second meeting to discuss the same agenda sug-gested that a decision was imminent. They knew they could not exhaust all the issues in two meetings and therefore expected to revisit the issue in a few more meetings before Jack made a decision; but J and J could not be sure. Secretly, they hoped they would simply grow to inherit the company from their Dad when he retired, but they were beginning to realize that such ideas were without any basis and such a hope was only a pipe dream.

Jack asked both John and Johanna to give the issues a serious thought, since they would be most affected, and told them that he would meet with them again during the early part of the forthcoming year. He indicated that he would make a decision as soon as the coming tax-filing period was over. This means that he would make a decision in three to four months.

The Accounting Firm

Jack founded the company at the age of 27, some 23 years ago, in the family basement, but with dedication, hard work, and luck, he now bills over 2 million dollars a year. Jack’s father was poor but hard working. He did not have the benefit of college education; he apprenticed as a carpenter after high school and had his own one-man carpentry shop in town. Though not wealthy, he had a reputation for being honest and reliable. He never married after Jack’s mother died during childbirth – when Jack was being born. As a bachelor he raised Jack alone, and taught him the values of hard work and dignity in labor. Even though he did

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not attend college, he always stressed the fact that college was a must and not an option for Jack, and saved money to make that possible. Jack helped in the carpentry shop while growing up but started working with a local accountant for whom his father David had done some work, and who in appreciation of David’s efforts offered to take young Jack under his wings.

Jack started working in Elmo’s accounting office when he started high school and continued through college (Elmo was a friend to Jack’s father). He immediately fell in love with the profession during his first day in the office and with his facility for figures everyone knew he was going to become an accountant. After college, Jack worked for five years for one of the larger accounting firms in the country at the time, but after five years he wanted to be on his own. He returned to Fayette, where he was born, married his high school sweetheart Amy, and bought a small two-story house. To cut down on expenses, he operated his office from the basement. Slowly, but steadily his reputa-tion as a hardworking and diligent accountant spread around town and the entire county.

The Big Move

Jack Gordon, CPA, became the accountant of choice for most of the small business companies around the county. After 10 years of operating out of his basement, he was finally able to buy another 2-story build-ing along the main street in Fayette for $550,000. He was fortunate to get a 15-year mortgage at an interest rate of 4.5% with 15% down pay-ment. The new office was opened with fanfare – balloons, popcorns, and candies for children and finger foods and drinks for adults. The local band performed and the mayor and other elected officials were invited. Jack operated his accounting practice from the second floor of the new building, which he named David’s House in honor of his deceased father. To help pay the mortgage on the house, Jack rented the first floor to one of the local attorneys.

Jack considered the decision to start his own practice as the first major decision in his professional career. The second major decision was to buy the house on the main street, and the third would be to employ associates, the number is yet to be determined, once the decision to hire associates has been settled.

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The Accounting Practice

Accounting practice involves a great deal of relationship management. Jack was a hands-on person who dealt personally with every client. He made it a part of his practice to visit his clients to discuss their problems instead of making them come to him. He says this saves his clients’ time and money. As time went by, he also took John and Johanna along and gradually the two started making independent visits to clients. They know how Jack would handle a situation and do so in his absence. Both Jack and his clients have grown to admire how John and Johanna deal with clients. In fact, some of his clients joke with him by telling him that “he needed to rest, stay home, and send only the good looking ones” (meaning John and Johanna).

Several issues hinge on getting good associates, for example, would he offer them a part of partnership? What is the role envisaged for John and Johanna in the future of the company? Jack loves fishing and has been hinting at retiring at 60 so he can spend more time fishing.

Case 2: The Peoples Bank

James Brown, the president of The Peoples Bank, is now confused about what to do next. He wondered aloud, “Should leave good enough alone?,” as we walked out of the conference room. He was the last per-son to “find his exit” after what was a contentious board meeting. This meeting was for the board to approve plans to introduce the bank’s credit card and the indications before the meeting were that approval would be given. However, things did not go as planned, hence another meeting had to be scheduled for a final vote. “Perhaps I have some heavy lifting to do within the next few weeks.” The next meeting is four weeks away.

The Bank

The Peoples Bank is a popular local bank that opened its doors in 1992. It is both state and federally chartered, but it strategically chose to begin with a very narrow scope and operated at only one location. Its initial operations involved taking deposits and making small business loans. However, as time passed, it gradually expanded its scope. It now disburses home and car loans and gives short-term consumer loans; it has become

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quite profitable from having made judicious decisions on loans, and now sets its sights higher. It wants to introduce credit cards, but several other operational questions are nested within the decision to introduce cards. For example, who must it target? Setting the target market and terms for the credit card are operational decisions that must be decided by the CEO and his staff; however, the board must approve the decision to introduce the credit card.

The Board

The board of directors consists of eight individuals. Of them, 2 are ex-bankers; they used to be presidents of 2 of the top-20 largest banks in the country. Two are well-known lawyers in the community; one is a pastor of one of the megachurches; one member is a professor of finance and banking; one is a college president; and the last one is a local businessman. Board members serve staggered terms and each term lasts for five years. Each member can serve for no more than three terms. The board members are approved by the trustees upon nomination. They can be nominated either by the president or by other trustees. Serving on the board is a compensated position, but the package is determined by trustees. Currently a board member is paid $50,000 annually.

Issuing credit cards had become a rather lucrative operation for the financial institutions, since very few cardholders pay off their balance at the end of each month. However, the economy was in a mild recession and many people were losing their jobs at the time this discussion was taking place. A loss of job, of course, places difficulty on an individual’s ability to make credit card payments. However, while making payments is difficult, using it liberally was becoming the norm as people were out of jobs and needed to meet their daily needs such as eating and making certain basic payments, for example, utility bills. Because of these nega-tive economic forces, the rate at which people were declaring personal bankruptcy was increasing and there was no law in place related to the discharge of credit card bills. This provides the backdrop in which these discussions were going on.

Some of the board members felt that the bank stood to improve its profitability by entering the credit card market. Some felt that the deci-sion was late and that they should have been in the market years earlier.

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Given the current economic climate, they felt it would be a mistake to go after that market now. In the words of one member, “We will simply be giving out blank checks to people to live on with no means of paying back,” and it would spell disaster for the bank. Some members felt that they ought to leave “good enough alone.” James Brown personally wants to go after this market but has not been able to justify his feelings with numbers. As he walks out of the conference room, he wanders to Sally, his executive secretary, and gives the following instructions: (1) “Could you ask Mr. Smith, senior vice president for operations to meet with me tomorrow?,” and (2) “Also, could you try to make appointment for me starting next week to have a 30-minute phone conversation with each of the board members?” A majority decision is needed to pass a resolution.

Case 3: Zingo, Inc.

Finally, a meeting that was supposed to last for one-and-a-half hours but lasted for two-and-a-half hours was over. However, at the end Dr. Raymond, the CEO of Zingo, Inc., was as confused about next year’s plans as he was before going into the meeting. For strategic reasons Zingo wants to reformulate its strategic plans. It wants to make clean energy part of its central theme for the next year and the foreseeable future. Even though energy savings was the reason for the company’s existence, it never really developed a coherent clean energy theme. How will clean energy tie into energy savings that has hitherto been the com-pany’s mantra? Adopting the new theme means that all the company’s communication and new products must reflect this new orientation. For this reason he charged all the vice presidents to come up with plans for their respective departments that could be put together into one cohesive corporate plan.

The meeting that just ended was intended to give each vice president the chance to present his respective plan and show how it could fold into the firm’s plan; instead, each vice president presented what appeared to be a stand-alone plan with no indication as to how it would support the firm’s new goals. Mr. Raymond did not hide his disappointment at their failure to make progress and asked to meet again in two weeks with the agenda that each vice president not only present his new plan, but also show how the plan complemented that of other departments. He encour-aged the vice presidents to not to hesitate to collaborate.

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The Company

The market for light bulbs, the main product of Zingo, Inc., has become very competitive, hence the need to distinguish oneself. Zingo, Inc., was formed by Dr. Raymond in 1995 during his first year as a PhD student in electrical engineering. However, the firm was dormant for several years as Raymond devoted all his time to pursuing his PhD degree. Dr. Raymond who grew up on a farm had a special appreciation for nature and had hoped to become either a horticulturalist or an agronomist. However, he was also keen on helping his father to fix any of the farm machinery that needed fixing. He entered college with the intention of pursuing a degree in one of the agriculture-related areas. However, he excelled in physics and mathematics during his first year, so he was advised by one of the college counselors to declare pre-engineering as his major. If his interest in mathematics and physics waned at the end of the second year, he could declare a different “major” and still be able to complete college on time. He continued to excel in mathematics and physics and therefore continued in the college of engineering after the second year and “majored” in electrical engineering.

