Coordinating a Global Brand Strategy

A global brand should have a global marketing strategy and set of standards for the brand. But, not all details of implementation should be dictated centrally. There needs to be some local flexibility in the marketing, advertising, and perhaps product customization. At the same time, individual country managers or regional managers should communicate with one another so that best practices discovered in one country can be shared with managers in another country.

Its easy to discount brand strategy ideas and say that they will never work in a certain country. But, sometimes fresh, unexpected, strategies can work well. By communicating effectively in working groups, success stories can be shared and new ideas can be tried in other places.

Local brand management efforts have to be coordinated somehow. One way is by having a global brand manager. Another way is having a global brand champion within the company. Or, perhaps a firm can have a global brand team with some authority. Each of these people/teams should also have specific responsibilities other than working on global brand management so that they have practical experience and credibility. The responsibility of this person/group needs to be harmonizing global brand strategies with country specific brand strategies.

Another idea is that the country managers of a global brand need to speak the same “language.” In other words, they need to use the same terminology when describing ideas. They should examine the same things such as the target segments, brand identity or vision, brand equity goals and measures, analysis of customers and competitors, and methods of success measurement.

Brands Serve Customers; Customers Don’t Serve Brands

Brands are created to serve customers; customers are not there to serve brands. Brands should do try to change themselves to fit customers’ needs and wants. A brand strategy should not be created and then segments found to fit the strategy; rather customer segments with large lifetime value (customer equity) should be found and then brands should be created to fit their needs.

Companies tend to view brands as encompassing of large segments. However, the proper trend is to create narrower brands in response to more narrow customer segments. In this way, the brands’ strategies can be better tailored to be a better fit to the needs of the segment served.

Remember this: If a brand strategy does not address which customers that it does not want to serve, then its not segmentized!

Implementing this idea of consumer segment driven brand formation is difficult. One reason is that brand managers have their brand turf to protect. Implementing a consumer segment driven brand strategy is only effective when there is top down commitment to it so that the idea permeates company culture.

One way to implement it is to have consumer segment groups and managers within the company that hold the purse strings of the brand managers. Again, remember that the brand is there to serve the customers; the customers are not there to serve the brand.

Also remember that the value of a brand depends on the customer. So, averaging the value of a particular aspect of a brand across a wide range of customers creates an artificial situation where the actions taken in response do not adequately address the feelings of hardly anyone within the customer segment.

Companies can have different brands in the company to appeal to different segments. Instead of trying to keep a changing customer in a certain segment, a company should strive to hand off the customer to another brand within the organization when the customer outgrows the segment. For example, if a person is a loyal customer to Fairfield Inn and then starts becoming a frequent business traveler, it could be time to hand that customer off to a more business oriented member of the Marriott Hotel family; and it may not be the best thing to try to keep him as a customer of the Fairfield Inn brand.

Product Distribution

Distribution Channels

Distribution channels are managed by mapping, searching, and finding ways to match a set of offers to a set of consumers.

Once a firm has developed a strategy, it must figure out how to determine who the target customers are and how to reach them. In addition, it must develop a methodology to extract information about its customers from its distribution channels. This is often underrecognized, but very important.

When considering how to appropriate value along the distribution channel and what the bargaining power between the producer/channel and from the channel/customer is there are several points to consider:

When thinking about a distribution channel, its important to consider efficiency vs. speed. Previously, it was thought that efficiency was the same as cost. But, today, efficiency is usually described in terms of speed. In the indirect channel systems, a firm needs to get information flowing from R to L (customer to supplier) quickly and fully. However, there are incentives for the indirect channels not to share information completely and accurately with suppliers. Technology helps facilitate R to L information flow. Technology increases the velocity, magnitude, and integrity of information flow. But, technology is poor about addressing the question of tacit information flow. The tacit information flow issue is a problem that marketing professionals haven’t really solved.

The marketing function in firms has become a strongly analytical function. Marketing is in the transition phase from an intuitive part of the business to a quantifiable part of business. Marketing today is where finance was 30 years ago. Its going toward being analytical like finance.

Consider the distribution channel for a knowledge based firm like a university.  A university is a keeper, generator, and distributor of knowledge. Historically, universities have had a direct distribution channel with no intermediaries. But, there are alternative models. For example, the University of Phoenix is an indirect conveyence of information via an online channel. Their business model is similar to mail order courses 100 years ago. Principle is the same. Indirect channels are just as valid for knowledge based providers.

Its said that a firm can only take monopoly profit once. In the simplest since, if a firm is a monopolist in a value chain, it may be tempted to forward integrate to take over the distribution channels so as to raise its margins. However, a true monopolist excising complete monopoly power allocates all profits to itself. None of the profits are allocated to distribution channels in a monopoly relationship. So, distributors of a monopolists’ product should have no producer surplus. Therefore, acquisition of distribution channels by a true monopolist does not increase its producer surplus and is doomed to failure. Its important to remember, however, that there are not many true monopolies. But, when there is a true monopoly, the monopolist can capture all value and there is nothing left for the distribution channel. So, integrating forward is worthless.

An example of this concept is Texas Instruments. In the early days of digital watches and calculators, TI basically had a monopoly. Yet, TI decided to integrate forward by opening up a whole series of stores to sell their watches and calculators, thereby eliminating distributors. TI escaped, but the venture almost put them out of business.

The vast majority of our products are moved to consumers through intermediaries (distribution channels.) Very little is sold direct.

Let’s examine the question of why distribution channels even exist. The answer is that they improve efficiency. Distributors add efficiency because they buffer and aggregate. Frequently when a consumer buys something from a distributor, the distributor has aggregated products across classes and provides it to retailers or customers in some convenient form. A simple example is a grocery store. Imagine going to a different store to buy canned goods, a different store to buy eggs and milk, and a different store to buy fresh produce…

Distributors facilitate the search process for the consumer. Searching for products is expensive for both buyer and seller. Consider the example of an entrepreneur starting a high tech company for medical related products. The new firm has a product concept in mind that works. But, they need to know “who wants it?” How a firm connects to the customers that really want it frequently turns out to be an overwhelming problem for startups. (The other overwhelming problem is acquiring capital resources, of course.)

Distributors also often provide an augmented product. Perhaps the distributor provides financing, government relations, warranties, or after sale service. Note that, recently, there are some distribution channels where distributors no longer takes responsibility for these kinds of things. Instead, some manufacturers are asking people to return problem products directly to the m. The feasibility of this is increased by technology, communications, and transportation improvements.

Distribution channels can add friction, such as addition cost and communication inefficiencies, to the delivery of a product to a customer. If suppliers and distributors bear the costs, the costs become part of the total price of delivery. On the flip side, if the consumer bears some of the costs, the supplier never sees any of that in the price. A simple example is transportation for a loaf of bread. If a firm bakes bread and has to send it off to a store far away, it will cost the firm money. But, at the same time, the customer might have to drive an hour to get to the store that distribute breads. Driving involves time and expenditure. So, both transportation costs from the supplier to the distributor and from the distributor to the customer increase the cost of product.

But, suppliers don’t see the customers’ costs in getting to the store. In general, both supplier and consumers have friction involved. Both kinds of costs are kinds of friction that have been introduced into the supply chain. The friction process shifts the supply/demand curves and moves the equilibrium point to the left. In other words, the price of the good increases and the quantity demanded decreases. Getting rid of friction makes the supply process more efficient.

One might ask how much it really costs to transport one loaf of bread in truck. The answer, of course, is that it costs very little. But, all of the small additions of friction in a supply chain quickly add up. Consider retailers like Best Buy, Macy’s or Lowes. The traditional markup between producers and retailers depends on the products involved. Diamonds are a couple 100%. Food is relatively low. But, markup can be around 50% for many products. That’s a huge amount. There must be more to these costs than just transportation of the product to the store; obviously, retailers are not netting huge profits.

Distribution of a product directly from the producer to the consumer is the simpliest channel of distribution.  Sometimes a firm can sell a service directly. Yet, often, it is more expensive to perform distribution functions in-house as opposed to outsourcing distribution functions.

