Marketing test 2

How channel members create value or cease to exist

. We talked in sessions 1 and 2 about how middlemen create value by time, place, and form, and possession utility. • In the Interactive Home Shopping article, we analyzed how the creation of those types of utility differs for online shopping versus catalogs and various kinds of brick and mortar store formats. Retailers provide alternatives for consideration, screen alternatives to help consumers form their "consideration sets", they provide key information to help consumers select from their consideration sets, they lower transaction costs of ordering and fulfillment, and provide other benefits. The article concludes that a major advantage of online shopping is the ability to provide very large numbers of alternatives, to help the consumer screen alternatives in line with their preferences, and to provide deeper information for making a choice. The article also analyzed whether the online channel was likely to produce extensive "disintermediation", where firms sell directly to consumers, bypassing retailers. The conclusion was that this would be relatively rare for large brands, because manufacturers and consumers need many of the services provided by the retailer. Only if the online channel could offer those benefits in another way was 3. 13 disintermediation likely. For example, if fulfillment costs are a small part of overall costs - e.g., in selling software to consumers - would disintermediation be likely. We argued that for brands with good store distribution, strong brands (e.g., Levis) would be more likely to disintermediate than weak brands (e.g., Savane). On the other hand, small brands that now have poor distribution and shelf space have more incentive to disintermediate to have a chance to be considered. This played out in Amazon Marketplace and other pure-play ecommerce. • In the Tesla Motors case, Tesla offered a new model for selling its innovative electric cars to consumers. Tesla concluded that they should not try to sell through existing car dealerships who had a fundamental conflict of interest in providing the information necessary for consumers to purchase these cars. Existing dealers get almost all of their revenue from promoting gasoline powered vehicles, touting the benefits of electric might hurt their other businesses. Tesla's model was to provide show-rooms in high traffic shopping areas to get to consumers before they had firmed up their consideration sets. Tesla specialists were there to provide information. Service would be provided not at your local dealership, but at a central service centers. Dealer networks for other brands sued Tesla and used their local political power to persuade politicians to create new regulations banning the model. Many states have laws requiring franchise dealerships and banning direct sales to from manufacturers to consumers. Dealers were not worried about Tesla but about the precedent if Ford were now allowed to sell direct and compete with the local Ford dealer (See discussion later about channel conflict with dual distribution systems.) They also worried that some new very low cost Indian or Chinese firm were to enter the market using direct channel. Dealers argued in court that dealerships stand as consumer advocates in disputes with manufacturers such as the GM ignition switch crisis. Further, they argued that prices are lower with independent dealers because of competition among dealers. In Session 13 we learned this argument was false.

6. Determine Cost, Volume, and Profit Relationships

6. Determine Cost, Volume, and Profit Relationships a. Understand four types of costs (Figure 13-8) i. Fixed Costs are costs we incur even when producing 0 units. They are also thought of as costs that do not change with how many units you produce. ii. Variable Costs are costs that change with how many units I produce iii. Total Costs = Fix Costs + Variable Costs iv. Marginal Cost is the change in total cost that results from producing 1 more unit of quantity: the slope of the total cost curve in Figure 13-9B. It is the counterpart to "marginal revenue", the increase in revenue from selling 1 more unit. b. Profit is maximized at a price and quantity level such that MR = MC. Fig 13-9. c. In session 10, Donnie revisited a figure showing demand and marginal revenue, noting that obviously, you don't want to produce more when marginal revenue falls below 0. But you don't want to produce to the point that marginal revenue = 0 unless marginal cost is 0 - That almost never happens. d. Another way to think of profit is: Margin x Quantity - Fixed Costs. "Margin" = Price - Variable Cost. If it costs you $0.50 per hamburger for ingredients and you sell it for $1.25, Margin = $0.75. If you start a new hamburger stand and buy a food truck for $50 K and pay someone $30 K to run it, your fixed costs are $80K. Now suppose you sell 400,000 hamburgers per year, your profit would be: $0.75 x 400,000 - $80,000 = $300,000 - $80,000 = $220,000 per year. I add this because it sets up our next critical topic, Break Even Analysis (Figure 13-9).

Measurement of advertising effects and the C-suite's quest to demonstrate ROI.

Advertising effects are difficult to measure for two reasons. First, as noted above, effects are small, and the signal to noise ratio is not very good. Second, in the real world, when you change (let's say TV) advertising, other things are changing too. Without a true experiment (like the IRI experiments in 1c above), it is hard to sort out causation. These two forces have combined to put increasing pressure on CMOs (Chief Marketing Officers) to demonstrate return on investment before the company is willing to spend a lot on marketing. These forces explain why so much of the ad budget is migrating to the 17 web, where it is measurement is easier, where one can do "A/B" tests randomly assigning different advertising to different IP addresses, and where costs are lower (WSJ: A New Way to Sell Oreos). Companies are spending more and more on social media but it is considered very difficult to measure effects of spending on social media. See below.

Factors Affecting Speed of Diffusion of Innovations.

All products and categories have some form of the general diffusion curve in Figure 11-1. But what determines how long a product stays in the introduction stage, and how fast it grows? Everett Rogers wrote one of the most famous social science books in history, Diffusion of Innovations. (This is also where the adopter categories above were first introduced.) He explained speed of diffusion in terms of his ACCORD framework: Advantage, Compatibility, Complexity, Observability, Risk, Divisibility.

Brand Equity.

Brand Equity. Brand equity generally refers to excess revenues for a branded product compared to a private label with the same characteristics. That excess revenue may come from selling more quantity than the competitors at the same price, or from selling the same quantity as competitors but at a higher price (or the combo). Brands have financial value, as reflected in the Interbrand brand rankings.

Branding and Brand Management

Branding and Brand Management. Our text gives one definition for a brand, but I think of it as defined by the set of associations discussed in class under "Brand Knowledge Structures." Strong brands have associations that are a) favorable, b) strong, 2 c) unique. We talked again about points of parity and points of difference among the associates of a brand. Brand personality is one type of brand association.