Raymond’s interest in the environment persisted all through his academic career. He observed that one area where he could make his contribution was to develop an alternative to the incandescent general lighting bulb, which was not very efficient, and formed Zingo, Inc., for the purpose.

After four years of graduate studies toward his PhD and two years of postdoctoral studies, Dr. Raymond accepted a faculty position, which he held for only two years before deciding to devote his full time to Zingo, Inc. He had already secured a patent for Z44, his version of an alternative to the incandescent bulb that is more efficient and uses no mercury. The challenge was to raise enough capital to start production.

Not having much money Dr. Raymond called on some of his friends and former professors who thought his ideas had merit. With his own savings of $60,000 and contributions from 9 others (in exchange for partial ownership) Dr. Raymond was able to put together $1 million. Dr. Raymond would have loved to take the contributions as personal loans instead of surrendering partial ownership of Zingo, but he knew that convincing people to give him personal loans would be difficult since he did not have much of his own.

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Changes in the Regulatory Environment

Not knowing anything about business himself, Dr. Raymond thought it would be wise to hire folk with business experience to advise him. In 2003, therefore, he used part of the initial $1 million to hire the 4 indi-viduals who now serve as the 4 vice presidents. Mr. Paul Lloyd is the vice president of finance; Mr. Samuel Francis is the vice president of market-ing; Simon Newton is the vice president of operations and production; and Ms. Davis Myers is the vice president of logistics and distribution.

Fortuitously, while Dr. Raymond was tinkering with his Z44, the mood around the world was beginning to shift toward energy conserva-tion. Many countries around the world were beginning to enact regula-tions to phase out the old incandescent bulbs. In 2004, not having enough money to start their own production, Dr. Raymond on the advice of his vice presidents (things were unanimous in the beginning) outsourced the production of 2 million bulbs, half of which were sold before the inven-tory was received, and the remaining half were sold within four weeks of the arrival of the inventory. Indeed, luck had been on their side. Within two years of operating actively, Zingo, Inc., broke even and was consider-ing building a plant to manufacture its own bulbs. While Dr. Raymond was in charge of the day-to-day decisions of the firm, he continued to work on new designs. However, given the intensity of competition in the market, one of his goals this year in addition to enacting clean energy orientation is to hire a four-member research team to help in developing new products faster.

Decision

The last meeting was rather contentious. Paul was of the opinion that they should try to expand into new markets and maintain their mar-gin of 40%. Mavis agreed with Paul and stressed the need to expand distribution, however, Samuel quickly pointed out that none of the sug-gestions from Paul and Mavis would do anything to help the firm in its refocusing exercise; instead, he was of the opinion that they should increase advertising budget by $240,000 and use advertising as the means to promote the company’s new orientation. Simon said that they should maintain status quo, and that there was no need for any refocus-ing as they were already doing well. None of them is looking forward to the next meeting.

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Case 4: Dixie Oil and Gas, Inc.

The competitive environment for natural gas and oil is getting intense and exciting as the demand for oil by China has significantly increased. China consumed approximately 3,363,000 barrels of oil per day in 1995. Ten years later, in 2005, China’s consumption of crude oil doubled to approximately 6,695,000 barrels per day. It is projected to overtake the United States as the world’s leader in oil consumption in the near future. Though not necessarily good for the environment, it is good news for oil and gas exporting companies such as Dixie, Inc., who now want to be known for more than oil and gas and as a global player instead of a regional oil and gas company. To this end, Dixie’s board of directors is considering a name change. The question to be decided is, whether the name change is necessary and what should the new name be; that is, should the board vote to go forward with the name change?

Oil and Gas Industry

The oil and gas industry has undergone dramatic changes since World War II. Some of the notable changes are deep-sea oil drilling and the development of global shipping network for crude oil. Also significant is the emergence of Middle Eastern countries as the world leaders of oil production. The dramatic increase in the world market price for crude oil, which was due to several reasons, notably, the oil cartel’s restriction on supply among other things, also saw the emergence of several other minor or regional oil companies such as Dixie.

The world’s apparent insatiable appetite for oil has led several people to start predicting the possible depletion of the world’s oil reserve at some future point if nothing is done to ameliorate the current consumption rate. Others have started to question the wisdom in relying so much on oil given the detrimental effect of its by-products on the environment. In fact, some countries started using a blend of gasoline that is not 100% gasoline to conserve gasoline consumption and also to protect the envi-ronment, albeit in a limited way.

Forward thinking gas and oil companies too have realized that “the party must come to an end sooner or later” as efforts to search for gaso-line alternatives are now in full gear. For this reason, many oil and gas companies have started repositioning themselves by investing in other products such as windmills, biofuels, and aluminum and plastics. Other

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companies have merged, for example, Mobil merged with Exxon to form ExxonMobil and so did British Petroleum, which merged with Amoco.

Dixie

Dixie was founded in the early 1960s by two industrialists, Herman Pruit and Manfred Longhorn. The name Dixie was chosen to reflect the company’s Southern roots. Dixie first started drilling for oil on land jointly owned by the partners, expanded to offshore drilling, and has even engaged in oil exploration in Angola, Central Africa. The com-pany has also invested in other companies such as a beverage company, a milk company, and a computer company. For these reasons the company would like to change its name to reflect its global presence as well as its wider scope. However, some of the executives are also aware that com-pany’s name change could be an expensive undertaking that could be fraught with problems.

Case 5: The Afriga

Anthony Ankaful is an enterprising young man who always dreamt of owning his own business. He started working for pay at an early age of seven when he helped his grandfather drop the daily newspaper. By the age of ten his grandfather assigned him his own route closer to their house, which he covered on bike. The work ethic he learnt at an early age always drove him to accomplish whatever he set his mind on. Now, it is another test of his mettle. He has to make a series of price- and product-related decisions as he is at the cusp of launching his new product, the Afriga.

Background

Malaria is a mosquito borne disease prevalent in Africa and other tropi-cal countries. This disease, which is responsible for the death of over half million people (mostly children) per year in Africa, is carried by the female anopheles mosquito. This mosquito transmits the disease when it bites its victim. There is currently no effective vaccine for the disease, but efforts sponsored by rich philanthropists such as Bill Gates are being made by several chemical and pharmaceutical companies to

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find an effective vaccine within the next ten years. In the meantime, other research efforts focus on either killing the carrier of the disease, the anopheles mosquitoes, or preventing it from biting people.

Anthony Ankaful, an African American, spent a semester in Africa on a study abroad program while an undergrad student and firsthand saw the havoc the mosquito could cause; besides the deadly illness, the noise from a flying mosquito could keep one awake all night! The experience lived with him. As a graduate student in biochemistry he spent a signifi-cant part of his time experimenting with chemicals that he thought were safe to the environment but deadly to mosquitoes.

After earning his PhD degree in biochemistry, Dr. Ankaful worked with 2 pharmaceutical companies for 25 years as a researcher. Initially, he worked with a large multinational company and as a result of his hard work rose to the rank of principal scientist with several patents in his name. However, in his own words, “he always felt confined.” So after 19 years, he left to take up a job with a small start-up pharmaceutical company. Even though he felt free in this company to pursue research areas of his choosing, his employer was not ready to start work on chemi-cals that Ankaful thought held promise in the war against mosquitoes. So, with the blessings of his employer, he left after six years to start his own chemical company, Afriga, Inc., whose first product, a chemical, is also called the Afriga.

The Company

Afriga, Inc., was established 2 years ago with 5-year loan of $2 million at 5% per year interest rate. Dr. Ankaful rented a small lab space in the local university’s research park and employed three other individuals, two of whom are scientists, salaried workers, and one is a marketing spe-cialist. Dr. Ankaful himself is working without a salary and plans to do so for the first two years of Afriga, Inc.’s existence. The product Afriga costs about $1.20 to produce and Ankaful plans to sell it for $2.00 per 10 fluid ounces per aerosol can. Afriga is sprayed to keep mosquitoes away, and one spray is effective in keeping mosquitoes away for about eight hours; thus, a spray before going to sleep can ensure that one gets a noise-less sleep from mosquitoes, and better still without mosquito bites.

The product, which proved very effective during trials, will be sold mainly in Africa. Dr. Ankaful and Remy, his marketing specialist,

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traveled around Africa last year with samples and have been able to secure tentative interest from several pharmacy stores around the conti-nent. However, they also know that the deals are not consummated until a final agreement is obtained.