Consider an industry where there are the 3 producers of similar goods and there are 5 consumers. In a direct distribution channel, each of these 3 producers has to interface with all 5 consumers. There are 15 connections that have to be made in order to get products to their final destinations.

Now, insert a distributor into this distribution channel. 3 producers connect with 1 distributor. The distributor then connects with 5 consumers. Now, there are only 8 connections between the producer and the final consumer. This is how cost is reduced by aggregation provided by a distributor. Of course, the distributor can also add additional value through something like providing the consumer with product financing.

The 3 producers/5 consumers example can be expanded by considering the amount of connections needed in a direct distribution channel between 100 producers and 10000 consumers. Perhaps, as the number of players grows, additional benefits of reduced number of transactions can be achieved by introducing yet another intermediary to further increase efficiency.

Note: One type of distributor is an “agent.” An agent is typically the only player in the distribution chain who doesn’t take title of the goods as they pass through her hands. She usually gets a small fixed percentage of the sales, but, she never really takes ownership.

Today, many products that used to be distributed by indirect channels are being distributed by direct channels.  The reason is that for some products, like text preparation, computers have allowed people to be eliminated and replaced by machines. This drastically reduces the cost of employing direct channels. Another similar idea is that travel agencies have essentially been eliminated by the internet; the cost to the airlines of selling tickets directly through the internet is so low that there is no longer a need for travel agents to act as intermediaries.

Let’s say that a new channel comes along that appears more efficient (e.g., Travelocity.) Supplier, such as airlines, can choose to stay with the old travel agent channel, use the new channel, or use both. In many industries, firms choose to use both the new and the old distribution channels simultaneously. The reason has to do with the firm’s attempt to capture as much value (producer surplus) as possible.

For the travel industry, using older distribution channels, such as travel agents, as well as newer distribution channels such as Travelocity and even direct sales are an attempt to implement multi-part pricing.

Some people want more services when they book travel than others do. A business traveler’s time might be used more efficiently by just calling travel agent and telling her where you want to go, when, and when you want to come back. The travel agent can call back a hour later with everything arranged. But, with Travelocity, the business traveler often spends a significant amount of time searching for the lowest price only to find that the price has changed before the purchase is complete. This might merely irritate the leisure traveler who just starts over. But, for the business traveler, the lost time can add up to a significant loss. In other words, the travel agency is an indirect channel that adds value. The agent exists to augment the product so that it appeals to a different group of people. By segmenting demand and having alternative channels that add value, as needed, for different customer segments, the airline is able to capture more surplus.

Of course, using a travel agency costs more than buying airline tickets directly from the airlines. So, its possible to observe that, for exactly the same primary product, cost is different in different channels because people want more or different services to go along with the product.

There are different levels of distribution, depending on the type of product involved:

  • Intensive Distribution — If a firm is selling a product (toothpaste, for example), it wants it available everywhere. This is intensive distribution. Walmart is an example of an intensive distribution channel.
  • Selective Distribution — A somewhat augmented product is distributed in fewer locations to impart a bit of exclusivity. Macys and Kohls are examples of selective distribution channels.
  • Exclusive Distribution — A firm has a single dealer for each geographic market. Exclusive distribution is typically used for luxury goods, specialty goods, or business products. Neiman Marcus is an example of an exclusive distribution channel.

Often, products are differentiated by the type of distribution chain employed. They are also differentiated using different product models for different distribution chains. For example, a consumer might buy Model 25 of a washing machine from Lowes or a Model 26 from a local appliance store. Neither store carries the other model. So, there are overlapping geographic areas for distribution of the firms products, but different models are sold depending on the retailer. Consumer can’t compare two products easily in this case. Another example is that models in BJs or Sams are different than in a specialty electronic store. But, the products might be exactly the same product with a different model number.

The choice of the kind of distribution channel has an impact on the brand: A firm should choose the distribution channel appropriate to the kind of brand that it wants to have.

Distribution Channel Conflict

Conflict incurrs in the distribution chain between the suppliers and the distributors. There are often overlaps in the distribution components that service end users. There can also be gaps in the distribution system. And there can be exclusive agreements that prohibit entry of additional distributors.

Distribution agreements can impose geographic restrictions, and restrictions on other products or services that a distributor can provide. Its important to think about the inevitable growth in the number of in distributors in any given market area. If a product has too many distributors and not so many customers, prices will increase. The reason is that each distributor starts selling less products when the distribution market gets saturated. This tends to happen for a variety of reasons over time. Distributors want to expand product range, so they start selling more products. Firms find themselves from time to time trying to straighten up the distribution channels. That’s tough and often guarantees lawsuits. But, its a necessary thing. The lesson is that a firm has to be very careful about how it lets the distribution channels grow because its hard to clean up bloated distribution channels.

Grey Market

A grey market is an unsanctioned, unwanted, Parallel Import Channel. The grey market provides a secondary market for products. Prescription drugs that are exported to Canada and then re-imported into the United States is an example of a grey market channel. Grey market channels disturb and undermine regular distribution channels.

Another example of a grey market channel is Kodak 35mm film. Kodak used to manufacture 35mm film to sell in China. Film is a high margin product; so, Kodak was able to price it according to the available purchasing power of the Chinese market. What Kodak found was that, suddenly grey market film from China began showing up in the United States. The film was exactly the same as the film sold through US distributors. But, the grey market importers were able to undercut the distributers’ selling price by 20%.

The same thing happened to Kodak with X-Ray film. X-Ray film used to be sold under “tender” — price cost only deal — only to governments in most countries. This was especially true for sales to developing countries. However, problems arose because the genuine Kodak X-Ray film was re-imported to the US and sold to US hospitals at half the price of US distributors.

The grey market can be thought of as just another way to achieve multi-part pricing – if firms could control it. Typically, grey market imports are illegal because they violate distribution contracts. For example, if Kodak sells film in India, they have a contractual agreement allowing the distributor to only resell it in India. But, still, companies have little control over the grey market.

The way Kodak solved problems with grey market film was by eliminating English from film packaging in China. By making Chinese the only language on the package, re-importation was not nearly as lucrative.

Reverse Distribution

Reverse distribution is a notion that’s come to the forefront only in the last 2 years or so. Products are beginning to be recycled and traded in for alternative uses; products that have been sold for a purpose are being recycled into a channel where there is a new use for the product. This is happening with electronics, soda cans, and even automobiles.

Reverse distribution arises from the notion of sustainable economics. Sustainable economics is a concept that has not really received the kind of focus that its going to receive in the future. The wave of sustainable economics is the future. Its only going to grow and is a real business opportunity.

Empathetic Design

Another new concept for product development is called empathetic design. It involves getting customers directly engaged in the development of new products. Neiman Marcus does this. Empathetic design turns out to be a great way to design new products, especially when style or tacit information is important. Frequently, firms’ attempts at empathetic design are disturbed by indirect distribution channels. Firms end up developing their own separate paths to reach customers. For example, one company takes its highest value customers to Bermuda for a week. Part of their day is spent on new product design. Knowledgeable consumers have a better idea than designers about what is coming next. Of course, empathetic design works best with incremental product development. Cutting edge product design is not as conducive to this method. For example, asking electronics customers in 1975 to brainstorm ideas for developing the internet probably would not have worked well.


Franchising is a means of collaborative product distribution. Franchising is a large, and growing, business model. There are currently 4500 franchisers and 600000 franchisees worldwide. A new franchise opens every 6.5 minutes and almost half of retail sales are done through franchising.

A franchise is allowing an outsider to pay a fee to copy a retail model. Often, franchise agreements are specific to a geographic location. A franchise contract provides a brand, knowledge, sometimes capital, training, and a set of regulations/restrictions on how the business is run. The franchisee provides capital, becomes part owner, agrees to operate within the franchise agreement. She pays a significant upfront cost to the franchise and has onerous restrictions on her ability to get out of the business. In exchange, the franchise takes a percentage of revenue while the franchisee is the residual claimant to the revenue left over.