Changes in media spending patterns due to changes in media habits plus changes in analytics and measurement. There is a fundamental change in the ad business, with more and more advertising going online. We discussed various forces.

Changes in media spending patterns due to changes in media habits plus changes in analytics and measurement. There is a fundamental change in the ad business, with more and more advertising going online. We discussed various forces. a. What's going on with TV advertising? The WSJ article TV Ad Dollars Shifting to Web Video addressed two important developments. More and more consumers are watching TV programming on the web or on tablets or smartphones. This viewership had not been captured by Nielsen TV measurement of audience size for TV programming, and the result had been that advertisers were unwilling to pay as much to advertise on the web. But now another major company, ComScore, is providing richer data about the lives of web-viewing audiences, and so companies are willing to pay more to advertise there (WSJ: "Nielsen Feels Digital Heat from Rivals"). ComScore is moving into measurement of exposure to TV advertising, and at the same time Nielsen is moving into measurement of exposure to digital advertising. Meanwhile, the WSJ article "Comcast Seeks to Harness Trove of Data" described how cable operator Comcast is trying to help advertisers get more out of TV advertising to tell advertisers more about the people watching specific shows. b. The shift of advertising spending to digital - and a bewildering set of players who enable creation, selling, and delivery of digital ads. The other thing happening is that that more and more of the ad budget is going to digital, as noted in the discussion above of the Oreos article. This showed up in two required articles. WSJ "Why Does It Take So Many Companies to Produce One Digital Ad?" talked about how Jet Blue used 40 firms to get one digital ad out to the market. Gone are the days where an advertiser hires one ad agency who does all the creative and gets the ad out on TV programming. With digital, to get an ad out on computers and mobile devices, firms employ geo-targeting, social analytics and listening forms to monitor online sentiment, ad networks to purchase ad exposures cheaply, etc. We discussed the LumaScape, an investment banks effort to understand all the players in the various sectors of digital marketing. The sheer complexity of the landscape makes it hard to understand what any one company is doing, which affects their ability to raise capital in capital markets (WSJ: Ad Tech Stocks Keep Falling in First Quarter). The movement toward digital and the analytics surrounding digital is changing the job market for people interested in the ad industry, as described in the required article, "Old School Ad Execs Sweat as Data Geeks Flex Muscle." If you are interested in getting into advertising, it is unlikely you will be in an ad creative role of the sort portrayed in Mad Men. Instead, ad agencies are hiring folks with analytics skills to be able to understand audiences and to use analytics to better prove a link between ad spending and ROI. The new digital agencies produce 50 times as many ads as in prior years for a given client, with much less effort around creative and more around analytics. c. What about social media? We discussed the most recent CMO Survey coming out of Duke University, documenting a disconnect between plans to increase spending 18 on social media and the experiences of most CMOs that social media spending was not very effective in generating sales. One of the major problems has been that it has been devilishly hard to measure effects of social media spending. We discussed the first credible study of effects of increasing comments on (the Chinese version of) Twitter on actual consumption. The authors studied effects of turning off the commenting function for a few days on viewership of Chinese TV shows. Results showed that Twitter comments functioned a lot like "reminder" advertising, and had elasticities similar to advertising. For a 1% increase in Twitter comments on posting about an upcoming TV show, we see about 0.05% increase in viewership of that show. That's similar to standard ad elasticities, where a 1% increase in spending produces about a 1/20th of 1% increase in sales. We showed how claims about Facebook ad effectiveness are oversold.

Compatibility with existing lifestyles and values speeds up diffusion.

Compatibility with existing lifestyles and values speeds up diffusion.We discussed the electric car, which requires no particularly difficult special skills to adopt. However, the cruising range on a battery charge has been an issue. So compatibility might be high for someone who only commutes short distances in an urban area, but not for someone who drives cross-country. Compatibility has also been a problem with Pepsico's Frito Lay division trying to sell healthy snacks to consumers who love unhealthy but tasty favorite chips.

Adopter Categories (Figure 11-5, note percentages in each category).

Different kinds of people are buying your product at different stages of the product life cycle. In the introductory stage, you start with innovators (first 2.5 %) who tend to be venturesome, with higher education, and a wide net of information sources that help them make up their own minds. They also are not that worried about convincing others. Then come the early adopters (13.5%) who are more socially interconnected, above average in education, and who tend to both give and receive product information with others. The early majority (34%) are folks who are influenced by the early adopters in their social networks. The late majority folks are skeptical of innovations initially (so they don't buy as fast on their own) and less socially interconnected (so they don't get ideas as quickly from others in their networks). The laggards (16%) are last to the party. They just aren't that into innovation, and financial concerns make them slow to adopt.

Divisibility (also sometimes called Trialability) speeds adoption by reducing perceived risk.

Divisibility (also sometimes called Trialability) speeds adoption by reducing perceived risk. If a product is divisible, I can try a small part of it before buying to understand what I'm getting. As an example, oftware firms often reduce risk of buying some expensive package by allowing a 30-day free trial.

Returning to Demand-Based Pricing in Figure 14-2. Price skimming.

Donnie noted that in Figure 13-7, we discussed pricing Newsweek at a single point in time based on an analysis of marginal revenue and marginal cost. Price skimming involves changing prices over time. Start out selling at a high price and therefore having low quantity but high margin. Then in later periods, reduce the price to sell to people who did not already buy at the higher price. Margins are lower than for the first set, but we pick up additional quantity. Continue reducing price in subsequent periods until you get to the point that sales are not generating positive margin. This is really price discrimination over time. Donnie noted that it works when you aren't giving up scale economies by selling lots more initially, as you would do if you set a single price in Figure 13-7. More importantly, there must be barriers to competition. You don't want to sell only to customers willing to pay a very high initial price, only to have a competitor swoop in to clean up the rest of the market.

• Relative Advantage.