Even though Dr. Ankaful plans to sell a can of 10 fluid ounces for $2.00, his decision with regard to this selling price is not final because he wants to make sure that the product is affordable to even people from low-income families. He is concerned that because he is not selling to consumers directly the actual retail price could be far higher than the $2.00 price tag at which he is selling to drug stores and pharmacies. It is conceivable that the retail selling price could be as high as $3.00 to $4.00 per unit, which will definitely place Afriga outside the reach of the poor. He plans to tackle the affordability issue some more later, possibly by establishing a nongovernmental organization that might supply the product to poor people.

To make their lives easier, Dr. Ankaful and Remy decided that because they are located only 30 miles from Miami, the product would be shipped from the port of Miami, Florida, FBO (free on board). The buyer is also responsible for insurance and freight. They are fully aware of the fact that this decision might limit or significantly cut down the number of drug and pharmacy shops that have initially expressed inter-est in the product. Currently, with the following cost information, Dr. Ankaful and Remy wonder how many units they would have to sell in order to achieve their goal to achieve 10% return on investment (ROI) in the first year. Material cost per unit is $0.80 and labor cost per unit is $0.40. Factory overhead is $200,000.00, shipping cost is $1,000.00, and advertising cost is $50,000.00.

Case 6: Honesty, Inc.

Jim Dolan is getting ready to embark on a seven-day field trip to visit four regional offices. He plans to take the 5:00 p.m. flight; before then, he has decided to spend the morning going over the notes of the previous day’s meeting on the reorganization of the sales force.

Mr. Dolan is the president and CEO of Honesty Insurance Company. Honesty is a national company that sells a wide range of property insur-ance policies – automobile, motorbikes, boats, homes, and office build-ings. Two years ago, the company considered expanding its offerings to

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include life- and health insurance policies. The company hired a con-sulting team that analyzed Honesty’s strengths and weaknesses as well as the opportunities and threats on the horizon recommended against the expansion and, instead, advised Honesty to focus on its current offerings. The recommendation was a bitter pill for Mr. Dolan who had envisioned presiding over a bigger company and sincerely thought there was money to be made with an expanded portfolio. Nonetheless, he rec-onciled himself to reality and decided to do the best he could with the company’s current offerings. Now, he would have to recommend to the board whether Honesty should hire its own sales force or continue using independent sales agents.

The Insurance Industry

The insurance industry is a highly competitive business that has a neg-ative image. The belief that the companies are eager to take people’s money by way of premiums but are very reluctant to pay when people make genuine claims is widespread. However, there are also many good and reputable companies in the industry. These reputable companies together with state regulators are working hard to clean the industry’s image. Even though insurance contracts are considered as private con-tracts and therefore a matter between contracting parties, because insur-ance has public policy implications, it is subjected to the supervision of a public agency.

The McCarran-Ferguson Act of 1945 was passed by Congress, among other things, to preserve the states’ jurisdiction over the insurance indus-try. Thus, there is no federal regulatory agency for insurance companies in the United States – instead of a federal regulatory body, the industry is policed by the regulatory agency of each individual state. Like every-thing else that is done on state-by-state basis, there are differences in the degrees of regulatory enforcement. Some states seem to defer more to the forces of the free marketplace to discipline bad actors, however, because it takes a long time in certain instances for the market mecha-nism to become fully functional, some unsavory business characters take advantage of unsuspecting consumers. Such was the case in the insur-ance industry in the 1970s, which witnessed the bankruptcy of a large number of insurance companies. Because of these bankruptcies and the fear that the federal government might start regulating the industry, the

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National Association of Insurance Commissioners (NAIC) adopted sev-eral model reforms.

Fears concerning the effectiveness of the states to deal effectively with this industry, which plays a very important role in people’s lives, persisted after the 1970s massive failures. However, there was no real desire in Washington, DC, to bring the industry under the control of a federal agency. In 1999, however, a modest effort was made to introduce some form of federal regulation, the Gramm-Leach-Bliley Act, known as the Financial Services Modernization Act, which was passed by Congress, among others, contained a minimum requirement that all states must include in their regulations. However, that did not satisfy people who really wished to see a stronger regulatory role of the federal government in the insurance industry. The Dodd-Frank Act of 2010 was perhaps another timid step, in the views of those who wish to see federal regula-tions, on the part of the federal government to regulate the industry. Among other things, this regulation established the Federal Insurance Office (FIO), which is responsible for monitoring and identifying gaps in the state regulations.

The Insurance Company

Honesty was established about 50 years ago as a regional insurance company. However, it has grown over the years into a modest national player in the property insurance market and prides itself on its relation-ship with its customers. The word in the street is, “They always come through when their customers need them.” Currently, it sells through independent agents, but is considering hiring its own sales force that would focus solely on Honesty’s business. Currently, Honesty does about $50 million worth of business and pays its agents 5% commission on sales. If it hires its own sales force, it estimates to spend about $4 mil-lion on salaries plus benefits as well as pay 2% commission in addition to their salaries. This decision is to be made in the meeting scheduled after Jim’s return.

Case 7: Golan, Inc.

Golan makes what it calls a low-prestige wristwatch that is aimed at the nouveau rich – the young investment bankers and the successful lawyers.

Appendix 1 l 171

The watch sells between $500 and $1,500 depending on the model; the lowest model, Golan 1, sells at $500, while the most expensive model, the Golan 3, sells at $1,500, and the Golan 2 sells at $1,000. The company counts itself lucky to have made almost half a million dollars in profit during the first year that it launched, three years ago, and continues to increase its profit steadily each year since; not many companies can say that about their performance.

Even though the company was launched in the midst of an economic downturn during which many consumers cut down on their purchase of nonessentials, particularly perceived luxury items, Golan watches seem to be an exception. It was launched against the advice of all seasoned businesspeople from whom Joseph Golan sought counsel. Now, it must decide where to allocate it communication efforts.

The Timepiece Industry

The timepiece industry has often changed with the passage of time, how-ever, the industry has undergone dramatic changes during the last four decades. The debut of digital electronic watches in 1970, which many thought was simply a fad, dramatically changed the wristwatch industry. Watchmakers like Timex that initially wrote off digital watches as a fad and did not invest in the technology almost lost their shirt when the so-called fad refused to go away. They had to play catch up in order to stay viable. At the height of its popularity the digital watches were so popular that they almost eclipsed their analog counterparts, however, both the analog and the digital wristwatches now exist side by side. Most of the contemporary watchmakers such as Casio and Timex now make both analog and digital wristwatches.

Part of the “revolution” in the industry is driven by advancements in technology. Wristwatches now not only tell time, but they also tell day of the week, year, and even serve as a compass, global positioning system (GPS), or altimeter. They can also perform other time-related functions such as a timer, an alarm, and a chronograph. Some digital wristwatches serve as storage for phone numbers, heart-rate monitor, and even TV control device. Because one only needs to be able to distinguish figures from 1 to 12 to be able to tell the time, they are popular with even children who might not have been able to tell the time with the analog watches.

172 l Appendix 1

The Old Man and the Watches

Daniel Golan, Joseph’s father, was a master watch repairer. He worked at his craft well past his retirement age until his poor eyesight made it impossible for him to continue. His small shop was adjacent to their home so it was really difficult for him to retire. He only had to open a couple of doors to move away from home to work! He loved his craft and his customers, and as the only watch repairer, he was also equally popu-lar with his customers. The introduction of digital watches significantly cut down his business, but by then he was well past his retirement age and only continued to service old timers who kept collectors’ watches or antique wall clocks.

Young Joseph spent a lot of time playing around his father’s shop and was fascinated by the old pendulum clocks that would chime on the hour. With time he also learned how to fix timepieces but also knew that he was not going to repair watches as a career. He went to college and studied business administration. While in college he bought and sold things online as a hobby, but as time went on he realized he was making a reasonable profit, so he thought of buying and selling online on a major scale. With his business background, he realized quickly that it would be better for him to specialize in selling only one thing online. After some research he zeroed in on watches, so he bought and sold only watches until he graduated with his MBA, three years ago, at the age of 25.

For his project in the MBA program’s entrepreneurship course, Joseph wrote a business plan for the Golan, Inc., a watchmaker and seller. He designed what he called a low-prestige watch that was aimed at the young upwardly mobile market. The watch casing is plastic, but with a mineral scratch-resistant surface that made it popular with outdoor enthusiasts. It is also water resistant to a hundred feet. In addition to being able to tell time, the watch has other functions such as alarm, GPS, heart moni-tor, chronograph, and data transmission capabilities. It can also tell date and year. He took the design to China and looked for a manufacturer who could make the watches for him at a reasonable price. He had three models, Golan 1, Golan 2, and Golan 3. The Golan 3 has all the fea-tures named above, but the Golan 1 and 2 have only some of them. All the watches look alike; all are water resistant to a hundred feet and have scratch-resistant surface.

