Global Business Problems

strategic analysis & decision making ?to critically examine the nature of strategic analysis & decision making ?to understand the importance of analysing an org.’s external environment ?appreciate the role of an org.’s resources and capabilities as a basis for formulating strategy 2 Global Business Problems John Wallace California State Polytechnic University-Pomona Fall 2015 Global Business Problems IBM 480 California State Poly Univ-Pomona THIS PRINT COURSEPACK AND ITS ELECTRONIC COUNTERPART (IF ANY) ARE INTENDED SOLELY FOR THE PERSONAL USE OF PURCHASER. ALL OTHER USE IS STRICTLY PROHIBITED. ISBN 1323094571 XanEdu™ publications may contain copyrighted materials of XanEdu, Inc. and/or its licensors. The original copyright holders retain sole ownership of their materials. Copyright permissions from third parties have been granted for materials for this publication only. Further reproduction and distribution of the materials contained herein is prohibited. 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The user hereby releases XanEdu Publishing, Inc. from any and all liability for any claims or damages, which result from any use or exposure to the materials of this course pack. - In print copy only - Online only Unmarked items are available both in print and online Global Business Problems Table of Contents “Chapter 1: Foundations of Strategic Marketing Management” by Kerin, Roger A; Peterson, Robert A 1 “Chapter 2: Financial Aspects of Marketing Management” by Kerin, Roger A; Peterson, Robert A 33 “Chapter 3: Marketing Decision Making and Case Analysis” by Kerin, Roger A; Peterson, Robert A 53 “Rediscovering Market Niches in a Traditional Industry” by Tse, David; Ho, Mary 65 “Coca-Cola's New Vending Machine (A): Pricing to Capture Value, or Not?” by King, Charles; Narayandas, Das 75 “Nin Jiom: Selling Traditional Chinese Medicine in Modern Hong Kong” by Bennett Yim; Vincent Mak 85 “Heineken N.V.: Global Branding and Advertising” by Quelch, John A. XanEdu Extra An Excel-formatted spreadsheet containing the exhibits for the case above is available at http://content.xanedu.com/hs/596015p2.xls 93 “Pepsi Blue” by Quelch, John A. 107 Bibliography 117 i ii C H A P T E R 1 Foundations of Strategic Marketing Management The primary purpose of marketing is to create long-term and mutually beneficial exchange relationships between an entity and the publics (individuals and organizations) with which it interacts. Though this fundamental purpose of marketing is timeless, the manner in which organizations undertake it continues to evolve. No longer do marketing managers function solely to direct day-to-day operations; they must make strategic decisions as well. This elevation of marketing perspectives to a strategic position in organizations has resulted in expanded responsibilities for marketing managers. Increasingly, they find themselves involved in charting the direction of the organization and contributing to decisions that will create and sustain a competitive advantage and affect long-term organizational performance. The transition of the marketing manager from being only an implementer to being a maker of organization strategy has resulted in (1) the creation of the chief marketing officer (CMO) position in many organizations and (2) the popularity of strategic marketing management as a course of study and practice. Today, almost onehalf of Fortune 1000 companies have a CMO. Although responsibilities vary across companies, a common expectation is that a CMO will assume a leadership role in defining the mission of the business; analysis of environmental, competitive, and business situations;developing business objectives and goals;and defining customer value propositions and the marketing strategies that deliver on these propositions. The skill set required of CMOs includes an analytical ability to interpret extensive market and operational information, an intuitive sense of customer and competitor motivations, and creativity in framing strategic marketing initiatives in light of implementation considerations and financial targets and results.1 Strategic marketing management consists of five complex and interrelated processes. 1. Defining the organization’s business, mission, and goals 2. Identifying and framing organizational growth opportunities 3. Formulating product-market strategies 4. Budgeting marketing, financial, and production resources 5. Developing reformulation and recovery strategies The remainder of this chapter discusses each of these processes and their relationships to one another. 