Faster diffusion if consumers perceive bigger benefit of the innovation compared to existing ways of solving the same problem. This of course includes cost. We discussed "What Exactly Is An Apple Watch For" and asked the question of what exactly this expensive gadget does that is superior to, say, a FitBit, or a Fitbit on one wrist and a Timex watch in another. One can share health data from an Apple Watch with one's doctor. But how big of a deal is that? Or one could say that one can more discreetly check for messages on one's Apple watch in Lynch's class than by pulling out one's iPhone. But how big a deal is that? We also gave the example of electric car, which right now is expensive and unless someone places very high value on ecological concerns, not dramatically better than other forms like hybrids.

Identifying Constraints on Pricing (all in text)

Identifying Constraints on Pricing (all in text) a. Demand for product class. If demand for product class fall, it is hard for me to price high for my specific model. Fluctuations in product class demand affect my product more if I have low differentiation. b. Newness of the Product... Stage of Product Life Cycle.... In introductory and growth stages, more ability to price high. In maturity stage of life cycle there are many substitutes and so it is hard to price high. c. Single product versus product line. In product line pricing, you have to worry about cannibalization. A new product that looks successful as a stand-alone but that cannibalizes another higher margin product may not improve profits d. Cost of producing and marketing a product e. Cost of changing prices and how long prices will prevail. (Sometimes called "menu costs") By now pretty easy to change prices online. Harder in physical stores. f. Type of competitive market. i. Pure competition ("Wheat Prices Fall As Plantings Rise). You can't affect prices. Price Taker. If you planted more wheat because high price last year, supply goes up and prices come down. ii. Monopolistic Competition - Many sellers who sell on non-price factors - e.g., based on brand equity. The cold cereal market is a good example, where hundreds of products compete on the grocery store shelf despite only minor differences. Toothpaste is another example here. Iron Man Triathlon sells out, when the same course by a different promoter does not. Apple name makes people willing to pay more. iii. Oligopoly. A handful of sellers who are sensitive to each other prices. e.g., airlines. When one firm drops prices, others tend to follow because differentiation is slight. The less differentiation, the more the likely competitive response to any firm's actions. In some drug categories ("For Prescription Drug Makers, Price Increases Drive Revenue"), there are some very small number of competitors - e.g., in antidepressant category or in statin heart drugs, there are about six players, each with some significant differentiation so that one is not perceived as that good of a substitute for the other. iv. Pure Monopoly. (For Prescription Drug Makers, Price Increases Drive Revenue). With monopolies, there is lack of substitutes, and this results in "pricing power" documented in the article. Increasing prices increases total revenue, rather than causing declines in quantity that are so steep that total revenue goes down. The article discusses how patents create monopolies. When a drug comes off-patent, now generic substitutes come 5 into market and demand becomes more elastic because of existence of substitutes. Even when a drug comes off patent, they still may retain some pricing power due to customer loyalty, inertia, and 3rd party payer systems where the customer gains little from choosing the cheaper generic. A patented drug can still have substitutes, and the rebates that drug companies give to insurance companies are steeper if there is some other patented drug that is a close substitute.

Identifying Pricing Objectives. Our text identifies several pricing objectives:

Identifying Pricing Objectives. Our text identifies several pricing objectives: a. Managing long-run profits. Amazon plows profits back into the business, showing break-even performance for long periods of time with goal of building market share. b. Managing for current profits. This was illustrated by three articles about the Boulder / Denver rental market from 2009 to 2015. In 2009, supply of apartments was plentiful, and renters had the upper hand. Owners flexibly negotiated prices. With high fixed costs and low variable costs, it was better to rent for something than to leave a unit vacant. Owners did not simply lower rents, so renters who did not search and find alternatives paid regular prices. By 2011, supply had tightened. In this environment, the apartment complexes had pricing power and raised prices and therefore profits. When profits increased, this invited new entry and the building of new apartment complexes, as seen in the 2015 article as well. c. Managing for target return. Many Fortune 500 companies use this objective, to allow assets of the firm to be allocated to projects that get higher rates of return. d. Sales objectives. Sell $X in coming year e. Market share. Focus on how we are doing relative to competition. Common for consumer packaged goods 4 f. Unit volume. Number of units sold. (Sometimes comes into play when one is worrying about break even volume) g. Survival. Sometimes when you can't make money on a customer, you accept a price that covers variable costs even if it will not cover fixed costs h. Social responsibility pricing. i. Status quo... You charge the going price in this industry.

What are Marketing Channels?

Marketing channels refer to the path from original manufacturer to end consumer or to end B-to-B customer. This is also thought to be about the "Place" P of the 4 Ps. For example, if a manufacturer sells to a retailer, who in turn sells to a consumer, the retailer is the "place" of the transaction (where?) as well as the "how" of purchase.

Observability speeds up diffusion.

Observability speeds up diffusion. Diffusion of innovations is a social process - like catching a cold. Holding constant how an innovation performs on the other ACCORD dimensions, if an innovation is consumed in private (e.g., Tommy John underwear), diffusion is going to be slower than for something consumed in private (e.g., electric car, or some new style of shoes) consumed in public. That's because if one adopter likes the product and a second person sees it, this may spur a conversation or imitation

Perceived Complexity slows down diffusion.

Perceived Complexity slows down diffusion. We gave the example of perceptions of how hard it is to set up a router for a home network. It may not actually be complex, but it is perceived as complex. An iPhone may be amazingly complex from a technological standpoint, but it was not perceived as complex and this speeded diffusion.

Perceived Risk slows down innovation.

Perceived Risk slows down innovation. This can be financial, social, functional, or physical risk. What if I buy one of those new home-delivered beds and I don't like it? (Financial) What if I back some new political movement and my friends shun me (social)? What if I move all of my stuff over to a new operating system like Android and my favorite programs don't run (functional)? What if I have Lasik eye surgery and I wind up with the rare side effect of nighttime glares, halos, or double vision (physical)?