Appendix 1 l 173

Joseph started selling his watches, naturally, online. He also attended a lot of track meets and marathons and other fun races at which he would try to sell the watches. The runners loved the watches. Soon it became a must have among runners. He touted the fact that runners could wear the same watch everywhere – “even to weddings” he would add. Currently, Joseph does all the personal selling by himself. He also carries the watches in a suitcase and visits bars in different cities fre-quented by young professionals and tells and sells; but by far, most of the watches are sold online. Joseph has no store, only a post office box. The decision he must make now is whether to hire about three or four other individuals to help him with personal selling or open a small store. He also sponsors boys and girls scouts and helps the neighborhood high school band with donation. These activities give him a good reputation in the community.

Case 8: Healthcare America Medical Center

The health-care industry in the United Sates has changed over the years, albeit ever so slowly. Even though Americans collectively spend more on health care than citizens of any other nation, studies have shown that Americans are not necessarily getting the best outcome for each medical dollar spent. Reports of fraud, wastage, and overbill-ing are jarring enough to make one fall sick, yet the massive overhaul that many people have called for is slow in coming, if it would ever come. In 2013, Health Affordability Bill has been passed to change the system and make health insurance more easily affordable in 2014; however, talks about repealing this act continue in certain circles. It is clear, however, that the way in which the system was operating was not sustainable in the long term.

Health-care providers in the United States can be divided into three categories – nonprofit medical facilities, which make up about 62% of the industry, government facilities, which are mainly owned by cities and counties comprise about 20%, and private for-profit facilities, which make up about 18%. Because of the contracting economic conditions, the tax base or revenue sources of many municipalities have been neg-atively impacted. As a result of the economic downturn, the funding of many public hospitals such as Healthcare America Medical Center has been drastically reduced. Meanwhile, competition for patients has

174 l Appendix 1

increased as for-profit hospitals have mounted aggressive campaigns. To exacerbate the situation, several walk-in clinics operated by major drug-stores and staffed by nurse practitioners and physician assistants have also sprung up.

The chief executive officers (CEOs) of hospitals such as Healthcare America Medical Center are now caught in an invidious position. As if the above developments are not enough to send them crazy, there is additional pressure from the third-party payers such as insurance com-panies to contain costs. Many Americans do not know how much their visit to the hospital or doctor(s) costs; they know only what their co-pay is, which is generally a small portion of the cost that has been negotiated by the insurance company. For that reason, some people argue that since many visit the doctor(s) needlessly, health-care reform should include a higher co-payment from all insured. Once people have to pay more, they would reduce visits to the doctor(s). Of course, there are several sides to this argument. First and foremost is the assumption that people visit their doctors needlessly.

Healthcare America Medical Center, in the midst of all these changes, needs to make a decision on whether it should advertise more. A deci-sion to advertise more will call for an increase in advertising budget by $250,000.

The Medical Center

Healthcare America Medical Center was established in 1915 by Dr. Blake. He was the only physician and by default took in all patients regardless of race. However, Dr. Blake’s personality was such that he neither believed nor acted in a manner consistent with the belief of supe-riority of any race. He built Healthcare America initially as Dr. Blake’s Healthcare Center and operated it until his death in 1950. From a 2-room infirmary, he managed to build the facility into a 20-bed hos-pital and acquired the adjoining plots of land. Dr. Blake never married and did not have any children, so he left the facility to the county in his will. However, being selfless even in death, Dr. Blake stipulated in his will that the county refrain from naming the facility after him.

The county assumed ownership of the facility soon after the death of Dr. Blake, hired a CEO, Mr. Sun, who held a professional hospital

Appendix 1 l 175

administration degree and has operated a hospital since. The hospital expanded under Mr. Sun, who managed the hospital for 15 years. Mr. Zade took over when Mr. Sun retired and managed the hospital for 20 years. Expansion continued until Mr. Zade also retired. However, Mr. Burns, who took over from Mr. Zade, did not last long. His man-agement style and frequent clashes with county officials led to his ouster after four years. Ms. Davis took over for another ten years before the current CEO, Mr. Brown.

Currently, Healthcare America Medical Center has 560 beds with an operating budget of $80 million, most of which comes from the city and part of it comes from the federal government as provided under the Hill-Burton Act of 1964. The act requires hospitals to treat the poor in exchange for a federal funding. However, it seems Healthcare America Medical Center has been treating a disproportionately large number of uninsured patients; hence, its operating budget has been in deficit during the past three years. With reduced funding from the city because of the deteriorating economic conditions, unless some bold decisions are made soon, the hospital will not only begin to lay off employees, but it will also have to eliminate certain departments. The meeting Mr. Brown has just had was a strategy session intended to design actionable plans to restore the hospital’s financial health. However, it seems the only concrete thing that came out of the session was to increase its advertising budget by $250,000.

Case 9: Vincent’s University

The market for higher education in the United States has been evolving with the changing mood and sensibilities of the society. College educa-tion, like everything else that conferred status or represented an oppor-tunity to be upwardly mobile in society, was closed to people of African descent in post-emancipation era. Grade schools existed for them, but they were separate and unequal. A few high schools, which were also seg-regated and poorly funded, existed. A few made it through high schools, but that was as far as they could go.

As time passed, a few progressive universities mainly in the Northeast admitted a handful of students of African descent who showed excel-lent promise even with their poor circumstances. However, even those

176 l Appendix 1

students had restrictions, such as they could not live on campus and so forth, placed on them. But they persevered. As time went by, because of segregation, a few states, mostly in the South, built separate state univer-sities for blacks only. These universities have come to be known as the Historical Black Colleges and Universities (HBCUs). In the midst of these transitions, a few privately owned “Black” universities also opened their doors to cater to the increasing number of blacks who were graduat-ing from high schools but who had nowhere else to go for higher educa-tion. Vincent’s university was one such school.

Even though the school was well known internationally and has developed a reputation for educating blacks in the technical fields, its enrollment had started to decline while costs kept rising. The current president, Dr. Lloyd, is contemplating increasing tuition fee across the board by 10%. Many consider the tuition fee to be already high and there are talks on campus about possible student protest.

Higher Education in the United States

College education, though not a guarantee, is one of the surest tickets to the middle class; many, including the so-called nontraditional students, are opting for a college degree. This means that enrollment in universi-ties has increased over the past five to six years. However, advancement in technology and the increased numbers of privately owned for-profit universities who offer flexible programs online and over weekends have proven to be quite successful in attracting students away from the tradi-tional schools. However, higher education in the United States continues to be a magnet in attracting international students, particularly to gradu-ate programs.

Even as many students are enrolling in colleges and universities, the soaring cost of college and university tuitions, which have led to massive debts of students by the time they graduate, have become common topics of discussion on the Sunday talk shows. According to the College Board, tuition in a four-year public university increased at the average annual rate of 4.3% between 1983–84 through 1993–94, an average annual rate of 3.7% between 1993–94 through 2003–4, and an average annual rate of 4.2% from 2003–4 through 2013–14. Average annual tuition rates for four-year private, nonprofit universities for the same period were 4.1%, 3.1%, and 2.3%.

Appendix 1 l 177

Vincent’s University

Vincent’s University began as Vincent’s College in 1856 with a total enrollment of 18 students, 14 males and 4 females in its first year. It was started by Mr. Wolf Thompson who believed strongly that black college students must be equipped with technical/vocational skills to be able to employ themselves upon graduation instead of relying on white-owned companies to employ them. This philosophy was popular among elderly blacks and many parents worked hard to send their sons and daughters to St. Vincent’s College. The students at Vincent’s grew their own crops, raised their own animals, and even helped to build some of the buildings on campus.

From one-building school, the school expanded to three buildings after the first year and ten buildings in three years, thanks to the indus-triousness of the students and their teachers. After 10 years of existence, the enrollment was 200 students and the number of buildings on campus increased to 20. In addition, mathematics, reading and writing, training in agriculture, mechanics, and home science for females continued. With donations from philanthropists and many whites who were sympathetic, more faculty members were hired and adjoining plots of land were also acquired.

Over the years, Vincent’s reputation for high-quality technical edu-cation for blacks spread. Governments in Africa and the Caribbean Islands sent their bright students to Vincent’s for technical education. The school was one of the few to offer a veterinary medicine degree. Vincent’s enjoyed the loyalty of its alums who continue to support it by donations and by sending their children also to Vincent’s. It is difficult to find a student whose parents or relatives have not attended Vincent’s. However, as years went by, with openness of the so-called white uni-versities to admit African Americans, enrollment at Vincent’s and other predominantly black universities plateaued in the 1970s and then started to decrease in the 1980s.