Franchising works best for multi-unit enterprises which are easily duplicated and rely on the brand equity of the franchise. Examples are: Stores, service areas, dental clinics, pharmacies and Business-to-Business (B2B) franchises.

First, from the point of view of the franchise, the franchising system saves the hassle of doing the end to end distribution. Franchising allows for increased revenue without as much increased expense to the franchiser. A franchise is really selling the idea of its business to a certain extent.

The franchisee has a vested interest to see that the enterprise works out. This vested interest limits agency costs because the principal (the franchise) and the franchisees have the same objectives since the owner/agent is also a principal (owner.)

From the point of view of the franchisee, she can be a successful late entrant into a business. She has less need to worry about first mover advantage. Late entrants into a business are almost never as profitable as first movers. But, as a franchisee, a viable business can still be established.

Franchising is a popular business model in the US and Europe as well as for US and European firms operating outside of their home countries. Its also very popular with Japanese firms. It may not be as popular of a model in India with Indian companies or in China. But, with the advantages of franchising, its popularity is likely to grow.

Note that many franchises are owned by corporate group, creating somewhat of an aggregation of franchisees.

Franchising in expanding companies addresses the problem of the franchise not being familiar with new markets. For example, McDonalds in France might serve wine for lunch. The McDonalds parent company in the US might not have thought of that a priori.

Advantages of franchising include:

  • Name recognition.
  • Training/management assistance. The franchise works with its franchisees to train employees to do a good job. Its easy to damage a reputation; so the franchise has an interest in creating homogeneity among the franchisees.
  • Pooled marketing and purchasing. Typically, the franchisee has no choice about whether or not to participate.
  • Corporate level financial assistance.
  • Quicker startup with a cookie cutting design. Multiple units are very similar. The corporate franchise knows how to get the new business up and running.
  • Risk is quite low; lower failure rate.

Disadvantages of Franchising:

  • Fees are frequently quite high to start the business.
  • The franchisee is constrained in many ways including marketing and image, being forced to make purchases from the franchise (to ensure homogeneous product).
  • Typically involves geographic restrictions; so a franchise’s growth is limited.
  • Territory infringement. There may be issues with the scope of the geographic areas so that too many franchises are allowed to open in a small geographic area.
  • The franchise often imposes restrictions of how a franchise can be sold. A franchisee might have only the option to sell her business back to the franchise for a defined price.

The Internet as a Distribution Channel

The Internet can be an efficient distribution channel. But, although the internet disintermediates, it can also create new intermediaries like Travelocity or Ebay.

80% of new car buyers do research online before buying a vehicle. But, very few people are buying cars online. People collect information online and then go someplace to look at the products. This is a free-rider problem. Another example of the free-rider problem is customers who go to a high end electronic store and get complete information about available products. Then, they go to Best Buy and buy the item at the lowest price. Yet another example is calling a full service stock broker to get information, analysis, and recommendation about a stock and then going to E-Trade to buy the stock for the lowest commission.

The internet has had a significant role in globalization. Customers have more power today than they have had in the past because they have more information. The cost of search is lower.

Communication speed really hasn’t increased since the telegraph; electrons on a wire still move at near the speed of light. But, the bandwidth has increased significantly. So, in fact, communication is much faster.

Transportation is another significant factor behind globalization. Today, airplanes and not just ships and trains are used to transport people and goods worldwide. This enables companies like Zara to sell Spanish made products all over the world quickly through air shipments.

Containerized shipping allows firms to ship huge quantities of goods cheaply. The per-product cost of shipping something across the ocean is analogous to the small price of shipping one loaf of bread on an 18 wheeler.

Adding together the changes in the transportation structure and the internet creates a situation where globalization can have a huge impact on trade. The rate of improvement in transportation and information technology has picked up considerable steam in the last 10 to 20 years and promises to continue making the world a smaller place.

What does transportation and information technology improvements have to do with distribution channels? Consider global brands. A firm would be foolish to blindly start peddling goods in markets that it doesn’t know anything about; its extremely difficult to enter an unknown market in a location where the local culture may be quite different than what the firm is used to.

The notion of “distance” has been developed at Harvard. — If firms can ship things from one place to another economically, why does it matter if things are made down the street or across the world? Michael Porter posed this question a few years ago. He came to the conclusion that geographic distance matters more today than before.

Porter’s conclusion was that, with growth in communication, we can share information pretty uniformly around the world at any one time. The advantages of being in one place or another are lost. Yet, there is clearly a difference between doing business in one part of the world (or country, for that matter) and another.

The difference is the ability to communicate tacit information. Tacit information is skill building. Its hands on experience – like riding a bicycle. Its hard to share some kinds of information. What Porter found is that tacit information flows in tight geographical places. Examples: Hollywood or Bollywood makes movies; Silicon Valley and Bangalore are hubs of information businesses. In other words, many industries are clustered in specific geographic locations. The reason is that clusters improve the flow of tacit information.
Cage distance: Distance is cultural, administrative, geographic, and economic. Each of these is a “distance.” Cage distance is the modern way of thinking about distance between people or between firms. Distributors help reduce cage distance because they can eliminate a significant amount of cultural, administrative, geographic, and economic gaps and help firms do business in new places. The larger the cage distance, the more a distribution partner is needed.

Note that clusters can move over time. This is especially true if one firm is “the cluster.”

The internet is becoming just another channel of distribution. Its not a special case anymore. Its a channel of distribution like all others. It is becoming a alternative, parallel, distribution channel for many products such as medical tourism, shopping for books online, etc.

The internet will likely have the largest impact on developing countries. The reason becomes apparent when we look at other new technologies such as cellular phones. For example, in China, consumers are adopting cellular phones at a rapid place in locations where it wouldn’t be worth putting in a wired infrastructure. The phones can reach people in mountainous regions and other inaccessible places.

This is the case in many countries; developing countries will likely have few landlands ever.

Likewise, the internet is likely going to provide a new distribution channel in developing countries. The legacy/parallel distribution channels in Western countries many never develop in the developing world.

Use of the internet as a new distribution channel is evidence in India’s eChoupal network. With eChoupal, farmers get direct access to information flow. Other indirect channels have never developed.

An interesting book about the opportunity of using technology and capitalism to improve the plight of the poor in the developing world is “The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits” by C.K. Prahalad. I highly recommend this book.

There is a significant experience attribute involved in products like automobiles. The experience attribute is one of the reasons that most people go to dealers to make a car purchase. The issue is, as we look at the classes of products, we need to figure out which ones are efficient to distribute via the internet.

Software is just as complex as automobiles, but consumers buy software on the internet. They also buys books online and sometimes medicines. What class of products are best distributed on the internet?

The augmented product and freerider problem only exist as long as there are alternative channels. At some point, if the alternative channel disappears, the augmented product and freerider problem go away.

Will car sales become an online business? Is it that people are more experienced with computers (Dell does OK online) than with cars? … Maybe the reason is that the car is not as easy to return. But, say that a local dealer handles the kind of car that you want to buy. Maybe it would be in their best interest to deliver the car that a dealer in Texas would be willing to sell you for a better price. Or maybe its in their best interest to sell it to you themselves for the same price as the Texas guy without having to charge all of the shipping. In addition, they could say that they are giving you service. Shipping price from Texas would be a deadweight loss in the distribution channel. — Guess: Trend is one way. Car dealers in the next 10 years are likely to be more service dealers which provide delivery. Some segment may exist to purchase in the traditional way. But, just like there are still people who want to purchase from travel agents, there will likely be people who want to use the traditional channel. This is a multi-price segmentation with an augmented product. However, likely, most people will want to purchase more through electronic means like the internet.