The Profit Equation. Your text says on p. 192:

The Profit Equation. Your text says on p. 192: Profit = Total Revenue - Total Cost. Let's break that down Total Revenue = Unit Price * Quantity Sold Total Cost = Fixed Cost + Total Variable Cost Total Variable Cost = Per Unit Marginal Cost * Quantity So plugging things in and restating the profit equation: Profit = Unit Price * Quantity- (Fixed Costs + per unit Marginal Cost * Quantity) Hmmm. Rearranging terms: Profit = Quantity * (Price - per unit Marginal Cost) - Fixed Costs We often refer to the per unit profit margin as (Price - Per Unit Marginal Cost). So the last equation is often expressed as: Profit = Quantity * Margin Per Unit - Fixed Costs. Fixed Cost is a cost that does not vary with the amount sold - e.g., the cost of buying a food truck in our example. Variable Cost is a cost that increments with amount sold - e.g. the ingredients and labor costs going into a sandwich. We saw how to find information on some of these terms to solve for others in the article AT&T may not rejoice at $35-a-Month Plan, Though Tightwads Do. We calculated the (much smaller) margins on the new Direct TV Now streaming service compared to the margins on a regular Direct TV subscription. You should be able to do that and to work any example coming from the equations above.

Product Life Cycle.

The product life cycle is generally applied at the level of categories of products (e.g., faxes, smart phones, soft drinks) rather than at the level of brands. Every innovation has a diffusion curve that shows an introductory stage (Are Electric Car Sales About to Accelerate?), a growth stage (Cuties), a maturity stage (coffee), and a decline stage (greeting cards and arguably Coke in the reading Coke Sticks to Its Strategy). Moreover, competition is quite different at each stage. At introduction, there are very few competitors and the focus is on creating primary demand. At the growth stage, the category starts to become profitable and attracts new competition. At the maturity stage, the category is a bit cursed with product proliferation, the most competitors of any stage. To avoid having this become a big zero sum game, you have to find new uses for your product and new users - as for example, when cold cereal industry started selling to folks wanting cereal as great for dinner or a late snack. At decline, competitors start to thin out as firms begin "harvesting" brands that are no longer profitable. Figures 11-1 and 11-2 in your book show that all aspects of the marketing mix are managed somewhat differently at each stage. For example, at introduction, the focus is on building awareness of the category. At decline, you crank back dramatically on marketing spending. (You can connect this to our Day 14 discussion of advertising elasticity: % change in quantity of sales for a 1% change in ad spending. At decline stage, there is very low return to ad spending.) But because competition has thinned and marketing costs are low, it is possible to be very profitable even in decline.

How powerful is advertising?

We began the session asking whether advertising is a powerful stimulus that has a lot of influence on consumer purchase behavior, or a relatively weak stimulus. The answer, surprisingly, is that advertising is a relatively weak stimulus compared to other elements of the 4 Ps. We showed this in two ways: a. We discussed the (non-assigned) article Europe Faults Alcohol Marketers for Binge Drinking: UK Proposes $286 MM Ad Ban." Here, policy makers in the UK (probably correctly) saw binge drinking as a problem; they (probably incorrectly) assumed that alcohol advertising has large effects on "primary demand" - i.e., overall consumption of alcohol. What the literature shows is that any effects are primarily on "selective demand" - demand for one brand versus another. An industry spokesperson said, "No, our ads are not intended to increase drinking, they are intended to influence brand choice." There is a large literature on tobacco advertising and a smaller literature on alcohol advertising that supports that ads have weak effects on primary demand. In contrast, campaigns like "Got Milk?" are intended to boost primary demand for the overall category of milk. b. We discussed the concept of "advertising elasticity." Ad Elasticity = % change in quantity sold / % change in ad spending. Put differently, what percent more will we sell when we increase $Ad spending by 1%? Ad elasticities are positive, not negative - i.e., when we increase ad spending, quantity sold goes up. What the data show is that sales go up by much less than 1% for each 1% increase in ad spending. One recent study across hundreds of categories showed that for a 1% increase in ad spending, sales go up by 0.05% (1/20th of 1%), so ad elasticity = 0.05. That's pretty darned weak. Another classic study showed slightly stronger effects, average "short term" ad elasticity = 0.12, average long term elasticity = .24. c. When is ad elasticity higher or lower than those averages? A third study broke down when effects are stronger or weaker. This was a study of IRI BEHAVIORSCAN split cable field experiments, where households are randomly assigned to different advertising conditions to be able to make true causal inferences about advertising effects. Ad elasticity is higher when introducing new products or brand extensions than when advertising an existing product. In other words, advertising produces more bang for the buck with new products than mature products. For mature brands, increasing "media weight" - how much you are spending on advertising has almost zero effect. Why might that be? For new products, you are making people aware of the product and informing them. It's harder to change what consumers think about existing products.

Effects of channel structure on pricing - effects of vertical integration -- "double marginalization."