1 1 2 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT ¦ DEFINING THE ORGANIZATION’S BUSINESS, MISSION, AND GOALS The practice of strategic marketing management begins with a clearly stated business definition, mission, and set of goals or objectives. A business definition outlines the scope of a particular organization’s operations. Its mission is a written statement of organizational purpose. Goals or objectives specify what an organization intends to achieve. Each plays an important role in describing the character of an organization and what it seeks to accomplish. Business Definition Determining what business an organization is in is neither obvious nor easy. In many instances, a single organization may operate several businesses, as is the case with large Fortune 500 companies. Defining each of these businesses is a necessary first step in strategic marketing management. Contemporary strategic marketing perspectives indicate that an organization should define a business by the type of customers it wishes to serve, the particular needs of those customer groups it wishes to satisfy, and the means or technology by which the organization will satisfy these customer needs.2 By defining a business from a customer or market perspective, an organization is appropriately viewed as a customer-satisfying endeavor, not a product-producing or service-delivery enterprise. Products and services are transient, as is often the technology or means used to produce or deliver them. Basic customer needs and customer groups are more enduring. For example, the means for delivering prerecorded music has undergone significant change over the past 30 years. During this period, the dominant prerecorded music technologies and products evolved from plastic records, to eight-track tapes, to cassettes, to compact discs. Today, digital downloading of music is growing. By comparison, the principal consumer buying segment(s) and needs satisfied have varied little. Much of the recent corporate restructuring and refocusing has resulted from senior company executives asking the question,“What business are we in?” The experience of Encyclopaedia Britannica is a case in point.3 The venerable publishing company is best known for its comprehensive and authoritative 32-volume, leather-bound book reference series first printed in 1768. In the late 1990s, however, the company found itself in a precarious competitive environment. CD-ROMs and the Internet had become the study tools of choice for students, and Microsoft’s Encarta CD-ROM and IBM’s CD-ROM joint venture with World Book were attracting Britannica’s core customers. The result? Book sales fell 83 percent between 1990 and 1997. Britannica’s senior management was confident that the need for dependable and trustworthy information among curious and intelligent customers remained. However, the technology for satisfying these needs had changed. This realization prompted Britannica to redefine its business. According to a company official:“We’re reinventing our business. We’re not in the book business.We’re in the information business.” By early 2006, the company had become a premier information site on the Internet. Britannica’s subscription service (eb.com) markets archival information to schools and public and business libraries. Its consumer Web site (britannica.com) is a source of information for about 200,000 subscribers and its search engine provides some 150,000 Web sites selected by expert Britannica staffers for information quality and accuracy. Business Mission An organization’s business mission complements its business definition. As a written statement, a mission underscores the scope of an organization’s operations apparent in its business definition and reflects management’s vision of what the organization 2 DEFINING THE ORGANIZATION’S BUSINESS, MISSION, AND GOALS 3 seeks to do. Although there is no overall definition for all mission statements, most statements describe an organization’s purpose with reference to its customers, products or services, markets, philosophy, and technology. Some mission statements are generally stated, such as that for Xerox Corporation: Our strategic intent is to help people find better ways to do great work—by constantly leading in document technologies, products and services that improve our customers’work processes and business results. Others are more specifically written, like that for Hendison Electronics Corporation. Hendison Electronics Corporation aspires to serve the discriminating purchasers of home entertainment products who approach their purchase in a deliberate manner with heavy consideration of longterm benefits.We will emphasize home entertainment products with superior performance, style, reliability, and value that require representative display, professional selling, trained service, and brand acceptance—retailed through reputable electronic specialists to those consumers whom the company can most effectively service. Mission statements also apply to not-for-profit organizations. For instance, the mission of the American Red Cross is to improve the quality of human life; to enhance self-reliance and concern for others; and to help people avoid, prepare for, and cope with emergencies. A carefully crafted mission statement that succinctly conveys organizational purpose can provide numerous benefits to an organization, including focus to its marketing effort. It can (1) crystallize management’s vision of the organization’s long-term direction and character; (2) provide guidance in identifying, pursuing, and evaluating market and product opportunities; and (3) inspire and challenge employees to do those things that are valued by the organization and its customers. It also provides direction for setting business goals or objectives. Business Goals Goals or objectives convert the organization’s mission into tangible actions and results that are to be achieved, often within a specific time frame. For example, the 3M Company emphasizes research and development and