Global Marketing

"Strategy" is a synonym for a "plan". A firm's strategy takes into account contingencies. We want to study in detail how the firm brings all of its resources to bear in achieving a desired marketing outcome.Strategy formation is not an optimization bounded process. We develop a set of alternatives and select the best of them. The objective of corporate strategy is to create value. We're aiming toward something that creates value which will, in turn, create more value. Note that a strategy to "serve all customers" is not a strategy at all. A strategy must define what market the firm intends to serve to the exclusion of other customers and markets. What is necessary to create value in a firm?
  • Point of differences
  • Unique resources. Resources allow a firm to provide value to consumers. But:
    • Are they unique?
    • Can the firm protect them in same way?
    • Is there durability to the resources? In other words, are there barriers to other firms seeking to enter the market?
    • How do you capture value? Value capture is called appropriation. Consumers have to know that a product or service is for sale. The firm has to be a cog in the supply chain. If it isn't, then the firm is not in the value creation zone.
    • Unique resources include tangible assets, intangible assets, and organizational capabilities. When evaluating a firm's unique resources, one of the first things to evaluate is the firm's brand equity. How much does the brand name matter to the company?
  • Market for your product. Does anyone care that the firm's product or service even exists?
IBM is good example of a firm that was not able to appropriate the value of their product, the PC. They made the PC "real." But, they lost money in the PC business. In 1980, computers were "glass houses." They were large and fit in huge glass cabinets. The market expected this kind of computer and the technology supported it. Information was retrieved from computers through terminals. IBM noticed the emergence of PCs developed by companies such as Commodore and Apple. But, IBM didn't believe that customers were really interested in desktop computers and considered them little more than a fad. In addition, IBM did not make money on terminals used to access their mainframes; they made money on hardware and software and services. IBM's strategy with the PC was aimed at stimulating its mainframe business by lowering the cost of dumb terminals. With this in mind, IBM developed the PC and encouraged Intel to sell the PC processors to anyone. In this way, IBM hoped that the cost of terminals would decrease significantly. Instead, the PC significantly undermined IBM's mainframe business. The strategy didn't work because IBM chose not to appropriate the value of the PC. T he PC had durability and value to customers. But, IBM did not capture the value. However, Microsoft was able to appropriate value in the PC business. So was Intel. The problem was that IBM did not appropriate the technology; they didn't capture the value. They had a set of unique resources. But, they gave the unique resource power to Microsoft and Intel by allowing them to sell the "guts" of the PC to anybody. A strategy is a plan of action for a firm; but it's a broad plan. It doesn't describe the firm's actions at every step along the road of value creation. A strategic plan is a long term plan. How long the term is depends on the market that the firm is in. "Long term" is 30-40yrs in the power industry. It's, perhaps, 12 months in the electronics business. Maybe "long term" is merely a few months in the toy business. What determines what kind of planning horizon a firm should have? The answer depends on industry. The forecasting horizon depends on the response time of the firm. Yet, if a firm can meet any customers' need in 24 hours, why would it need to plan any further in the future? The reason is that another firm might be able to respond even faster. Companies must do forecasting on a firm-wide basis. For example, Toyota found that their marketing team lagged behind the factory in response time. To improve the responsiveness of the overall organization so that shorter term forecasts could be used, it had to improve the responsiveness of the marketing team to match the factory's response times. There are three kinds of strategy: 1. Competitive Strategy - a long term plan to create a sustainable competitive advantage in a selective product market. The competitive strategy answers the question of "How do we make money?" 2. Business Unit Strategy - Answers the question of "How should we compete?" 3. Functional Strategy - defines and develops the marketing skills needed to support the competitive strategy. It answers the question of "What capabilities are required?" Each of these types of strategy incorporate the unique threats and opportunities of the global environment. The strategy formulation process consists of five parts: 1. Environmental scanning --- Lets draw a circle around the firm. Everything out of the circle is the environment. Examples are competitors, regulation, political situation, consumers, etc. What is the estimate of what a firm's future is going to look like? Its "noisy." The further out a firm tries to predict its operating environment, the less accurate the picture is. 2. Internal Assessment --- What is the firm good at? What does the firm need for the future? Think of the firm as a circle. Think of the circle representing the firm as being surrounded by a triangle. The triangle represents the needs of the firm. Notice that some of the firm's capabilities are not needed. These are capabilities that the firm needs to rid itself of. But, there are needs of the firm that are outside of the firm. Likewise, there are required resources outside of the firm that the firm doesn't possess but needs to acquire for the future. 3. Strategic Alternatives -- Formulation of strategy is about forming alternatives. What alternatives do the firm have that can be used to create value? 4. Valuation and Choice - Which alternatives should the firm choose? 5. Implementation - Once a firm has developed a competitive strategy, it has to implement it. Practical advise for a firm is that a great implementation is better than having the absolute best winning strategy. Unfortunately, firms often deemphasize implementation. Implementation is not "exciting;" so managers often only give it lip service. Also note that acquisitions usually don't create the value predicted. There are two ways to look at a firm's strategy: 1. Market Based View - The firm finds what a customer wants and tries to satisfy the need. 2. Resource Based View - The firm has unique resources. The firm attempts to find customers who value these unique resources and seeks to serve them in the marketplace. Really, both the Market Based View of the firm and the Resource Based View of the firm degenerate into the same thing. Both views have to be considered when developing a competitive strategy. Fitting Competitive Strategy into the Organization Before examining how the firm's strategy fits into the organization and its architecture, we must first define what a "firm" is. A "firm" is really a nexus of contracts - implicit or explicit. Whether something is inside or outside a firm's boundaries is merely a question of whether it is part of an implicit or an explicit contract. A firm can also be thought of as a set of resources or a bundle of processes. At the heart of the organization are its values, beliefs and culture, organizational capabilities, and its vision of the future. When framing a strategy for the firm, we must first look at the elements that make up an industry:
  • Suppliers
  • New entrants into the industry
  • Substitute products. An example is substitution of digital cameras for film. Or substituting lasik surgery for contact lenses. Or, perhaps in the future, substituting some sort of electronic paper for physical paper. If a folding monitor that goes in a consumer's pocket is developed, demand for physical paper will likely be reduced.
Note that disruptive technical substitutes for a product almost always come from outside of the industry effected. For example, buggy makers did not develop the automobile. Competitive advantage is the ability of the firm to make economic rents in excess of those in the industry. To determine the areas where excess economic rents can be charged, first look at the industry as a whole. Then, look at firms in the industry that are not competing successfully. The issue for these firms is often poor appropriability. Michael Porter of Harvard Business School developed a five forces model for industry analysis. His model was published in 1980 when the United States was still in the midst of a manufacturing economy. But, they are still valid today. Among his conclusions were that a firm may compete on the basis of cost leadership or on the basis of product differentiation. However, competing on both fronts is difficult. Porter warns firms not to get stuck in the middle and try to compete on both cost leadership and differentiated product. A similar warning is also applicable to individuals striving to advance careers: Try to either participate in a successful project or in a troubled project. Don't get caught in a "middle of the road" project! Generic strategies are strategies that are low cost and easy to implement that differentiate a product. However, there is temptation for a firm to try to be a low cost provider and also attempt to differentiate its product from those of competitors. In some situations, Porter's theories may be breaking down over time due to technological advances. While its true that producing unique products costs more than providing tried and true standardized products, streaming and rapid (just in time) inventory can make up for the additional costs. For example, it could be argued that Dell has a superior product that is also very cost effective. In addition, Toyota has developed a built to order, rapid delivery, system for automobiles. In a sense, Dell and Toyota are value providers with very differentiated products. The quality movement has also allowed firms to create products that are more likely to work correctly the first time. So, the costs of repairs and returns are lower for modern products than they have been in the past. Besides Dell and Toyota, another example of mass customization is a company called Zara. Zara is a women's clothing company that is able to reduce product development and production time to just two weeks, compared to an industry standard design cycle of twelve months. Zara has invested heavily in up front product design to cut the design cycle time. Gap and H&M are Zara's major competitors. Gap and H&M have responded to Zara by streamlining their existing design cycle. This streamlining has allowed them to cut their development time to 3 or 4 months. But, Zara has people in stores and on the streets talking to customers and converting existing designs into better designs. Most Zara products are made in Spain in home factories. Zara produces each style in low quantities. Such low quantity production in a Western country is more expensive than mass production in China. But, Zara trades off inventory and large production ability with lean production --- quick movement of inventory. Another model introduced by Michael Porter is the Global Value Chain. The Global Value Chain consists of:
  • Firm Infrastructure
  • Human Resource Management
  • Technology Development
  • Procurement
  • Operations such as Inbound and Outbound Logistics
  • Marketing, Sales, and Service
In Porter's Model, information flows from the firm to the market (Left to Right Flow). But, also important is Right to Left flow of information from the consumer back through the value chain. Right to Left flow is every bit as important as the opposite, normal, direction. Market research for extension of existing products works well. But, asking people about products that are not aware of (outside of the consumer's experience) is likely misleading. For example, asking someone in 1975 to evaluate the idea of developing the internet would likely provide unhelpful information for a firm. Market Based View of the Firm One strategy is to strive to serve all of the needs of a particular customer. One example is a company that installs an oil pipeline in Saudi Arabia. In addition to actually installing the physical pipeline, the firm may be required to provide additional services such as building schools and hospitals in towns that it passes through. In this case, the capability of the company is to be able to effectively respond to various requests of the customer. That capability is a unique resource. Using the Market Based View of the firm, a company needs to attain information from the customer, disseminate the information to the relevant parties (internal to the firm as well as subcontractors) and implement the customer's requirements. The first step in implementing a Market Based Strategy is to define the customer or customers to be served by segmenting and re-segmenting the possible customers. Then, once customers have been identified, the firm must understand their current and latent wants. Finally, the firm must organize itself to respond to the customers' requirements. Of course, in doing so, the firm must not put itself in the position where the very life of the firm is compromised in the effort to satisfy customer requirements. Also, in developing a Market Based Strategy, the firm has to decide how to balance focus on competitors with focus on the customers. A firm that is highly customer and highly competitor focused is deemed to be strategically integrated. If the firm ignores competitors and, instead, focuses primarily on customers, it is said to be customer preoccupied. Firms that focus mostly on discounting competitors with little emphasis on customers are said to be marketing warriors. Of course, firms that focus neither on competitors nor on customers are strategically inept. Resource Based View of the Firm The Resource Based View of the firm is the most important way to view the firm's strategy. It focuses on how the firm's competitive position is related to the resources of the firm. The goal is to achieve a Sustainable Competitive Advantage. What is a Sustainable Competitive Advantage? And how does a firm know if it has one or not? The answer is that a firm with a Sustainable Competitive Advantage has continuous profits/sales that are higher than others in the industry and that its profits are difficult to imitate. NOTE: If there is no producer surplus, there is no Sustainable Competitive Advantage. Criteria for using resources of the firm to achieve a Sustainable Competitive Advantage are:
  • Demand: Is the resource valuable to the customer?
  • Durability:
    • Is the resource scarce?
    • Is there imperfect imitability? How easy is the product or service to copy? A resource is difficult to imitate if it is physically unique. Its difficult to imitate if it is developed only after many other resources have to be developed first. Its difficult to imitate if there are economic barriers to entry into the trade. Finally, its difficult to imitate if there is casual ambiguity. For example, Toyota was able to develop lean production capabilities in the 1970's. But, even though it opened its factories and processes to inspection by competitors, its competitors were not able to duplicate it successfully. Likewise, if a company possesses processes and resources it doesn't need, getting rid of them can be difficult. For example, Gap and H&M were able to streamline their processes in response to Zera. But, they weren't able to achieve a two week product development cycle.
    • Is there imperfect tradability and substitutability? Can some other resource provide a substitute?
  • Competitive position: Is the product or service offering superior to the competitors'?
  • Appropriability: Can economic rents from the product be captured?
The history of the firm is important. Changing from one specialty to another is extremely difficult. Firms are likely to succeed in endeavors in which they have been successfully involved with in the past. In other words, the firm's ability to create value is dependent on its stock of unique resources and the organization's skill in using them. These both develop over time and depend on the firm's history. Persistent asymmetries in real, or consumer perceived, unique resources exist during a firm's sustainable advantage. The important thing to note is that unique resources can be perceived even if they not real anymore. Because of this, a firm's competitive advantage can often continue after it no longer has a unique product. An example of this is Ivory soap. Ivory soap has been on the market since 1879. It's not unique anymore and hasn't been for quite some time. But, many customers perceive it as being "better" than other soaps. So, it continues to sell successfully. Of course, possession of a unique resource is necessary for obtaining a competitive advantage. But, it doesn't guarantee a competitive advantage. For example, a firm may have a unique resource enabling it to produce solar powered freezers in the Arctic. But, its very unlikely that this firm would be able to appropriate this resource to obtain a competitive advantage in the market! Economic deterrence is a way that a firm can limit a competitor's entry into the market and can protect its unique resources. Economic deterrence can be economic action or the treat of it. This kind of deterrence can be quite important in industries where large capital investments are required to create output. The IC manufacturing industry is an example of this type of industry. There is a limit to capacity in a facility to build IC's. Increased demand for IC's may necessitate building new facilities. But, too many facilities could create excess capacity. The simple threat by a big chip maker to build a new facility could put a lid on plans by smaller manufacturers to build facilities. The threat would make a new facility a bad investment for the smaller firm. Another example of economic deterrence is Proctor and Gamble's clear signals that it will not allow another firm to tread on Tide soap's market share in the US market. If another company decided to compete head to head with Tide, Proctor and Gamble would simply lower the price of Tide as low as necessary to keep its market share, touching off a price war. The Market Focused View of the firm and the Resource Based View of the firm are really the same concept starting from different ends of the value chain. The Market Focused View starts with the customer and asks what the firm can do for it. The Resource Based View starts with the firm's capabilities and asks which customers need those capabilities. Expanding a Firm's Opportunities Breakthrough opportunities are opportunities with a new set of customers as well as opportunities with a new set of products. With breakthrough opportunities, the company doesn't know the product and doesn't know the customer. As such, breakthrough opportunities are highly risky. Market expansion involves geographic expansion of the market. Customers are new, but the products are existing. Evolutionary goods are packaged goods. Toothpaste or other consumable goods are examples. Evolutionary products are marketed to existing customers in existing markets. Product Expansion involves marketing new products to existing customers. Demand forecasting is done by market research metrics, demand curve creation, etc. The research identifies value created by each feature. How does a firm trade off potential product features to maximize value? The answer is that the firm looks at the external environment. The marketing team analyzes the competitive position of the particular feature in the marketplace and the best time (market timing) to introduce a feature or product. Out of the four choices for expanding a firm's opportunities, what are the best two to choose? Nowadays, the marketing experts drive the decision. In the past, product developers drove the decision. They would develop products and then the marketing team would be tasked with marketing them. Today, the marketing team comes up with new products and the product development team is responsible for designing them. Besides market forecasting, firms forecast future demand through scenario planning. Scenario planning is important for an industry in the long horizon. However, along with scenario planning comes long term capital decisions and uncertain forecasts. The best company doing scenario planning is Shell Oil. Shell Oil creates descriptions of several extreme external environments. Then, they ask, "Does our strategy hold up in those environments?" And "what will the outcome be if the scenario happens?" -- A good book discussing this is called "The Art of the Long View: Planning for the Future in an Uncertain World" by Peter Schwartz. A final way to do demand forecasting is expeditionary marketing. Expeditionary marketing is when a company builds small quantities of a product and then tests it in limited markets. Based on the results, they decide whether to go forward with a wider product launch. This marketing technique is typically employed in the packaged goods business. One problem with expeditionary marketing is determining how good the sample is. Another problem can occur if another company gets wind of the test and then tries to do something to sabotage it. For example, say that a company tests a new product in Australia. A second company finds out and begins simultaneously testing a really bad product, purposefully, in Australia. The first company's test product may succeed in Australia only to fall flat on its face in a wider market. Product Attributes All products have three attributes: 1. Search: Characteristics of a product that can be determined before purchase. 2. Experience: Characteristics of a product that can only be determined after purchase. (Example: How does a Snickers bar taste? The customer will only know after she has tasted it!) If purchase or trial of a product is inconvenient, a substitute for experience can be endorsements. Endorsements are surrogates for experience. 3. Credence: Credence attributes are attributes that a customer may never be able to determine. Examples: "Are these vitamins really better for me?" "Did the brain surgeon really take out the bad parts of my brain that were causing my psychosis? Maybe he took some parts out that I might need for other reasons later." "Did the medicine that the doctor gave me for my cold really cure my cold?" Market Leadership Some definitions of Market Leadership are:
  • Unaided recall by customers of the firm - regardless of whether they prefer it or not.
  • Brand identification if prompted.
  • Market share or rate of change of market share. Many people prefer this definition.
  • "The firm that defines the dimensions of competition." This is the best definition.
For the last 30 years or 35 years, Toyota and Honda have been the market leaders in the auto industry. Currently, they are setting the market trend for fuel efficiency. During the energy crisis in 1974, Toyota and Honda had their first successes on this front. Toyota and Honda have always had very efficient cars. So, their cars became popular in the 1970's because of their efficiency. The US auto industry scrambled to catch up in the dimension of efficiency. Then, in the early 1980's, the energy crisis had passed. Toyota's major competitive advantage became quality: Toyota "never" has to be repaired! In the early 1980's, Ford did a survey of its customer service compared to other companies. They thought something was wrong with the data. They found that the Toyota and Honda vehicles were significantly better quality than any cars produced in Europe or the US. Ford, GM, and Chrysler struggled to implement their own quality programs for about ten years. The differences start to shrink. At some point, quality was no longer a major distinction between US automakers, Toyota, and Honda. Yet, Toyota and Honda maintained market leadership because they could develop a new product with half of the engineers in half of the time of the US firms. By the time GM , for example, could develop a new model, Toyota and Honda could developed four times as many models with the same number of engineers. They added more brands like Lexis and Acura to their product line GM was forced to eliminate the Oldsmobile. Toyota and Honda successfully refined the dimensions of competition every time the US companies caught up and made the dimension of competition a non-factor. That is Market Leadership. Dimensions of Competition Firms compete on the basis on many things. In the arena of tangible products, competition is based on:
  • Performance
  • Features
  • Serviceability
  • Customer expectation
Conformance to specification is irrelevant because customers expect conformance to specification, unlike in the past. Today, the criteria for product or service evaluation is more subjective - almost like a piece of art. The basis of competition in the service sector is similar. However, there are differences because much of service evaluation is subjective:
  • Reliability
  • Responsibility
  • Assurance - knowledge, courtesy of employees, and ability to convey trust and confidence.
  • Empathy with customers needs
  • Tangibles
Tangibles include the appearance of the service personnel and the firm's facility. These dimensions do not change much across industries - be they insurance, credit cards, or something like car repair. Studies have shown that the most important of these competition dimensions is reliability. The least important is tangibles. Service providers tend to recognize that reliability is the most important dimension. But, they mistakenly believe that providing tangibles is closely behind. Its not. Research has shown that suppliers are exceeding customer expectations in tangibles. But, they are failing to meet expectations in all other dimensions. The dimension they fail to meet the most is reliability. This is true in general regardless of the service industry. Deciding Whether or Not to Develop a New Product If a firm is trying to decide whether or not to develop a new product, it should first determine if there is demand for it or not. Next, it has to ask if it will create value for the company by effectively competing with other firms in terms of cost or product differentiation. This is often determined by computing the Net Present Value (NPV) of the product development cycle. But, NPV may not be the best way to evaluate new product development. Perhaps a product itself will not create value for the firm but will be important to the firm's overall strategy. Modeling the value of such a development effort can be performed using option theory. Equity options are the right to buy/sell a security at some future point at a set price. Similarly, a firm can ask how much they are willing to spend today in order to put off a decision until tomorrow. This concept drives Research and Development (R&D) and advertising budgets. Instead of simply calculating NPV, the total value calculation for a project should include other variables as well: Apply rules of derivatives to a two stage development cycle. Call the cost of developing the product $D. Assume that Pts is the probability of technical success for the product. $C is cost to launch the product. Pcs is the probability of commercial success once the product is launched. Only if a product is technically and commercial successful can a firm realize NPV for its development. Otherwise, the project costs are all lost. The idea that a firm can make decisions to continue development or to stop development in the middle of the development process allows the modification of the NPV calculation as follows: ECV = Estimated Commercial Value = (NPV * SI * Pcs - C) * Pts - D SI is the Strategic Importance of the product to the firm. It describes how important the success of the project is to the company's future. It describes, for example, the ability to use the technology or skills developed for other projects as well. In a sense, the SI variable is the manager's fudge factor. It makes the point that $D is not necessarily sunk cost for a dead project, if it fails. This concept allows a firm to balance its portfolio. Note that ECV could be positive if two projects are considered together but negative if they are considered separately. The opposite is also true. This concept applied to product development is called the "theory of real options." Only 5% of ideas in the conceptual phase ever make it to the market place. The further development proceeds toward the marketplace, investment costs grow. They grow exponentially. So, its very important to engage in the stop/evaluate process. And it's important to identify losing products early, even if they have strategic importance. The reason is that, as a product gets closer to market, the reusability of the additional skills or developed technology decreases. Strategic importance is most important in initial stages of produce development. Source of New Product Ideas New product ideas come from the following sources:
  • Examining the alignment of new or improved products with the current customer space.
  • The maturity of the technology and the alignment of the customer to the product space. The new product might not be new to the world, but it might be new to the customer.
When a firm's product has a high level of alignment with the customer base and a high level of product maturity, 80%+ of new product ideas come from customers. When technology is low and product awareness is high, new product development tends to be developer (engineer) driven. When product awareness is low and technology is high, we see combinations of technologies or new applications of the technologies. Technology Market Co-evolution is a term used when technology is pushing product development. Firms tend to use the axiom: "I can do it; somebody wants it." New ideas are presumed to have market demand. Probabilities of Success with Introducing New Products When there is an existing product technology and an existing customer base, there is a 90% chance of commercialization. An example of such a situation is toothpaste and soap. Something that's not necessarily intuitive is that its easier to build a product than it is to build a market for a product. There is a 25% chance of success for an existing product introduced to a new market. But, there is a 50% chance of success for a new product introduced to an existing market. Building Knowledge in an Organization Building knowledge in an organization is much like playing a musical instrument: practice makes perfect. When a firm does something over time, the cost goes down because it get better at it. Costs decrease over time. This is called the experience curve. Note that much of the experience curve is generated around price and not cost because public data for product cost is generally unavailable. log(Cost for the Nth Product) = -a * log(Cumulative Volume) The slope of the curve is -a. Note that price elasticity of demand is (Change in Demand) / (Change in Cost). This is similar to a. The slope is a percentage. When cost has changed to 75% of what it previously was when a firm doubles the volume it has produced, the experience curve is called a 75% Experience Curve. Typical experience curves are between 70% and 85%. R&D and retailing have the flattest Experience Curves (95%). Product subassembly has steep, 70% Experience Curves. High tech products like hard drives have curves that are even steeper (54%), which indicates that they rapidly become cheaper as more are produced. The experience curve was originally developed by the US Government based on experience during World War II. The government used it to negotiate quantity discounts for bombers. The experience curve is different from Economies of Scale. Economies of Scale suggests that costs go down as the firm's rate of production increases. In contrast, the Experience Curve suggests that a firm's costs go down with total volume ever produced increases. The Experience Curve basically describes the organizational capability of the firm. Experience curves can be used to predict the future cost of a product. For example, they can be used to predict the cost of wind power versus coal power in the future as more and more energy is produced with these technologies. Interestingly, the experience curves are much steeper for solar power than for wind, while coal power experience curves are relatively flat. This indicates that wind and solar power will get progressively cheaper until power production with solar and wind are cheaper than power production with coal. There is a caveat, however. A very flat experience curve for a technology like coal power is often indicative of an industry with little competition. When competition enters the picture in the future, the price of generating power with coal may very well begin decreasing. Tacit Knowledge One might think that in the world of rapid communications, communication over distances is easy. Not so. Distance may very well make communication even more difficult now than it used to be. The reason is that know-how and know-why are hard to transmit. Evidence of this is clustering of certain industries in geographic locations. For example, financial services are largely clustered in New York and London. Movie making takes place in Hollywood or Bollywood. High tech development takes place in Silicon Valley, the Boston area, the Washington DC area, and Austin. Experience curves become flatter as geographic distance increases. The reason is that passive knowledge is shared because of close proximity. It's very hard to pass passive knowledge over distances. If a firm is a market share leader in an area, it can locate anywhere because it is the cluster. So, Kodak might be able to locate anywhere. But, a new chip manufacturer would be at a disadvantage to locate in Kansas; high knowledge workers tend to cluster. Its expensive to move a firm with this kind of worker because, when the firm moves, significant skill loss occurs. However, think a firm having a 100% market share moving down the experience curve. It wishes to maintain its 100% market share; but a competitor arises. The original firm still has a cost advantage. To keep this cost advantage, the original firm strives to move down the experience curve at least as fast, if not faster, than it did before. This allows it to maintain the cost advantage - which is a sustainable competitive advantage. As long as the its market share remains larger than the next competitor, the firm is moving down the curve faster than the competitor. A high annual market growth rate and high relative market share is a sustainable competitive advantage. A high relative market share but a small annual growth rate of the market discourages a firm from moving down the experience curve. This means that the firm stops spending on R&D. It stops spending on advertising. The product becomes a "cash cow." The firm is still in a relatively strong position. However, as R&D is cut, the high market share can be eroded leaving the firm with low market share in a low growth market. This is a disaster for the firm, of course. "Cash cow" businesses tend to pay large cash dividends as the proceeds from sales are not reinvested in the business. This scenario was, sadly, played out in the 1970's and a large amount of corporate value was destroyed. Service Firms The following are characteristics of service firms:
  • Provide something that is not a physical product.
  • Responds to a need.
  • Typically no inventory.
  • Site location determined by the customer. The service is performed at a place that is convenient for the customer.
In a service firm, customers get involved in the service as it is performed. This is called the joint production problem; the service is produced and consumed at the same time. The demand function for a service is heterogeneous. That means that it is different for each consumer. The function of marketing is to transform a tangible good into a service. If a customer buys an auto, it provides her with a service. People buy tangible goods that can provide a service. Until mid 1990's, productivity in the service industry was relatively low. Low productivity causes lower GDP. A shift began in the 1990's because of second generation IT implementation in the service businesses. That's at the heart of why the productivity of service firms increased so significantly in the late 1990's and early 2000's. This increase in productivity is analogous to what happened when automation hit the manufacturing industry. The first generation of automation helped replace people. The second generation of automation focused on what the machine could do; not just its ability to replace people. In the IT industry, technology first duplicated what people did. In the second generation, services were expanded by using the ability of the technology. Myths About Service Industries
  • They low valued. However, services are provided by doctors, lawyers, accountants, etc. which cannot really be described as low value.
  • Services are not capital intensive. For most service industries, the largest investment is in IT (computing, telecommunications, etc). The firms with the largest capital budgets are banks, insurance companies and retail. All of these are service industries; service industries are capital intensive.
  • Service industries are small scale. On the contrary, the biggest companies in the world are in the service industry. Walmart, ATT, and Microsoft are good examples.
David Ricardo was an English economist who followed Adam Smith. In 1919, there was a serious controversy as to whether manufactured goods produced wealth. After all, manufactured goods cannot be eaten or worn. Similarly, today there is discussion as to whether service industries create wealth. There is definitely anecdotal evidence they do. Most wealthy people have made their fortune not in agriculture nor in manufacturing but in service industries: entertainment, sports, Wall Street CEO's, etc. Even the former Lehman's CEO still has a considerable amount of wealth. Not as much as before; but still a significant amount. Service industries are industries other than manufacturing, agriculture, and government. The service industry has made up more of GDP than manufacturing in the US since 1838. Service dominates all advanced economies and is growing. Productivity causes the shift to service based economies. The number of people in manufacturing and agriculture decreases because of increased productivity and technology even though the gross amount of goods and agricultural products products increase. For example, the US produces more food today with 1.4% of the population involved in agriculture than it did 100 years ago with 60% of people involved in farming. After World War II, Peter Drucker, who is widely considered the father of modern management, predicted that the physical amount of material in products would shrink over time.  This has turned out to be true.  The importance of material in products is shrinking. At least 50% of the activities in a manufacturing firm could be classified as service jobs if they were outsourced. Measuring Customer Satisfaction One of the most important goals of customer satisfaction forms is to make the customer believe that the firm cares about what they think.  Surveys were rare until about 20 years ago. When firms think of customer satisfaction, they usually think about whether customers' minimum requirements have been met.  However, they should really be thinking about whether or not the customers' expectations were exceeded - to her delight.) Customer satisfaction is extremely important because loyal customers are significantly more profitable than new customers.  In addition, the value of customers increases over time.  Customer satisfaction leads to future sales and referrals.  But, unfortunately, sales commissions are usually paid for acquisition of new customers rather than retention of existing customers. Remember that people respond to incentives.  But incentives can only be provided effectively when the proper performance measurements are used.  Its difficult to measure retention of customers and easier to measure new business acquisition. In retail, one way to measure customer retention is bar coding.  Firms can now keep track of the "door" (customers who trade, leave, and don't come back.)  Some of the most advanced firms are taking advantage of this.  However, most are still just using bar codes to measure inventory flows. Net Promoter Score The ultimate customer satisfaction survey question is:  Would you refer us to a friend on a scale of 1 through 10? Scores of 1-6 indicate that the customer is a detractor from the business. They are less likely to return and more likely to spread negative information about the firm. Scores of 7-8 indicate reasonably satisfied customers. But customers who indicate scores of 9-10, are promoters of the firm. They are very likely to provide the firm with repeat business and referrals. The Net Promoter Score is defined as follows: NPS = % Promoters - % Detractors There is a huge correlation between net profitability and NPS!