We carried this over to day 14. The main conclusion from all of this is that prices will be higher and quantity sold lower in a market where a manufacturer sells through an independent retailer who sets its own prices than when the manufacturer sells directly to the end consumer. Please see the solution on the last page of this handout, and the following explanation of the numbers you see. Let's consider the case in which a manufacturer chooses to own a downstream intermediary rather than selling to them and letting them set their own prices. We considered the example of price setting by a monopolist who chooses the profit maximizing price if selling direct to consumers (which would happen if they were vertically integrated). Then we looked at how things would change if they had the same cost structure but sold at a "wholesale price" to a monopolist retailer, who in turn set its own profit maximizing retail price. We saw that the retailer would set a price to a consumer that was higher than the "direct" price of the manufacturer selling direct to consumers. That increase in price due to markup needs from the intermediary is called "double marginalization." This refutes a key argument of the dealers associations in the Tesla case. Moreover, because price is higher, quantity sold is lower. Finally, and interestingly, total channel profits are higher for the direct case (manufacturer profits 14 alone) than when selling through an independent retailer. In the latter case, Total Channel Profits = (Manufacturer Profits + Retailer Profits). Please see the attached sheet for the full solution to the problem we discussed. • Manufacturer sells direct to consumer. In the first panel, we see that if the manufacturer "vertically integrated" and sold direct to the end customer, it would make the most money if priced at $30 compared to higher prices, given a marginal cost of $10. When selling for $30, Quantity = 10, margin (P - MC) = $20, so 10* $20 = $200 - more than any higher price. • Retailer facing w = $10. In the second panel, we see what would happen if the same manufacturer with a marginal cost of $10 sold to the retailer at a Wholesale Price w = $10 (kind of stupid to sell for the same price as marginal cost, but ignore that for the moment. In that case the retailer would have to figure out in that situation what price would make the retailer the most profit. Retailer Profit = Quantity sold x retailer margin, and retailer margin = price to consumers minus wholesale price, or Q*(P-W). o In that case, if the retailer sets P = $30, then retailer margin = P - w = $20 and retailer profit = 10 * ($30 - $10) = $200. We see that the retailer makes more money at that price than at any other price. o At P = $40 (retailer profit = $180 = 6 * ($40 - $10)) o At P = $50 (retailer profit = $80). Hence, facing a wholesale price of $10, the retailer would price the product at P = $30 and make $200. What does this do to the manufacturer? In that case, the manufacturer makes profit = Q * (w - mc) - quantity time manufacturer margin = 10 * $0 = $0. Manufacturer margin is wholesale price charged to the retailer minus marginal cost. If the retailer sets price at $30, then the manufacturer sells Q = 10 units but makes no money because margins are zero. Not great. • Retailer facing w = $20. Now let's look at the third panel to see how the manufacturer does if the wholesale price is set at $20, not $10. In that case, the quantities sold to consumers are the same as in the second panel, but what is changed is the margins. o At P = $30, retailer margin = $30 - $20 = $10. So retailer profit at P = $30 = 10 * $10 = $100. o At P = $40, now retailer margin is $20, so retailer profit would be a bit higher: 6 * $20 = $120. o At P = $50, retailer margin would be $30, but selling only 2 units, retailer profit = 2 * $30 = $60. What would the retailer do in this situation? Obviously, they would choose to price at P = $40 to make the best of the situation. How does the manufacturer fare if the retailer choses P = $40? Manufacturer margin at wholesale price w = $20 would be (w - mc) or ($20 - $10 = $10). So if the retailer decides to price at P = $40 and sells 6 units, the manufacturer profit = 6 * $10. Better than what the manufacturer would have got by setting wholesale price at $10, but we will see that the manufacturer does better by setting w = $30. • Retailer facing w = $30. Now let's look in the fourth panel to see what the retailer does if the manufacturer sells at a wholesale price of $30. 15 o Now at P = $30, the retailer makes no margin - retailer profit = 10 * $0 = $0. o At P = $40, the retailer margin (P - w) is $10, so retailer profit is makes Q* (P - w) = 6 * $10 = $60. o At P = $50, retailer margin is ($50 - $30) = $20, and retailer profit = 2 * $20 = $40. Thus, the retailer makes the most money by pricing at P = $40. In that case, the manufacturer margin is (w - MC =)$20, so the retailer profit is 6 * $20 = $120. • Given all this, what wholesale price should the manufacturer charge? At w = $10, when the retailer chooses the retail price P = $30 that is good for the retailer, the manufacturer sells 10 units and makes $0 profit. At w = $20, when the retailer chooses the retail price P = $40 that is good for the retailer, the manufacturer sells 6 units and makes $60. At w = $30, when the retailer chooses the retail price P = $40 that is good for the retailer, the manufacturer again sells 6 units but now makes $120. So what should a smart manufacturer do? Obviously, sell at w = $30 to maximize its profits! (You can work the case of wholesale price w = $40 to convince yourself that you can't do better by w = $40 compared to w = $30.) So that is what will happen when selling through a retailer. The manufacturer will set a wholesale price that makes it most profitable, and that will be higher than the price it set when selling directly to consumers in panel 1. This shows that in the Tesla case, the defenders of the dealers association were wrong in their arguments that selling through an independent dealer leads to lower prices for consumers. 16

Why do brands matter? In other words, where does that revenue premium come from in our discussion of "brand equity?"

Why do brands matter? In other words, where does that revenue premium come from in our discussion of "brand equity?" On the consumer side, a brand helps get the product into the consumer's "consideration set" and engenders customer loyalty so they aren't looking around for alternatives. That makes a strong brand relatively immune to competitors marketing actions or their own marketing crises (think Toyota unintended acceleration crisis). Strong brands command larger margins with less price elasticity of demand. Moreover, channels of distribution are favorable; retailers want to carry and support strong brands because it is in their interest to do so. Moreover, strong brands have more efficient spending for marketing communications. Finally, strong brands produce licensing and "Brand extension" opportunities. For example, how in the heck did Amazon get into selling women's underwear, as we discussed on Day 13? They have favorable associations that are quite general and not specific to any given category.

Break Even Analysis

a. A break even analysis figures out how many units we would have to sell at a particular price and cost structure to break even. Put differently, we start in the hole for our fixed costs. How many units do we have to produce to exactly cover our fixed costs? b. The book uses a particular version of the breakeven formula, and Donnie taught you that formula for BEP = Break Even Point: BEPQuantity = Fixed Cost = FC Unit Price - Unit Variable Cost P - UVC c. Notice that the denominator of the ratio on the right is what I called "margin" - how much profit we make on a per unit basis, ignoring fixed costs. Let's make that substitution in the denominator BEPQuantity = FC = FC P - UVC Unit M argin d. Now let's multiply both sides by Unit Margin, resulting in the equation: Fixed Costs = BEP Quantity x Unit Margin. When you see it that way, you realize that the Break Even Point Quantity is the quantity that makes Quantity x Margin exactly cover our fixed costs. e. Example in 13-9. Price per picture = $120, and Unit Variable Cost is $40. So what does that make "Margin" per picture? Fixed costs are $32 K, so at a margin of $80, what quantity (BEP Q) would lead to us exactly covering that $32K fixed costs? Using d above, If $32K = BEP Q * Margin = BEP Q * $80, it's easy to solve for BEP Q = $32,000 / $80 = 400 pictures. f. Applications: i. What if we change fixed costs? Is new machinery worth it if it adds to fixed costs but reduces variable costs? How many units until we cover the cost of the new machinery? Figure 13-10 ii. What if we change variable costs by becoming more efficient? iii. What if we change our Price? iv. One can also assume a fixed quantity and solve for Break Even Price.