Decisions

To deal with stagnant and decreasing enrollments in the late 1980s, the school’s authorities decided to change its name from Vincent’s College to Vincent’s University. This proposal generated a lot of strife as did debates on campus and among alumni. Those who were for the name change

178 l Appendix 1

believed it would signal that Vincent too had become a major player in the world of higher education. In fact, in addition to the bachelor’s degree and a veterinary medicine degree, it would award master’s degrees in all the fields of engineering and physical sciences. Furthermore, support-ers argued that in countries outside the United States where the school actively recruited, “college” is used to refer to high schools instead of a four-year bachelor’s degree granting institution, and therefore the name change would make it easier to recruit international students, as there would be less confusion over its name.

Those who opposed the name change argued that the school was tinkering with their historical tradition and it was the name that made Vincent’s beloved and dear to them. They threatened to withhold their support for school if it went forward with the name change and started a petition drive to remove all those school officials who supported the name change. Eventually, the name change went through, no support-ing official lost his/her job and Vincent’s College became Vincent’s University in 2000. Sadly, however, the name change did not translate into the envisioned boost in enrollment. After ten years with the new name, the school needed to do something else to stop the red ink. This time it was to increase tuition fees by 10%. While some universities charge different tuition fees for different “majors,” for example, tuition fees for engineering is generally higher than that of business, and busi-ness is higher than that of education and social sciences, however, at Vincent’s with the exception of veterinary programs all tuition rates are the same. Currently the average tuition fee is $20,000 per year. Those who thought the planned increase was a bad idea argued that increase in the tuition fees instead of raising revenue would lead to a decrease in revenue and back sliding of quality education at the school.

Case 10: Sunco Appliances

The middle class is expanding at a rapid rate in many African countries. With newly discovered oil fields in many parts of the continent comes an increasing purchasing power. The annual economic figures from many of the countries in which there is oil exploration show evidence of vastly improving conditions. A cursory tour of cities such as Accra, Ghana, and Lagos, Nigeria, show shops that are filled with a wide range of electrical and electronic appliances. Items such as refrigerators and TV sets, which

Appendix 1 l 179

were exclusively reserved for the rich, are now aspirational items that can be seen on everyone’s shopping list for Christmas. Generally, the aver-age worker buys these high-ticket items in the month of December for Christmas.

Sunco manufactures refrigerators and wishes to capitalize on the growing size of the middle class in Africa by exporting to that market. Initially, it plans to sell in Ghana and Nigeria, using these two countries as a foothold. It would expand to two or three other African countries after the initial two years of operations in Ghana and Nigeria. Initially, it will use an export strategy in which it will manufacture the items in the United States, and ship them to the stores in Accra and Lagos. Eventually, it plans to set up its own manufacturing facilities in these two countries. Preliminary studies are promising, but instead of selling through other retailers in these countries, Sunco has decided to setup its own stores in Accra, the capital of Ghana, and Lagos, the largest city in Nigeria. Store spaces, the requisite permits, and licenses have all been acquired and everything is a “go.”

Sunco has modified its design for its refrigerator meant for Africa where electricity is often interrupted, to make the products sell bet-ter in Africa. A device that looks like a small television dish harnesses solar power and is connected to the refrigerator just like the TV dish. This device stores energy that the refrigerator can draw on during pro-tracted power failure. This seemed like a very good feature to distinguish Sunco’s product from the rest in the market. However, the solar modifi-cation was the only adjustment made by Sunco; the appliances shipped to Africa were of stainless steel and similar to the standard kitchen size (about 18.3 cubic feet) refrigerators sold in the United Sates. Six months after the first shipment Sunco officials realized that sales were far less than they had projected. What happened, what did they miss, officials began to ask?

Name Index

3M, 71

Abernathy, 14, 16Accra, 178, 179Adam Smith, 6, 10Adams, 70, 80, 133, 148Advertising Age, 126Africa, 166–8, 177, 179Afriga, 166–8Agarwal, 143, 148Aharony, 51, 54, 66Ahearne, 97Akerlof, 52, 53, 63, 67Alchian, 8, 11, 16Alden, 121, 129Amy, 157–9Anderson, 14, 16, 93, 97, 98, 114,

124–6, 129Angola, 166Anthony Ankaful, 166, 167Apple’s Newton, 151Arias, 121, 129AT&T, 108Atkinson, 92, 97Atlanta, 40, 100, 151Atlanta Summer Olympic Games, 100

Ballantyn, 27, 32Bang, 117, 130Barry, 114, 124–6, 129Basu, 121, 129

Bayus, 78, 80, 95, 97Behrman, 14, 16Berger et al, 24, 29, 30, 32Berle, 8, 16Berry, 27, 32, 39Bhattacharya, 51, 53, 54, 67Bolzmann, 121, 129Bowen, 100, 111Bradfrod, 94Brantner, 70, 80, 133, 148Bridgestone, 153Britt, 114, 124, 129Brock, 121, 130Bruner, 105, 112Bryant, 121, 130

Camel, 121Campbell, 75, 114, 129Campbell’s Soup, 75Caribbean Islands, 177Carrol, 4, 16, 27, 32Central Africa, 166Chakraborty, 121, 129Chakravarti, 121, 129Challagalla, 97Chaney, 76, 77, 80Chattopadhya, 121, 129China, 40, 165, 172Chowdhury, 92, 97Christopher, 27, 32Clairol’s Touch, 72

182 l Name Index

Clayton Act, 138Coase, 2, 3, 6, 8, 10, 11, 16Coca-Cola, 100, 151, 152Colley, 118, 125, 129Comtois, 45, 47Congress, 169, 170Cooper, 69, 80, 137, 148Crawford, 69, 80Crittenden, 14, 16Cyert, 3, 5, 16

David, 21, 159Davidson, 153, 155Davis Myers, 164Demsetz, 8, 9, 11, 16Department of

Transportation (DOT), 75Devinney, 76, 77, 80Ding, 59, 67Dixie, Inc, 165Douglas McGreagor, 86Dow Jones Industrial

Average (DJIA), 127Downes, 51, 54, 55, 67Dr. Blake, 174Dr. Lloyd, 176Dr. Raymond, 162–4Drucker, 36, 47

eBay, 142Economist Intelligence Unit, 150Eddy and Saunders, 75, 76Edgett, 69, 70Edwin Ebel, 99Eliashberg, 58, 64, 67, 77, 80Eliot Spitzer, 147Elmo, 159eMarketer, 114, 123, 129Erickson, 78, 80, 95, 97Euromoney Country Risk Survey, 150

Facebook, 105, 107Fama, 5–8, 16Federal Insurance Office (FIO), 170

Federal Trade Commission, 64, 67, 97, 138

Federal Trade Commission Act, 138Federated Department Stores, 147Feldhamer, 49, 67Fill, 101, 112Financial Services Modernization

Act, 170Firestone’s 15”, 153Food and Drug Administration

(FDA), 75Ford Edsel, 38, 51Ford Explorer, 153Ford Motor, 153Fornell, 79, 81Franke, 117, 130Frankental, 101, 111Friedman, 4, 16Frito-Lay’s Olestra, 151Frost, 106, 112, 126, 130

Gabor, 58, 59, 67, 134, 148Ghana, 178, 179Ghewal, 22, 32Giffen, 58Gillette, 70, 80Golan, 170–2Grafen, 49, 67Gramm-Leach-Bliley Act, 170Granger, 58, 59, 67Grossman, 58, 62, 63, 67Gupta, 24, 28, 32

Hayek, 10, 16, 59, 67Hayes, 14, 16Health Affordability Bill, 173Healthcare America Medical Center,

173–5Heeler, 143, 148Heinkle, 51, 54, 55, 67Herman Pruit, 166Historical Black Colleges and

Universities (HBCUs), 176Hoffer, 153, 155

Name Index l 183

Honesty, Inc., 168Honesty Insurance Company, 168Horsky, 65, 67Hotmail, 106Hoyer, 121, 128Hozier, 128, 129Hughes, 97

IBM, 30–2Ishida, 95, 97

Jack Gordon, 157, 159Jacobson, 78, 80, 95, 97Jagpal, 15, 16, 58, 64, 67, 77, 78, 81James Brown, 160, 162Jarrell, 75, 80, 153, 155Jaworski, 93, 97Jensen, 6–9, 11, 14, 16Jim Dolan, 168Jindal, 97Johanna, 157, 158, 160John, 16, 67, 97, 157, 158, 160Johnson, 114, 124–6, 129, 152, 153Johnson and Johnson, 152, 153Joseph, 171–3

Kaplan, 137, 148Kaufman, 147Keller, 22, 27, 32, 70, 81, 114, 129Kerin, 24, 32, 70, 81KFC, 152Kihlstrom, 58, 61, 67Kim, 104, 105, 112Klein, 58–60, 67, 77, 78, 81, 121, 130Kmart, 43Knox, 27, 28, 33Koku, 15, 16, 58, 64, 65, 67, 77, 78, 81,