innovation in its business mission. This view is made tangible in one of the company’s goals: 30 percent of 3M’s annual revenues must come from company products that are less than four years old.4 Goals or objectives divide into three major categories: production, financial, and marketing. Production goals or objectives apply to the use of manufacturing and service capacity and to product and service quality. Financial goals or objectives focus on return on investment, return on sales, profit, cash flow, and shareholder wealth. Marketing goals or objectives emphasize market share, marketing productivity, sales volume, profit, customer satisfaction, customer value creation, and customer lifetime value. When production, financial, and marketing goals or objectives are combined, they represent a composite picture of organizational purpose within a specific time frame;accordingly, they must complement one another. Goal or objective setting should be problem-centered and future-oriented. Because goals or objectives represent statements of what the organization wishes to achieve in a specific time frame, they implicitly arise from an understanding of the current situation. Therefore, managers need an appraisal of operations or a situation analysis to determine reasons for the gap between what was or is expected and what has happened or will happen. If performance has met expectations, the question arises as to future directions. If performance has not met expectations, managers must diagnose the reasons for this difference and enact a remedial program. Chapter 3 provides an expanded discussion on performing a situation analysis. 3 4 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT ¦ IDENTIFYING AND FRAMING ORGANIZATIONAL GROWTH OPPORTUNITIES Once the character and direction of the organization have been outlined in its business definition, mission, and goals or objectives, the practice of strategic marketing management enters an entrepreneurial phase. Using business definition, mission, and goals as a guide, the search for and evaluation of organizational growth opportunities can begin. Converting Environmental Opportunities into Organizational Opportunities Three questions help marketing managers decide whether certain environmental opportunities represent viable organizational growth opportunities: • What might we do? • What do we do best? • What must we do? Each of these questions assists in identifying and framing organizational growth opportunities. They also highlight major concepts in strategic marketing management. The what might we do question introduces the concept of environmental opportunity. Unmet or changing consumer needs, unsatisfied buyer groups, and new means or technology for delivering value to prospective buyers represent sources of environmental opportunities for organizations. In this regard, environmental opportunities are boundless. However, the mere presence of an environmental opportunity does not mean that an organizational growth opportunity exists. Two additional questions must be asked. The what do we do best question introduces the concept of organizational capability, or distinctive competency. Distinctive competency describes an organization’s unique strengths or qualities, including skills, technologies, or resources that distinguish it from other organizations.5 In order for any of an organization’s strengths or qualities to be considered truly distinctive and a source of competitive advantage, two criteria must be satisfied. First, the strength must be imperfectly imitable by competitors. That is, competitors cannot replicate a skill (such as the direct-marketing competency of Dell Inc.) easily or without a sizable investment of time, effort, and money. Second, the strength should make a significant contribution to the benefits perceived by customers and, by doing so, provide superior value to them. For example, the ability to engage in technological innovation that is wanted and provides value to customers is a distinctive competency. Consider the Safety Razor Division of the Gillette Company. 6 Its distinctive competencies lie in three areas: (1) shaving technology and development, (2) high-volume manufacturing of precision metal and plastic products, and (3) marketing of mass-distributed consumer package goods. These competencies were responsible for the Gillete Fusion and Venus razor, which have sustained Gillette’s dominance of the men’s and women’s wet-shaving market. Finally, the what must we do question introduces the concept of success requirements in an industry or market. Success requirements (also called “key success factors”) are basic tasks that an organization must perform in a market or industry to compete successfully. These requirements are subtle in nature and often overlooked. For example, distribution and inventory control are critical success factors in the cosmetics industry. Firms competing in the personal computer industry recognize that the requirements for success include low-cost production capabilities, access to distribution channels, and continuous innovation. The linkage among environmental opportunity, distinctive competency, and success requirements will determine whether an organizational opportunity exists. 