Estimate Demand Curve and Revenue (italicized topics from last time)

a. Figure 13-4 A. Movement along a demand curve.... How quantity declines when prices increase. Can estimate by varying prices to different customer groups chosen at random. Example Amazon DVD pricing experiments. b. Figure 13-4 B. Shift of the demand curve. This happens when market conditions become more favorable (shift to right) or less favorable (shift to left). E.g., competitors raise prices, so now we sell a higher quantity at same price we were charging before. c. Sales Revenue estimation (Figure 13-6). Total Revenue = Quantity x Price; Marginal Revenue = change in revenue with selling 1 additional unit. We worked with an example in class where quantity varied from 0 to 10 and price varied from $150 to $50. For a particular demand curve, marginal revenue may start high with low quantities, and at higher quantities becomes negative. In my example, Total Revenue was maximized at a quantity of 7 or 8. Marginal revenue becomes negative at quantities higher than 8 in the example. d. If marginal revenue is negative, a wise seller will not produce an additional unit because it just reduces the seller's total revenue. e. You don't keep producing quantity as long as marginal revenue is positive. The key is that marginal revenue has to be more than marginal costs. So in the example just mentioned, suppose that the cost of making a unit was $50. In that case, marginal revenue at a quantity of 5 = $60 and marginal revenue at a quantity of 6 = $40. So you would stop producing at quantity = 5, because beyond that, marginal revenue is less than marginal cost.

teps in Developing the Ad Program. The first three steps below were illustrated in the WSJ article, "Twitter Users Diversity Becomes and Ad Selling Point."

a. Identify the target audience. It is common to choose a target audience based on demographics. That's in part because media are sold with descriptions of demographic composition. The article above noted how various social media have user bases with different demographic makeup than the general pool of Internet users. For example, black non-hispanic audiences are almost twice the share of Twitter users compared to their share of all internet users. So identifying the target audience leads to seeking a media vehicle where that group is disproportionately represented in the audience, to minimize the cost of reaching your target. The target can be narrow. In generating buzz about "12 Years a Slave", the target was influential celebrities like Pharrell Williams, because other black consumers people are much more likely to respond to a post by him than to a post by the studio. b. Specify the ad objective. The ad objective is usually something related to the "hierarchy of effects" described below...to drive either thoughts (cognitive stage), feelings (affective stage), or behavior (usually purchase, though lately more focus on the behavior of generating word of mouth). In the Twitter article above, the objective was to get influential black celebrities with large twitter followings to tweet about the movie. In the text and in class, we also talked about ad objectives to inform, remind, and persuade. The first two are mainly about getting your brand in the consideration set, and the persuading objective is about helping you be preferred to other brands in the same consideration set. c. Set ad budget. We didn't talk much about this, but the key things to impart are that first, if your objective is something like generating a certain awareness level for a new product, there are firms like BASES (a division of Nielsen) that can tell you how much you have to spend to reach a certain level of awareness. If you objective is to increase sales, you can use ad elasticity estimates to figure out incremental volume, your margin on that volume, and how it compares to ad cost. 5. Brand knowledge structures. When we want to influence the cognitive stage in a hierarchy of effects, we usually try to influence awareness/ consideration or brand image. 6. Consideration set. We returned to the key concept of "consideration set" - the set of brands actively considered at the point of choice. In order to be chosen, a) your brand has to be included in the consideration set, and b) the consideration set must not include a brand you like better. Many, many marketing variables work through these two principles 19 a. Defining competition. We used the Wendy's example to show that a firm competes most intensely with other alternatives that co-occur most often in consideration sets that include Wendy's ("cooking/eating at home). b. Who co-occurs in consideration sets with my brand? We highlighted the role of mental categories and subcategories. For example, the category of fast food has sub- categories of burgers, chicken, pizza, sub shops. The category of soft drinks has subcategories of colas, lemon lime drinks, ginger ale, etc. Thinking about one brand in a subcategory often triggers considering other alternatives in the same subcategory.

Using the framework to understand which brands benefit most from "reminder" advertising. We discussed the most cited paper in marketing about consideration sets, a classic paper (by my second PhD student) about the effects of reminder advertising.

a. Major versus minor subcategories. Product categories often have "major" subcategories that come immediately to mind when you think about the category and "minor" subcategories that come to mind less readily. For instance, for the category fast food, burger places would be the major category, and sub shops a minor subcategory. It turns out that how readily you think of a subcategory isn't related to how much you like the subcategories. You guys all thought of burgers first and were slow to think of sub shops, but that doesn't mean that you like burgers more than sub shops. When sub shops don't make a sale to you, it's usually because they were never considered. Similarly, you might like ginger ale as much as colas but usually forget ginger ale unless you are on an airplane. b. Major versus minor brands in a subcategory. Within a given subcategory, some brands are "major" brands that come to mind right away (Burgers triggers McDonalds right away, Sub Shops triggers Subway) and some are "minor" brands that come to mind much less readily (say Hardees or Half Fast Subs). Within a subcategory, how fast a brand comes to mind is pretty strongly related to how much you like it. Most people like major brands better than minor brands in a given subcategory c. How this affects the payoff from reminder advertising. In the study we discussed in class there were five conditions with random assignment to conditions. People in the control condition was asked to say what fast food restaurant they wanted a coupon for, allowing market share estimates in the absence of reminder ads. Four other groups were asked the same question, but earlier in the study they had been primed with brief exposure to reminder ads mentioned the brand name and nothing else for: major brand in major subcategory (McDonalds); minor brand in major subcategory (Hardees); major brand in minor subcategory (Subway), or minor brand in minor subcategory (Half Fast Subs). i. Reminder ads for McDonalds have little effect, because a) even in the control group, you are almost certain to think of burgers and McDonalds. ii. Reminder ads for Hardees have no effect. You'd be more likely to consider them with reminder advertising, but you'd likely immediately remember McDonalds and choose McDonalds -- no different from the control group. iii. Reminder ads for major brands in minor (niche) subcategories have huge beneficial effects. A reminder ad for Subway makes you think of sub shops and makes you consider Subway, and because you like the major brand more than other sub shops, you get a big lift in choice share compared to the control group. 20 iv. Interestingly, reminder ads for minor brands in minor categories (e.g. Half Fast Subs) does get that brand in the consideration set, but also reminds people of the major brand (Subway), and sales go to that brand. So reminder advertising works best for leading brands in niche subcategories. (I forgot to mention that this year we had a speaker from Stanford who had a paper showing how everything above pans out in a large field study of many categories.)