147, 148Kotler, 22, 27, 37, 70, 71, 81, 114, 129Krishnan, 93, 97, 121, 129Kumar, 32–3, 112

Lagos, 178, 179Lagrosen, 104, 110, 111

Lambe, 95, 97Latham, 92, 97Lavidge, 123, 129Leffler, 58–60, 67, 77, 78, 81Lehmann, 24, 32Leland, 51–4, 68L’Etang, 101, 111Levin, 14, 16Levy, 22, 32, 81Lewin, 102, 111Lewis, 118, 129Locke, 92, 97, 106London Olympics, 100Lovelock, 21, 33Low, 110, 111Low et al, 102, 111

MacDonald, 15, 16–17Majluf, 51, 57, 68Malaria, 166Manchester United, 100Manfred Longhorn, 166March, 3, 5, 17March/April, 59, 80Markwick, 101, 112Marquardt, 114, 126, 127, 130Marshall, 11, 17, 59, 68Masulis, 51, 68Mathur, 127, 130Matzler, 22, 33MBA, 172McCarran-Ferguson Act, 169McGann, 114, 126, 127, 130McGuire, 120, 128, 130, 148Means, 8, 16Meckling, 6–9, 11, 14, 16Michael Porter, 36Microsoft, 141Milgrom, 58, 62, 68Miller, 5, 6, 16, 51, 68Mitsubishi, 152M-M, 51, 52Modigliani, 51, 68Monroe, 139, 141, 143, 148

184 l Name Index

Mooradian, 22, 33Mowen, 94, 97, 121, 129Mr. Brown, 175Mr. Dolan, 168, 169Mr. Paul Lloyd, 164Mr. Sun, 174, 175Ms. Davis, 164, 175Myers, 51, 57, 68, 164MySpace, 105, 107

National Association of Insurance Commissioners, 170

Nelson, 58, 60–2, 68New Coke, 151New York City, 41New York Marathon, 100New York Stock Exchange, 54Nguyen, 143, 148Nicholas Majluf, 57Nigeria, 178, 179Nike, 100Nottingham, 59

Oliver, 93, 97, 98Optimedia, 117

Pajero, 152Payne, 27, 32Peanut Corporation of America, 153Peltzman, 75, 80, 153, 155Pepsi-Cola, 151Perri, 58, 60, 68Peterson, 24, 70, 81Petty, 120, 121, 130Pfeffer, 5, 17Plant, 10, 17Polo, 43Post Office, 6, 100, 173Priceline, 142Pruitt, 153, 155Pyle, 51–4, 68

R. J. Reynolds, 151Rajan, 31, 32

Ramaswami, 94, 98Randall Eric, 106Rangaswamy, 43, 47Rao, 59, 67Rapp, 97Raskin, 121, 130Rasmusen, 58, 60, 68Reichheld, 19, 27, 33Reilly, 114, 126, 127, 130, 153, 155Remy, 167, 168Research in Motion, 39, 72Ring, 22, 33Riordan, 58, 61, 67Roberts, 58, 62, 68Robertson, 58, 64, 67, 77, 80Robinson, 3, 79, 81, 138, 143Robinson-Patman Act, 138, 143Rodriguez, 45, 47Rosenzweig, 110, 112Ross, 32, 51, 52, 58, 59, 62,

63, 67–8Royal Crown, 72Ruoh-Nam, 110, 112Ryals, 27, 28, 33

Sager, 102, 111Salancik, 5, 17Salter, 10Samuel Francis, 164Sasser, 27, 33Schatzberg, 128, 129Schmanlensee, 58, 61, 68Scholten, 120, 130Scott, 81, 121, 130Security Exchange

Commission (SEC), 55Shark, 119Sherman Act, 138, 139Sherman Antitrust Act, 138Shervani, 93, 94, 97Simon, 3, 4, 17, 97, 125, 130, 131,

148, 164Simon Newton, 164Singh, 94, 98

Name Index l 185

Slack, 45, 47Sony’s Betamax, 151Sony’s eVilla, 151Spence, 49, 50, 51, 63, 68Stahakopoulos, 93, 97standard industrial classification

codes (SIC), 77Steiner, 123, 129Stevenson, 105, 112Stewart Myers, 57Stout, 104, 105, 112Strauss, 106, 112, 126, 130Sunco, 178, 179Swary, 51, 54, 66Swyngedouw, 65, 67

Taran, 143, 148Taylor, 117, 129, 130The Afriga, 166, 167The Peoples Bank, 160the truth-in-lending laws also known

TILA, 139Thomas, 110, 112Tommy Hilfiger, 43TVA, 6Twitter, 105, 107Tylenol, 75, 152, 153

United States, 89, 100, 103, 113, 123, 126, 138, 146, 151, 153, 165, 169, 173, 175, 176, 178, 179

United States Football League (USFL), 151

Urban et al., 79US Post Office, 100

Van Bruggen, 43, 47Vermaelen, 51, 55, 56, 68Vincent’s University, 175–8Viswanath, 15, 16, 58, 64, 67, 77,

78, 81Vodafone, 100Volkswagen, 119Vroom, 92, 98

Walmart, 43Washington, DC, 67, 170Watson, 110, 112, 113, 130Webb, 95, 97Weitz, 94, 98Wells, 121, 130Wheeler-Lea Act, 138Wiener, 58, 63, 68Wilson, 14, 16Winer, 76, 77, 80Wolf Thompson, 177Wolinsky, 58, 59, 68Worrell, 153, 155Wright, 21, 33

Yogurt Shampoo, 72Yoo, 104, 105, 112YouTube, 105, 107

Z44, 163, 164Zade, 175Zee printer, 136Zeephongsekul, 143, 148Zenith, 117Zingo, Inc., 162–4Zinkham, 113, 130

Subject Index

4Ps, 36–8, 45, 46

ABC, 121, 137absurdity, 120–2accountants, 2, 157Accounting Firm, 158, 159accounting practices, 24accounts payable, 5, 143accounts receivable, 5, 13, 143accrual accounting, 5achievement theory, 92Across-the-Board Price Cut, 145–7action, 22, 29, 46, 53, 101, 118,

119, 123Activity-Based Costing, 136, 137add-on bundling, 141advertising, 20, 22, 45, 58–62,

75, 78, 79, 99, 100, 104, 105, 107, 110, 113–28, 139, 145, 147, 154, 164, 168, 174, 175

Advertising as a Signal, 60advertising blitz, 75advertising effectiveness, 123, 124advertising signaling, 62agency theory, 6agents, 42–4, 50, 52, 83–5, 87, 94, 96,

169, 170agriculture, 110, 163, 177AIDA, 118alliances, 12, 65announcement, 54–8, 64, 76,

77, 127

announcing, 76, 78arbitrage, 55assumptions tractable, 3asymmetric conditions, 53, 57, 60, 64asymmetry, 49, 52, 57, 63, 66, 85ATR, 118, 120attention, 7, 27, 59, 85, 104, 105,

118–20, 122, 123, 145, 147automobile, 2, 20, 39, 40, 63, 75,

119, 168autonomous movement, 11

B2B, 143bankruptcy, 9, 14, 52, 66, 161, 169Behavioral Theory, 3bilateral, 2billboards, 115, 117black box, 131blessings, 38, 167blind, 1Blog, 105–7BlogPulse, 106boats, 168bonding costs, 7bounded rationality, 1branch, 1Broadcast Media, 115, 116brokers, 42–4bundling, 140, 141Business Analysis, 71, 73, 74business-to-business, 143buy into, 40

188 l Subject Index

cash f low, 13catalogs, 30, 43CBS, 121celebrity endorsements, 59, 61central planning authority, 10CEO, 10–13, 153, 161, 162, 168,

174, 175cheap, 45Christmas festivities, 157chronograph, 171, 172citizen, 5, 137, 173click-through, 105, 126cluster free, 127CLV, 20, 23–31, 89CLV formulation, 24coalition, 4, 5, 14coalition of interests, 5collaboration, 15, 27, 31, 133Commercialization, 71, 75Commission, 43, 55, 64, 84–7,

138, 170Commission plus Base Salary, 85Commission plus Bonuses, 85Commission plus Contest, 85, 87communication, 20–3, 45, 49, 89, 91,

99–120, 162, 171communication elements, 99, 113Communication mix, 20, 21, 100,

108, 109Communication process, 56Communication Processes, 89, 91,

114, 115communication strategies, 99, 104community, 5, 12, 100, 161, 173Company Ethics, 89Company Uniform, 99, 100, 108competitive pricing, 13computer programmers, 11Concept Development and Testing,

72, 73consume perquisites, 8Consumer Credit Protection Act, 139consumers, 2, 20–3, 38–40, 42, 43,