4 IDENTIFYING AND FRAMING ORGANIZATIONAL GROWTH OPPORTUNITIES 5 A clearly defined statement of success requirements serves as a device for matching an environmental opportunity with an organization’s distinctive competencies. If what must be done is inconsistent with what can be done to capitalize on an environmental opportunity, an organizational growth opportunity will fail to materialize. Too often, organizations ignore this linkage and pursue seemingly lucrative environmental opportunities that are doomed from the start. Exxon Mobil Corporation learned this lesson painfully after investing $500 million in the office products market over a 10-year period only to see the venture fail. After the company abandoned this venture, a former Exxon Mobil executive summed up what had been learned:“Don’t get involved where you don’t have the skills. It’s hard enough to make money at what you’re good at.”7 By clearly establishing the linkages necessary for success before taking any action, an organization can minimize its risk of failure. An executive for L’eggs hosiery illustrates this point when specifying his new-venture criteria: [P]roducts that can be sold through food and drugstore outlets, are purchased by women, . . . can be easily and distinctly packaged, and comprise at least a $500 million retail market not already dominated by one or two major producers.8 When one considers L’eggs’ past successes, it is apparent that whatever environmental opportunities are pursued will be consistent with what L’eggs does best, as illustrated by past achievements in markets whose success requirements are similar. An expanded discussion of these points is found in Chapter 4. SWOT Analysis SWOT analysis is a formal framework for identifying and framing organizational growth opportunities. SWOT is an acronym for an organization’s Strengths and Weaknesses and external Opportunities and Threats. It is an easy-to-use framework for focusing attention on the fact that an organizational growth opportunity results from a good fit between an organization’s internal capabilities (apparent in its strengths and weaknesses) and its external environment reflected in the presence of environmental opportunities and threats. Many organizations also perform a SWOT analysis as part of their goal- or objective-setting process. Exhibit 1.1 on page 6 displays a SWOT analysis framework depicting representative entries for internal strengths and weaknesses and external opportunities and threats. A strength is something that an organization is good at doing or some characteristic that gives the organization an important capability. Something an organization lacks or does poorly relative to other organizations is a weakness. Opportunities represent external developments or conditions in the environment that have favorable implications for the organization. Threats, on the other hand, pose dangers to the welfare of the organization. A properly conducted SWOT analysis goes beyond the simple preparation of lists. Attention needs to be placed on evaluating strengths,weaknesses, opportunities, and threats and drawing conclusions about how each might affect the organization. The following questions might be asked once strengths, weaknesses, opportunities, and threats have been identified: 1. Which internal strengths represent distinctive competencies? Do these strengths compare favorably with what are believed to be market or industry success requirements? Looking at Exhibit 1.1, for example, does “proven innovation skill”strength represent a distinctive competency and a market success requirement? 2. Which internal weaknesses disqualify the organization from pursuing certain opportunities? Look again at Exhibit 1.1, and note that the organization acknowledges that it has a “weak distribution network and a subpar saleforce.”How might 5 6 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT E X H I B I T 1 . 1 Sample SWOT Analysis Framework and Representative Examples Selected Representative Selected Representative Internal External Factors Strengths Weaknesses Factors Opportunities Threats Experienced Lack of Upturn in the Adverse shifts Management management management Economic business cycle; in foreign talent depth evidence of exchange growing per- rates sonal disposable income Well thought Weak distribu- Complacency Entry of Marketing of by buyers; tion network; Competition among domestic lower-cost effective subpar sales competitors foreign advertising force competitors program Available man- Higher overall Unfulfilled Growing Manufacturing ufacturing production costs Consumer customer preference for capacity relative to key trends needs on high private-label competitors and low end products of product category suggesting a product line expansion possibility Proven inno- Poor track Patent protec- Newer R&D vation skills record in Technology tion of com- substitute bringing inno- plementary technologies vations to the technology imminent marketplace ending Little debt Weak cash Falling trade Increased U.S. Finance relative to flow position Legal/ barriers in regulation of industry regulatory attractive product-testing average foreign markets procedures and labeling Unique, high- Too narrow a New distribu- Low-entry Offerings quality product line Industry/ tion channels barriers for products market evolving that new structure reach a broader competitors customer population this organizational weakness affect the opportunity described as “new distribution channels evolving that reach a broader customer population”? 