Perceptual and Behavioral Issues in Demand Based Pricing.

a. Transaction utility and Acquisition Utility. One of the most important ideas in behavioral pricing is the distinction between "transaction" and "acquisition" utility. Acquisition utility is the standard economic concept of a comparison of (Inherent need satisfying aspects of purchase - price). Transaction utility is a comparison of (Internal Reference Price - Price). b. Internal Reference Price. A mentally stored price or price impression generated that is used to evaluate encountered prices such that prices about the IRP are evaluated unfavorably and prices below it favorably. The exact same offered price can be coded as a good deal or a bad deal depending on the IRP. Donnie's example was of purchases of Gatorade and of purchases of Newton Running Shoes. Depending on what he thought was the "real normal" price, the discount price looked like a good deal or a bad deal. c. Pricing to deal prone consumers. You don't want a pricing policy that leads deal prone consumers to simply stock up at cheaper price on a product they would have bought otherwise at a regular price. The key is that deal prone consumers are highly sensitive to "transaction utility." d. Forward buying / stockpiling. It is common to offer temporary price promotions on a consumer packaged good and for sales to spike with that price discount. The question is how many of those sales are incremental. You want the discount to pull in people who would normally not buy. But often you just get deal prone consumers in your current franchise to stock up and buy at a low price something they would have otherwise bought at a regular price. Evaluate the success of a promotion by incremental profit both in the weeks of a promotion and thereafter. e. Fairness perceptions influence Internal Reference Prices. The exact same price increase can be seen as either okay or a ripoff depending on whether consumers think 10 it is "fair." Economists would say that consumers should simply evaluate the Acquisition Utility at the new, higher price, and purchase if there is positive Acquisition Utility. But if a price increase is unfair, they heavily anchor on what they think is the "fair" price. Donnie explained that because of this, consumers are much less likely to abandon you when you raise your prices if the price increase is based on cost increases from the producer than if they are just based on what the market will bear (see his Peets Coffee example). Think about all the outrage at Martin Shkreli's "price gouging" on pharmaceuticals http://www.vanityfair.com/news/2015/12/martin- shkreli-pharmaceuticals-ceo-interview Donnie pointed out that in some markets, consumers understand and accept market principles. It is not considered unfair to sell your house for what comparable houses are going for, even though you bought it for hundreds of thousands less. But in other categories, the "fairness" mindset strongly affects Internal Reference Prices. f. Range effects. The Internal Reference Price isn't the only reference point people use to decide whether they are getting a good deal. When there are several products covering a spectrum of low to high prices, the endpoints dictate what is perceived to be low or high. Imagine a store selling products A, B, C, D, and E in ascending order of prices. Dropping item E makes item D seem more expensive, because now it is the highest price. Dropping item A makes item B seem cheaper, because now it is the lowest price. g. Other forms of "relative" price perception: decoy effect. Donnie discussed another famous form of relativism, using the example of Economist subscriptions. Suppose that you offer a high priced, higher value option A (Online Plus Print Economist for $125) and a low priced, lower value option B (Online Only Economist Access for $59). Consumers have conflict, because they aren't entirely sure of the price versus value tradeoff. By adding a third option (A-) to the set that is a clearly inferior version of the high priced, high value option (Print Only Economist Subscription for $125), consumers now see a clear comparison that favors A over A-. That makes them more likely to choose option A than if you did not have A- as a "decoy." (That "decoy effect" or "attraction effect was discovered by my former Duke colleagues.)