The Bass Diffusion Model

Total sales of a product in any given period = (Sales to Innovators) + (Sales to Imitators)

Innovators are people who are early adopters of the product. They are people who buy a product because they like it; not because other people are buying.

Imitators are people who have heard about a product from someone else and are likely buying it because other people are.

(Sales to Imitators) = (Total Market – Previous Buyers) * (% of Imitators) * ([Previous Buyers] / [Total Market])

The Bass Diffusion Model states that:

Qt = p(M – Nt-1) + q*(Nt-1/M)*(M – Nt-1)


Qt = the number of adopters during time t
M = ultimate number of adopters (market size)
Nt-1 = cumulative number of adopters at the beginning of time t
q = effect of each adopter on each non-adopter. This is the coefficient of imitation.
p = individual conversion rate absent adopters’ influence. This is the coefficient of innovation.

The innovation effect is described by:

p(M – Nt-1)

And the imitation effect is described by:

q*(Nt-1/M)*(M – Nt-1)

We can rewrite the Bass Diffusion Model as follows:

Qt = pM + (q – p)Nt-1 – (q/M)N2t-1

Notice that this is a quadratic equation. A regression analysis can be performed on the data to find coefficients such that:

Qt = a + bNt-1 – cN2t-1


a = pM
b = q – p
c = -(q/M)

M can be found by applying a variation of the Quadratic formula:

M = [-b +/- sqrt(b2 – 4ac)] / 2c

Finally, since a is known from regression and M has been calculated, p can be found. Then, p can be used to find q.

Researching “The Chronicles of Narnia: Price Caspian”

For MKT 402 at Simon, we have been asked to estimate the potential market, adoption rate, and predict the evolution of sales of the new movie “The Chronicles of Narnia: Price Caspian”. A good source of data is available at:

The first part of the assignment focuses on getting information that may help get reasonable values for potential market and diffusion parameters (innovation and imitation) of the movies. Interesting things to focus on are:

  • Are there any movies similar to this movie?
  • What are the sales of similar movies?