3. Does a pattern emerge from the listing of strengths,weaknesses, opportunities, and threats? Inspection of Exhibit 1.1 reveals that low-entry barriers into the market/industry may contribute to the entry of lower-cost foreign competitors. This does not bode well for domestic competitors labeled as “complacent”and the organization’s acknowledged high production costs. 6 FORMULATING PRODUCT-MARKET STRATEGIES 7 ¦ FORMULATING PRODUCT-MARKET STRATEGIES In practice, organizational opportunities frequently emerge from an organization’s existing markets or from newly identified markets. Opportunities also arise for existing, improved, or new products and services. Matching products and markets to form product-market strategies is the subject of the next set of decision processes. Product-market strategies consist of plans for matching an organization’s existing or potential offerings with the needs of markets, informing markets that the offerings exist, having offerings available at the right time and place to facilitate exchange, and assigning prices to offerings. In short, a product-market strategy involves selecting specific markets and profitably reaching them through an integrated program called a marketing mix. Exhibit 1.2 classifies product-market strategies according to the match between offerings and markets.9 The operational implications and requirements of each strategy are briefly described in the following subsections. Market-Penetration Strategy A market-penetration strategy dictates that an organization seeks to gain greater dominance in a market in which it already has an offering. This strategy involves attempts to increase present buyers’ usage or consumption rates of the offering, to attract buyers of competing offerings, or to stimulate product trial among potential customers. The mix of marketing activities might include lower prices for the offerings, expanded distribution to provide wider coverage of an existing market, and heavier promotional efforts extolling the “unique” advantages of an organization’s offering over competing offerings. For example, following the acquisition of Gatorade from Quaker Oats, PepsiCo has announced that it expects to increase Gatorade’s already dominant share of the sports drink market through broader distribution, new flavors, and more aggressive advertising.10 Several organizations have attempted to gain dominance by promoting more frequent and varied usage of their offering. For example, the Florida Orange Growers Association advocates drinking orange juice throughout the day rather than for breakfast only. Airlines stimulate usage through a variety of reduced-fare programs and various family-travel packages designed to reach the primary traveler’s spouse and children. Marketing managers should consider a number of factors before adopting a penetration strategy. First, they must examine market growth. A penetration strategy is usually more effective in a growth market. Attempts to increase market share when volume is stable often result in aggressive retaliatory actions by competitors. Second, they must consider competitive reaction. Procter & Gamble implemented a penetration strategy E X H I B I T 1 . 2 Product-Market Strategies Markets Existing New Market Market penetration development Offerings New offering development Diversification Existing New 7 8 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT for its Folgers coffee in selected East Coast cities, only to run head-on into an equally aggressive reaction from Kraft Foods’ Maxwell House Division. According to one observer of the competitive situation: When Folger’s mailed millions of coupons offering consumers 45 cents off on a onepound can of coffee, Maxwell House countered with newspaper coupons of its own. When Folger’s gave retailers 15 percent discounts from the list price . . . , Maxwell House met them head-on. [Maxwell House] let Folger’s lead off with a TV blitz. . . . Then [Maxwell House] saturated the airwaves.11 The result of this struggle was no change in market share for either firm. Third, marketing managers must consider the capacity of the market to increase usage or consumption rates and the availability of new buyers. Both are particularly relevant when viewed from the perspective of the conversion costs involved in capturing buyers from competitors, stimulating usage, and attracting new users. Market-Development Strategy A market-development strategy dictates that an organization introduce its existing offerings to markets other than those it is currently serving. Examples include introducing existing products to different geographical areas (including international expansion) or different buying publics. For example, Harley-Davidson engaged in a market-development strategy when it entered Japan, Germany, Italy, and France. Lowe’s, the home improvement chain, employed this strategy when it focused attention on attracting women shoppers to its stores. The mix of marketing activities used must often be varied to reach different markets with differing buying patterns and requirements. Reaching new markets often