Price Elasticity of Demand

a. When prices go up, quantity demanded goes down. But by how much? So much that Total Revenue (Quantity x Price) goes down, or does it actually go up because the higher price outweighs the small loss in quantity? (Again, refer to article, "For Prescription Drug Makers, Price Increases Drive Revenue") When raising prices actually increases total revenue, this is the definition of "inelastic demand." b. Is demand price elastic (e.g., bread) vs. inelastic (e.g, some medicines)? With elastic portion of a demand curve (left side of 13-4A with high prices, when you lower your prices, you actually increase revenue. In the inelastic portion of a demand curve (right side of 13-4A) with low prices if you lower your prices further, total revenue declines. c. Price elasticity is defined as: % change in quantity / % change in price. Because raising price lowers quantity and vice versa, price elasticity is (almost) always negative. (Although sometimes writers will leave off the negative sign.) d. Percent Change in Quantity. If Q1 is the quantity at the original price and Q2 is the quantity at a second, changed price, % Δ Q = (Q2 - Q1) / average of Q1&Q2. e. Percent Change in Price. If P1 is the original price and P2 is a second, changed price, % Δ P = (P2 - P1) / average of P1&P2. f. Example. Suppose that we sell 1000 units at a price of $1 per unit. When we raise the price to $1.10, we sell 800 units. % Δ Q = (Q2 - Q1) / average of Q1&Q2 = (1000-800) / [(1000 + 800) / 2 ] = 200/900 = 22.2%. % Δ P = (P2 - P1) / average of P1&P2 = ($1 - $1.10) / [(1.00 + $1.10) / 2] = - $0.10 / $1.05 = - 9.5%. Therefore, price elasticity of demand = -2.34. Be sure you can do these calculations from memory. I'll make the numbers easy to work with on exam. g. "Elastic" demand occurs when the percent change in quantity is greater than the percent change in price - e.g., if quantity declines by 2% when price is increased by 1%, price elasticity would be -2, which is "elastic." The example in (f) also shows "elastic" demand. h. "Inelastic" demand occurs when the percent change in quantity is less than the percent change in price - e.g., if quantity declines by 0.5% when price is increased by 1%, price elasticity would be -0.5, which is "inelastic." i. In general, demand is elastic when there are readily available substitutes (smoothie example) and inelastic when there are not good substitutes in the consumer's eyes (sunglasses at beach resort example). Donnie noted at the end of 7 session 9 that a differentiated brand (e.g., Horizon Organic Milk) may be facing inelastic demand when a generic competitor is facing elastic demand. j. Distinguish the issue of elasticity of demand for the product class versus elasticity of demand for your brand. Demand for gasoline may be price inelastic: you don't drive a lot more lately just because gas prices are much lower than a couple of years ago, and when prices were high, you couldn't readily switch to modes of transport besides cars. But at the same time, demand for a specific brand of gasoline may be highly price elastic, because different brands are perceived as close substitutes. k. The relationship between price elasticity of demand and total revenue. When demand is "elastic", total revenue goes down when you raise the price. (And, conversely, TR goes up when you cut price.) When demand is "inelastic", total revenue goes up when you raise the price. If elasticity was exactly 1 (neither elastic nor inelastic) total revenue would be the same at old and new prices. l. Let's use the example in f) to illustrate the point in k). At our original $1 price, Total Revenue = 1000 units x $1 = $1000. When we raise the price to $1.10, Total Revenue drops to 800 units x $1.10 = $880, implying elastic demand. m. You should be able to answer questions about my examples price elasticity of demand for soft drinks, cigarettes and for CU tuition.

Groupon article. The Groupon article illustrated many of the principles discussed above. (The video we watched was by Andrew Ross Sorkin. Fans of the TV show Billions may know that Sorkin is the creator of that show. 11

http://www.vanityfair.com/news/2016/01/billions-showtime-andrew-ross-sorkin-brings- wall-street-drama-to-tv . a. In the article, US Toy got stung by selling "loss leaders" via Groupon in hopes that consumers would come to their stores and buy other stuff. But they came in and bought only the loss leader item. It is a common experience. Groupon basically attracts cherry pickers. If they are current customers, the Groupon sales just cannibalize sales that might otherwise have been made at higher prices. b. The article also highlighted what kinds of products are good vs. bad fits to Groupon. Products that are high variable cost are bad for Groupon, because (in case of bakery example), it costs you more to make the product than the price you sell it for. Donnie and the article noted that products that have low variable costs and high fixed costs are a better fit... for example, a hair salon with excess capacity is paying employees independent of quantity. So if Groupon leads to some incremental sales, that fill up that unused capacity, that's incremental profit. 5. Penetration pricing. The opposite of skimming. Setting a low price from the beginning. One does this when there are not different segments with different willingness to pay, when there are low barriers to entry, and when there are economies ofscale that lower costs enough to make penetration attractive. The latter also comes into play with "Experience curve Pricing." i. In most cases, don't fall for the trap of going to everyday low prices (EDLP) if previously you have been following a "high-low" strategy (regular high prices with occasional discounts). Empirical research shows that most consumers are not price vigilant and can't tell you the price of something they just put in their shopping cart. But most people still have a sense of whether something is a good deal. Promotions are one signal that people use to see that they got a good deal. Prof. Lichtenstein cited the cases of P&G and more recently the JC Penney CEO who decided to move from away from their hi-low pricing strategy to EDLP. It was a disaster. Donnie didn't review this, but EDLP requires extreme price elasticity for the change in regular price to generate enough extra quantity to outweigh the loss in margin on "regular price" sales. ii. Another trap is to deal with increased cost to manufacture your brand by creating a more affordable but lower quality "fighter brand" (see p. 3 of the article. This can backfire if people just buy the cheap brand instead. Then you will be cannibalizing sales of your (presumably higher margin) regular brand when people buy the fighter brand. The other risk is that they don't like the fighter brand and it diminishes the brand equity and image of your overall brand.

Different types of Intermediaries and channels of distribution -- esp. whether they take title to merchandise.

• We discussed terms for different types of "middlemen" in Figure 15-1. "Middlemen" is the most general term. We focused on the next 3 types in 15-1. Agents or brokers facilitate a sale on behalf of the manufacturer but do not take title to the merchandise. Wholesalers and retailers actually take title. A wholesaler sells to another intermediary, and a retailer sells to the end consumer. • Middlemen who take title are called "merchant" middlemen. Middlemen who do not take title are called "functional" middlemen. We saw the distinctions in the class discussion of Alibaba (a Chinese blend of Amazon, eBay, Pay Pal and Google). Whereas Amazon actually takes title to (some of) its merchandise, Alibaba gets paid for advertising and other services to help sellers make their merchandise stand out. In the Amazon Rising video, we saw that Amazon actually takes title, and constantly pressures its sellers to lower prices to get good display position. This played out in the assigned article "US Sues Apple, Publishers over E-Book Pricing." Functional middleman Amazon had great power over book publishers like Hachette to lower prices or get buried deep in search results lists. Apple "solved" the problem for publishers by offering an agent model where they effectively conspired to help publishers fix prices for e-books and then just took a commission off the top - going from a merchant middleman model of Amazon to "functional" middleman model of Apple. Legally, there was no problem going to a functional, commission based model, but they were found guilty of price fixing.