57–63, 66, 69, 74, 77, 79, 86, 87, 97,

102–4, 110, 112, 114, 120–3, 125, 128, 131, 133, 137, 139, 142, 143, 146, 147, 151, 168, 169, 171

consumption, 9, 15, 46, 58, 133, 165contracts, 6–8, 11, 15, 59, 83, 86, 96,

132, 133, 140, 169cooperative efforts, 9co-operatives, 6coordination, 11coordinator, 3, 4, 6, 10copartnery, 7Corporate Design, 20, 23corporate forms, 8, 10corporate logo, 99, 100, 107, 108Corporate Logos and Colors, 107Corporate Name Change as a Signal,

65Corporate PR, 100corporate signaling, 51corporate social responsibility, 4, 5, 100corporation, 1, 8, 14, 28, 52, 64, 65,

70, 107, 153Cost Per T housand (CPM), 126cost-benefit analysis, 22, 100Coupons, 145, 146creative destruction, 113credible signal, 53, 55, 64, 65cross-disciplinary, 14cross-functional, 71CSR, 100, 101cues, 49, 64culture, 1, 143Current Trends, 14customer acquisition, 28, 29customer centric, 35customer lifetime value (CLV), 19customer loyalty, 19customer relationship management

(CRM), 29, 31

DAGMAR, 118, 120, 125deceptive advertising, 61definition, 1, 3–8, 16, 22, 24, 27, 31,

109, 114, 134, 144

Subject Index l 189

demographic factors, 40, 117departments, 12–15, 28, 31, 32, 37, 40,

41, 43, 44, 47, 75, 83, 92, 109, 110, 133, 147, 149, 154, 162, 175

desire, 38, 118–20, 132, 170direct mail, 30, 103, 119direct marketing, 45, 99, 100, 102,

103, 105disloyalty, 19Display Signs, 115, 117distribution options, 44dividend, 51, 53–5, 56Door-to-Door Sales, 88, 97down-sloping, 58downward pressure, 11drilling, 165, 166dual distribution, 43, 44dual distribution strategy, 43

Early Payment Discount, 143economic theory, 3, 9, 10, 58economic value, 27, 28, 42economists, 2–4, 6, 8–10, 41, 131, 134,

136, 150economy, 1, 3, 4education, 50, 51, 63, 126, 158, 175,

176–8efficient market hypothesis, 54Elasticity, 134–6Elasticity of Demand, 134elephant, 1ELM, 120, 159email, 30, 43, 103, 106, 151EMH, 54employees, 4, 5, 19, 31, 50, 51, 54, 63,

66, 71, 83, 86, 89, 91, 108, 157entrepreneur-coordinator, 4, 6entrepreneurs, 52–5environment, 5, 12, 133, 163–5, 167environmentalists, 5equilibrium, 7, 11, 51, 54, 60, 62event-study, 54, 65, 76–8, 127event-study technique, 54, 65, 78, 127evolutionary biology, 49, 50

exchange, 2, 3, 12, 54, 55, 86, 163, 175

expansion, 29, 169, 175experience goods, 60–2external, 5, 17, 41, 45, 57, 84, 85, 96

fable, 1Facebook, 105, 107factions, 5factors of production, 11faking, 51farmer, 2, 3FBO, 168FCPA, 89features, 2, 3, 10, 55, 74, 102, 119, 140,

150, 172Federal Trade Commission Act, 138feedback, 36, 91firmographics, 31First-Mover Advantage, 79focus-group, 38, 40, 72Foreign Corrupt Practices Act, 89forestry, 110forward-looking, 30foundations, 4, 6four-legged stool, 36, 37free market, 3, 10–12, 39, 41free market economy, 3free on board (FOB), 144, 168free riding, 50, 51full-cost, 131, 132, 136, 146full-cost pricing, 131, 132, 136functional areas, 13–15, 37, 38, 41, 44,

46, 71functional departments, 12functional silos, 14, 15, 66

gas stations, 25global positioning system, 171globalization, 70go/no-go, 70goal setting, 14, 92goal-setting theory, 92governance, 69

190 l Subject Index

government, 6, 26, 41, 59, 63, 153, 168, 169, 170, 173, 175, 177

GPS, 171, 172guaranteed, 62

heart monitor, 172heart-rate monitor, 171hierarchy of effects, 105, 118, 120high quality, 58–63, 136, 177holding shares, 6holistic approach, 36home, 5, 9, 20, 101, 102, 160, 168,

172, 177homeowner, 9hospital, 6, 35, 173–5households, 9, 59, 143human behavior, 4human capital, 9Humor, 120, 121

Idea Generation, 70–2Idea Screening, 70, 72IMC, 45, 104, 109–11, 113, 116, 117,

119, 124, 125impersonal communication, 21, 22independent contractors, 84industry, 2, 12, 21, 25, 31, 65, 70, 75,

76–9, 95, 104, 108, 128, 137, 150, 165, 169–71, 173

inferior quality, 59infirmary, 174information asymmetric, 53, 57, 60,

64, 93information asymmetric condition, 53,

57, 60, 64, 93information asymmetry, 49, 52, 57,

63, 66information-releasing events, 78inside information, 52–4, 57insiders, 51–5, 57, 63, 66, 76Instructional Materials, 20, 23,

108, 109insurance, 6, 58, 83, 144, 168, 169,

170, 173, 174

integrated communication mix, 109integrated communication strategy, 99integrated marketing communication,

45, 104, 109, 113interdisciplinary, 15, 79interest, 4, 5, 8–10, 12, 13, 24,

25, 50–2, 59, 61, 63, 66, 77, 84, 89, 95, 100, 101, 103, 105, 110, 114, 118–21, 126, 139, 151, 153, 159, 163, 167, 168

Interestingness, 120, 122intermediaries, 42, 43, 89, 145internal, 5, 45, 52, 57, 65, 66, 71, 73,

75, 84, 85, 87, 91, 96, 108internal rate of return (IRR), 73Internet, 103–5, 110, 117, 145, 146, 151Interstate Commerce Committee, 138intrapreneurial, 71invention, 2, 3, 113invisible hands, 10IPM, 120IREs, 78, 80IRR, 73, 74

junk mail, 102, 103Just Noticeable Difference (JND), 142

lawmakers, 4league, 5, 13, 151left out, 40legislators, 5legitimize, 5lemon problem, 63lenses, 37leverage hypothesis, 56linkages, 15, 35logos, 23, 107, 108, 115, 116low-margin, 101low-prestige, 170, 172low-quality, 60–3loyal customers, 31

macroeconomic, 2making assumptions, 3

Subject Index l 191

malaria, 166managerial propensity, 7managers, 4–6, 8–10, 13, 19, 23, 24,

52, 53, 54, 57, 69, 73, 83, 92, 95, 96, 105, 110, 121, 134

manufacturer’s suggested retail price (MSRP), 147

margin, 24–7, 41, 50, 51, 60, 61, 101, 132–4, 146, 164

marketing communication, 45, 99, 100, 104, 109–11, 113

marketing communication activities, 110, 111

Marketing Communication Channels, 100

marketing department, 13, 15, 28, 37, 41, 44, 47, 83, 92, 109, 149, 154

marketing mistakes, 149, 151, 153–5marketing mix, 20Marketing Mix Element, 20, 43marketing research, 38Marketing Strategy Development,

71, 73marketplace, 2, 13, 116, 169maximization, 4, 8, 9, 30, 131, 134maximize, 4–7, 9, 52, 61, 125,

131, 137maximize profit, 9, 131maximizing, 5, 14, 60MD, 10mechanic, 2, 3, 177messages, 21, 22, 43, 103, 106, 115–17,

122, 125, 151metaphor, 13, 36metric, 28–31, 109, 114, 126, 156mind-set, 29, 69, 83, 123minimum profit, 9mining, 110minority, 10misleading, 7, 31, 60mistakes, 149, 150–4mixed-joint bundling, 141modeling techniques, 15Modern Finance Theory, 5, 75, 76

money, 3, 4, 6, 21, 53, 57, 62, 73, 109, 111, 113, 116, 120, 123, 139, 147, 152, 159, 160, 163, 164, 169

monitoring costs, 7monopolistic, 25monopoly, 26, 41, 139mortgage, 103, 159mosquito, 166, 167motorbike, 39, 40, 43, 45, 168MSRP, 147multichannel distribution, 43multidisciplinary, 14MySpace, 105, 107

Naming New Products, 152natural evolution, 13NBC, 121negotiating, 5neoclassical theory, 5net present value (NPV), 27, 57, 74network of contracts, 6–8, 11, 15new projects, 5, 52new-product, 15, 20, 58, 62, 64, 69,