requires modification of the basic offering, different distribution outlets, or a change in sales effort and advertising. Like the market-penetration strategy, market development involves a careful consideration of competitor strengths and weaknesses and competitor retaliation potential. Moreover, because the firm seeks new buyers, it must understand their number, motivation, and buying patterns in order to develop marketing activities successfully. Finally, the firm must consider its strengths, in terms of adaptability to new markets, in order to evaluate the potential success of the venture. Market development in the international arena has grown in importance and usually takes one of four forms: (1) exporting, (2) licensing, (3) joint venture, or (4) direct investment.12 Each option has advantages and disadvantages. Exporting involves marketing the same offering in another country either directly (through sales offices) or through intermediaries in a foreign country. Because this approach typically requires minimal capital investment and is easy to initiate, it is a popular option for developing foreign markets. Procter & Gamble, for instance, exports its deodorants, soaps, fragrances, shampoos, and other health and beauty products to Eastern Europe and Russia. Licensing is a contractual arrangement whereby one firm (licensee) is given the rights to patents, trademarks, know-how, and other intangible assets by its owner (licensor) in return for a royalty (usually 5 percent of gross sales) or a fee. For example, Cadbury Schweppes PLC, a London-based multinational firm, licensed Hershey Foods to sell its candies in the United States for a fee of $300 million. Licensing provides a low-risk, quick, and capital-free entry into a foreign market. However, the licensor usually has no control over production and marketing by the licensee. A joint venture, often called a strategic alliance, involves investment by both a foreign firm and a local company to create a new entity in the host country. The two companies share ownership, control, and profits of the entity. Joint ventures are popular because one company may not have the necessary financial, technical, or managerial resources to enter a market alone. This approach also often ensures against trade barriers being imposed on the foreign firm by the government of the host company. Japanese companies frequently 8 FORMULATING PRODUCT-MARKET STRATEGIES 9 engage in joint ventures with American and European firms to gain access to foreign markets. A problem frequently arising from joint ventures is that the partners do not always agree on how the new entity should be run. Direct investment in a manufacturing and/or assembly facility in a foreign market is the most risky option and requires the greatest commitment. However, it brings the firm closer to its customers and may be the most profitable approach for developing foreign markets. For these reasons, direct investment must be evaluated closely in terms of benefits and costs. Direct investment often follows one of the three other approaches to foreign-market entry. For example, Mars, Inc. originally exported its M&Ms, Snickers, and Mars bars to Russia but now operates a $200 million candy factory outside Moscow. Product-Development Strategy A product-development strategy dictates that the organization create new offerings for existing markets. The approach taken may be to develop totally new offerings (product innovation) to enhance the value to customers of existing offerings (product augmentation), or to broaden the existing line of offerings by adding different sizes, forms, flavors, and so forth (product line extension). Apple Computer’s iPod is an example of product innovation. Product augmentation can be achieved in numerous ways. One is to bundle complementary items or services with an existing offering. For example, embedded software, application aids, and training programs for buyers enhance the value of personal computers. Another way is to improve the functional performance of the offering. Digital camera manufacturers have done this by improving photo quality. Many types of product-line extensions are possible. Personal-care companies market deodorants in powder, spray, and gel forms; Gatorade is sold in more than 20 flavors; and Frito-Lay offers its Lay’s potato chips in a number of package sizes. Companies successful at developing and commercializing new offerings lead their industries in sales growth and profitability. The likelihood of success is increased if the development effort results in offerings that satisfy a clearly understood buyer need. In the toy industry, for instance, these needs translate into products with three qualities: (1) lasting play value, (2) the ability to be shared with other children, and (3) the ability to stimulate a child’s imagination.13 Successful commercialization occurs when the offering can be communicated and delivered to a well-defined buyer group at a price it is willing and able to pay. Important considerations in planning a product-development strategy concern the market size and volume necessary for the effort to be profitable, the magnitude and timing of competitive response, the impact of the new product on existing offerings, and the capacity (in terms of human and financial