Estimation of sales for similar movies is critical since “Prince Caspian” will be released on May 16, 2008 in the United States — which is after the assignment is due.

A good starting place is always Wikipedia since Wikipedia provides an overview and links to primary sources of information:

The movie is a children’s fantasy movie and is a part of Disney’s series “The Chronicles of Narnia.” The first movie in the series was called “The Lion, the Witch, and the Wardrobe.” The movie will be released on June 5 in Australia, and on June 27 in the United Kingdom.

King Miraz is an evil king and he is preventing the rightful heir to the thrown, Prince Caspian, from taking power. The Narnian people are trying to help Prince Caspian and, using a magic horn, have summoned four Pevensie children to help them. Prince Caspian is an adolescent and is in the process of “growing up.” In the movie, unlike the book that its based on, Prince Caspian and Peter Pevensie are somewhat rivals. The Prince is in the process of learning the skills necessary to be a good leader.

The Pevensie children have been in Narnia before. But, while they were gone, one human year (and 1300 Narnaian years) have passed. In the meantime, Narnia has basically been destroyed through the oppression of the Telmarines. The movie is a family movie, but its likely to appeal more to boys than to girls. believes that the movie has a potential audience of 400 million people.

Trailers for the movie can be viewed at:

Looks like there are lots of battle scenes. I’m surprised that its only rated PG.

I collected data from Box Office Mojo for three movies that seem similar to Prince Caspian. These movies are all in the “Fantasy – Live Action” category:

  • The Chronicles of Narnia: The Lion, the Witch and the Wardrobe. Prince Caspian is a sequel to this movie and, so, its obviously similar.
  • Harry Potter and the Order of the Phoenix. This movie is the only movie suggested by Box Office Mojo as a similar movie. To Box Office Mojo, a similar movie is one that is comparable “in terms of audience appeal, genre, tone, timeframe and/or release pattern.” Furthermore, Box Office Mojo suggests that similar movies can be used “to aid in forecasting and to provide suggestions for movie viewing.” This movie contains fantasy/wizardry and battle scenes.
  • Lord of the Rings – The Fellowship of the Ring. This movie was released in 2001. The gross domestic sales were adjusted to 2008 dollars. I’m not sure about the foreign sales. I picked this one because it appears to me that the subject matter is similar. This movie was listed in the “Fantasy – Live Action” category near The Lion, the Witch, and the Wardrobe.

Recap of the Capital Asset Pricing Model (CAPM)

The CAPM states the following:

E(R) = Rf + β(E(Rm) – Rf)

where R is the return on the asset of interest, Rf is the risk-free rate of return, Rm is the rate of return for the entire market (the market portfolio) and β is a parameter that describes the sensitivity of the asset’s return to the market’s return.

To estimate a stock’s β, you therefore need historical data on a stock’s returns, the market’s returns, and the risk-free interest rate. You can calculate returns from an asset’s prices as follows:

Rt = (Pt + Dt – Pt-1) / (Pt-1)

Where Rt is the asset’s return in period t, Pt is the asset’s price in period t, and Dt is the dividend on the stock in period t (usually 0). It is customary to use a broad-based market index (such as the S&P 500 or the Wilshire 5000) to estimate the returns on the market portfolio and to use the returns on short term US Treasury bills to estimate the risk-free rate of return.

The following regression model can then be used to estimate a stock’s β:

Rt – Rft = α + β(Rmt – Rft) + ut

If the CAPM holds, α = 0, and the regression output allows you to test this hypothesis (as well as other hypotheses related to α and β.

Statistical Significance of a Voter Survey

In a survey of 400 likely voters, 215 responded that they would vote for the incumbent and 185 responded that they would vote for the challenger. Let p denote the fraction of all likely voters who preferred the incumbent at the time of the survey, and let p̂ be the fraction of survey respondents who preferred the incumbent.

Give an estimate of p.

p̂ = the sample mean = 215 / 400 = 0.5375

This is also the estimate of the population mean, p.

Calculate the Standard Error (SE) of the estimate, p̂.

This is a Bernoulli sample. So, the sample variance for a Bernoulli sample is:

sx2 = p̂ * (1- ?p̂ )

sx2 = 0.5375*(1-0.5375)

sx2 = 0.2486

So, the SE of the estimated mean is:

SE = sqrt(sx2 / n)

SE = sqrt(0.2486 / 400)

SE = 0.0249

What is the p-value for the test H0 : p = 0.5 vs. H1 : p != 0.5?

The first thing to note is that, because the alternate hypothesis is !=, this is a two-sided hypothesis.

Next, compute the t-statistic assuming the null hypothesis:

t = ( (Sample Mean) – (Null Hypothesis) / SE )

t = (0.5375 – 0.5) / 0.0249

t = 1.506

The p-value for the two sided hypothesis is, therefore,

p = 2 * NORMDIST(-1.506, 0, 1, 1)

p = .1321

Note that we use the negative t-statistic in this calculation of area under the curve because we are interested in the area that is inconsistent with the null hypothesis.

What is the p-value for the test H0 : p = 0.5 vs. H1 : p > 0.5?

This time, we have a one-sided hypothesis test. So, the answer is half of what it was for the two sided test:

p = NORMDIST(-1.506, 0, 1, 1)

p = 0.066

The results of the one-sided hypothesis test differs from the two sided test because in the one-sided test, we are only interested in the case where the average is > the null hypothesis. In this case, we’re interested in the case where the incumbent may actually have less than 50% of the population support. In the two-sided case, we were interested in the case where the incumbent had support from less than 50% of the population as well as the case where the incumbent had more than 57.5% of the population’s support.

Do the survey results contain statistically significant evidence that the incumbent was ahead of the challenger at the time of the survey?

It depends on the chosen significance level. For significance levels > 0.066, there is statistical evidence that the incumbent is ahead.

Finding Probabilities Using the Central Limit Theorem – #2

In a population μY = 100 and σ Y2 = 43. In a random sample of size n = 64, what is Pr (101 < Ȳ < 103)?

The sample variance = (σ Y2 / n) = 43/64 = 0.671875

Therefore, the Standard Error (SE) = sqrt(0.671875) = 0.81968.

Normalizing this to a Standard Normal Distribution,

Z = ((103 – μY) / SE)

Z = ((103 – 100) / 0.81968) = 3.66

The Z value is the number of Standard Errors away from the mean that will yield the desired Ȳ value of 103.

This is a one sided hypothesis since we are interested in the probability of Ȳ being < 103.

In EXCEL, the probability that Ȳ is < 103 is:

=NORMDIST(Z-Value, Mean of 0, Standard Deviation of 1, 1 for Cumulative)

=NORMDIST(3.66, 0, 1, 1)


Using the same logic for the probability of Ȳ being < 101,

Z = ((101 – μY) / SE)

Z = 1 / 0.81968 = 1.22

NORMDIST(1.22, 0, 1, 1) = 0.8888

The difference between the two is the probability of Ȳ being between 101 and 103.

Answer: 0.1111

Finding Probabilities Using the Central Limit Theorem

In a population μY = 100 and σ Y2 = 43. In a random sample of size n = 100, what is Pr (Ȳ < 101)?

The sample variance = (σ Y2 / n) = 43/100 = 0.43

Therefore, the Standard Error (SE) = sqrt(0.43) = 0.6557.

Normalizing this to a Standard Normal Distribution,

Z = ((101 – μY) / SE)

Z = ((101 – 100) / 0.6557) = 1.525

The Z value is the number of Standard Errors away from the mean that will yield the desired Y value of 101.

This is a one sided hypothesis since we are interested in the probability of Y being < 101.

In EXCEL, the probability that Y is < 101 is:

=NORMDIST(Z-Value, Mean of 0, Standard Deviation of 1, 1 for Cumulative)

=NORMDIST(1.525, 0, 1, 1)