70–80, 95, 96, 114, 118, 133, 149, 150–2, 162, 164, 166

New-Product Announcement, 58, 64, 76, 77

New-Product Introduction, 15, 64, 69, 70, 71, 75–9, 150

new-product introduction, 15, 64, 69–71, 75, 76–9

new-product preannouncement, 58, 64, 76, 77

nonprofit, 88, 173, 176Nonprofit Institutions and

Sales Force, 88not-for-profit, 35, 88NPV, 57, 74nucleus, 1null hypothesis, 76

objective functions, 7objective/definition, 6

192 l Subject Index

objectives, 3, 4, 7, 11–13, 27, 101, 103, 109, 124, 131

offerings, 20, 23, 29, 43, 45, 46, 51, 58, 65, 100, 131, 132, 140, 168, 169

office buildings, 168Online, 88, 106, 108, 109, 113, 172,

173, 176optimizing, 14organization, 88, 89, 92, 94, 101, 106,

117, 131, 140, 168Other Internet/Web-Based Means of

Communications, 105Other Issues on Price, 137outsiders, 51–3, 57, 63, 108ownership rights, 8

packages, 20, 42, 115, 118, 142partners, 7, 104, 160, 166patent, 133, 163, 167payback period, 73paying its full way, 132Pecking Order Theory, 57pendulum clocks, 172penetration, 133, 142perpetuity, 5perquisites, 8, 9personal computer, 78personal selling, 45, 99, 100–2,

119, 173persuasion, 114, 122pharmaceutical, 70, 75–7, 122, 133,

150, 166, 167pharmaceutical industry, 70, 76,

95, 150phenomenon, 1, 143phone numbers, 171pillar, 1place, 8, 9, 20, 36–8, 41, 45, 47, 87, 91,

96, 104, 107, 109, 113, 150PLC, 69, 77positioning strategy, 151Post Office, 6, 100, 173post-1937, 2post-emancipation, 175

PR activity, 100preannouncements, 58, 64, 78preannouncing, 78Predatory Pricing, 139pre-nineteenth-century era, 8prescient value, 29present-value, 23price, 3, 10, 11, 13, 20, 21, 25, 28, 29,

31, 36–8, 40–5, 47, 55–9, 60, 62–6, 72–4, 76, 77, 79, 80, 109, 111, 126, 127, 131–51, 153, 166, 168, 172

Price as a signal, 58Price Bundling, 140price discrimination, 137, 138price line, 137, 140price mechanism, 3, 10, 11, 62price-earnings ratio (P/E ratio), 55Pricing Based on Geographic

Location, 143, 144Pricing Based on Special

Orders, 143, 144Pricing to Business Customers, 143Print Media, 115, 116, 145private for-profit, 173Product Development, 14, 70, 71, 74product life cycle, 29, 64, 69, 142product line, 139, 140Product Recall, 75, 153, 154productivity, 50Product-Line Pricing, 139, 140product-specific assets, 77profit maximization, 8, 9, 131promotion, 20–4, 36, 37, 45, 99, 100,

106, 114, 119, 139, 145, 146property insurance, 168, 170property rights, 6–8, 11public offerings, 51Public Relations, 5, 20, 23, 45,

99, 100, 154Publicity/Public Relations, 20, 23pull-strategy, 145push strategies, 145

quotas, 88, 90, 92

Subject Index l 193

R & D, 39, 74, 76, 79, 133R & D budget, 39, 79real functional, 74real options, 30real-estate, 42, 94realistic definition, 3real-world, 9, 14, 30, 52, 140Rebates, 145, 146receivers, 114–16recency, 30regulators, 5, 164, 169, 170relationship management, 29, 31,

94, 160renting, 9reputation, 9, 59, 61, 75, 139, 145, 158,

159, 173, 176, 177residual loss, 7Resource Allocation, 12, 30retail price, 145, 147, 168retention, 25–9, 31, 55, 120, 125return on advertising (ROA), 114, 124returns, 28, 52, 74, 76, 77, 78, 114,

124, 127, 128, 134, 157revenue, 24, 28, 30, 31, 59, 85, 88, 95,

131, 136, 137, 146, 149, 173, 178reverse auction, 142risk-adjusted, 28, 30risk-neutral, 53ROA, 124, 126, 128road map, 46ROI, 12, 37, 46, 73, 74, 79, 109,

116, 168

salaries, 9, 11, 170Salary, 11, 84–7, 167Salary plus Bonuses, 85, 87Salary plus Contest, 85, 87sales force, 83–96, 101, 102, 168–70Sales Force Compensation, 83, 85, 89Sales Force Management, 87, 89, 96Sales Promotion, 20, 22, 23, 45, 99,

100, 119, 131, 145, 146sales quotas, 88, 90, 92salesmen, 83

salespeople, 85, 89, 90, 94, 95salespersons, 83–96, 102saleswomen, 83sample, 20, 23, 127, 145, 168satisfice, 4satisficing, 14savings banks, 6school of thought, 4search goods, 60self-interest, 9, 10selling agents, 94selling and general administrative

expenditure (SG&A), 78, 95Selling and New Products, 95selling team, 94, 95, 101, 102sender, 49, 114–17, 120separation, 6, 8, 9separation of owners, 6, 8SG&A, 78, 95shareholders, 4, 8, 9, 12, 28–31, 35, 56,

66, 75, 76, 127, 150, 151shareholdings, 10shirk, 7, 8, 9shortage, 11SIC, 77signaler, 50, 51signaling, 49–50, 55, 57, 58, 62–6,

76–8, 108, 128, 131signaling hypothesis, 55, 63, 64Signaling in Marketing, 57signaling model, 50, 51, 54, 62, 128signaling theory, 49, 53signals, 49, 50, 52, 55, 59, 60, 62, 64,

66, 78silo mentality, 13, 14, 31skimming, 133, 142smokeless cigarette, 151soccer team, 13, 100social responsibility, 4, 5, 7, 100specialization of labor, 2Steps in New-Product Introduction, 71stock, 4, 6, 7, 9, 10, 15, 28, 29, 42,

51, 54–7, 59, 64, 65, 76–8, 103, 126, 127

194 l Subject Index

straight-commission, 85, 86strategic marketing plan, 35–7, 45–7strategic plan, 12, 14, 35–7, 46, 162strategic planning, 12, 14, 35, 36strategic plans, 35, 36, 162strengths, 39, 40, 45, 46, 71, 150, 169subcoalitions, 4supervisory controls, 93suppliers, 5, 12Support and Training, 89, 91SWOT, 39, 45symbols, 23, 114–16

target market, 20, 37, 40, 41, 43, 45, 103, 116, 133, 161

Team Selling, 92, 94, 95technology, 22, 24, 28, 70, 77, 87, 88,

101, 103, 105, 106, 115, 117, 133, 142, 171, 176

telecommunication, 100, 101, 108, 150

telesales, 30Test Marketing, 71, 74, 75, 151text messages, 43, 106The Board, 145–7, 160–2, 165,

169, 176the mail, 103, 145The Place, 41The Price, 3, 11, 13, 37, 40–2, 44, 55,

58, 62, 72, 74, 131, 133–7, 139, 140, 142, 143, 144, 146

The Product, 13, 22, 29, 37, 38, 41, 42, 47, 58, 59, 61–4, 69–75, 77, 91, 92, 101, 103, 109, 118, 119, 123, 131, 133, 134, 136, 139, 140, 142, 145–7, 150, 151, 153, 164, 167, 168, 179

the standard industrial classification codes, 77

The Use of Quotas as a Management Tool, 92

Thought Leadership Conference, 28tie-ins, 142TILA, 139

TiVo, 122top-performing, 69total fixed cost, 135, 136total variable cost, 135, 136Trade Discount, 143, 144transaction costs, 3transit systems, 6truth-in-lending laws, 139tusk, 1TV commercials, 122TV or radio, 125Twitter, 105, 107

uninformative, 62union, 5universities, 6, 35, 58, 65, 66, 88,

175–8utility functions, 59

value, 2, 5, 6, 14, 19, 21, 23–31, 35, 42, 51–7, 61, 69, 71, 72, 74–6, 78, 89, 101, 133, 135, 149, 158

variable-cost, 131, 132vehicles, 20, 108, 115, 116, 119venture capital, 53Viral Marketing, 105, 106Volume Discount, 143voluntary exchange, 12

wall, 1, 172warehouses, 44warranties, 58, 62–4warranty, 62–4Warranty as a Signal, 62Warranty Improvement, 64watchmakers, 171Web-Based Information, 99, 100, 103websites, 43, 87, 103–5, 107, 119wristwatch, 45, 102, 170, 171

YouTube, 105, 107

Zee ink, 136Zee printer, 136

Decision Making in Marketing and Finance

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