investment and technology) of the organization to deliver the offerings to the market(s). More important, successful new offerings must have a significant “point of difference” reflected in superior product or service characteristics that deliver unique and wanted benefits to consumers. Two examples from General Mills illustrate this view.14 The company introduced Fringos, a sweetened cereal flake about the size of a corn chip. Consumers were supposed to snack on them, but they didn’t. The point of difference was not significant enough to get consumers to switch from competing snacks such as popcorn, potato chips, or tortilla chips. On the other hand, General Mills’ Big G Milk ’n Cereal Bar, which combines cereal and a milk-based layer, has succeeded because it satisfies convenienceoriented consumers who desire to “eat and go.” The potential for cannibalism must be considered with a product-development strategy. Cannibalism occurs when sales of a new product or service come at the expense of sales of existing products or services already marketed by the firm. For example, it is estimated that 75 percent of Gillette’s Gillete Fusion razor volume came from the company’s other razors and shaving systems. Cannibalism of this degree is likely to occur in many product-development programs. The issue faced by the manager 9 10 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT is whether it detracts from the overall profitability of the organization’s total mix of offerings. At Gillette, the cannibalism rate for Fusion is viewed favorably since its gross profit margin is significantly higher than the company’s other razors.15 Diversification Diversification involves the development or acquisition of offerings new to the organization and the introduction of those offerings to publics not previously served by the organization. Many firms have adopted this strategy in recent years to take advantage of perceived growth opportunities.Yet diversification is often a high-risk strategy because both the offerings (and often their underlying technology) and the public or market served are new to the organization. Consider the following examples of failed diversification. Anheuser-Busch recorded 17 years of losses with its Eagle Snacks Division and incurred a $206 million write-off when the division was finally shut down. Gerber Products Company, which holds 70 percent of the U.S. baby-food market, has been mostly unsuccessful in diversifying into child-care centers, toys, furniture, and adult food and beverages. Coca- Cola’s many attempts at diversification—acquiring wine companies, a movie studio, and a pasta manufacturer, and producing television game shows—have also proven to be largely unsuccessful. These examples highlight the importance of understanding the link between market success requirements and an organization’s distinctive competency. In each of these cases, a bridge was not made between these two concepts and, thus, an organizational opportunity was not realized.16 Still, diversifications can be successful. Successful diversifications typically result from an organization’s attempt to apply its distinctive competency in reaching new markets with new offerings. By relying on its marketing expertise and extensive distribution system, Procter & Gamble has had success with offerings ranging from cake mixes to disposable diapers to laundry detergents. Strategy Selection A recurrent issue in strategic marketing management is determining the consistency of product-market strategies with the organization’s definition, mission and capabilities, market capacity and behavior, environmental forces, and competitive activities. Proper analysis of these factors depends on the availability and evaluation of relevant information. Information on markets should include data on size, buying behavior, and requirements. Information on environmental forces such as social, legal, political, demographic, and economic changes is necessary to determine the future viability of the organization’s offerings and the markets served. In recent years, for example, organizations have had to alter or adapt their product-market strategies because of political actions (deregulation), economic fluctuations (income shifts and changes in disposable personal income), sociodemographic trends (increasing racial and ethnic diversity), attitudes (value consciousness), technological advances (the growth of the Internet), and population shifts (city to suburb and northern to southern United States)—to name just a few of the environmental changes. Competitive activities must be monitored to ascertain their existing or possible strategies and performance in satisfying buyer needs. In practice, the strategy selection decision is based on an analysis of the costs and benefits of alternative strategies and their probabilities of success. For example, a manager may compare the costs and benefits involved in further penetrating an existing market to those associated with introducing the existing product to a new market. It is important to make a careful analysis of competitive structure; market growth, decline, or shifts; and opportunity costs (potential benefits not obtained). The product or service itself may dictate a strategy change. If the product has been purchased 10 FORMULATING PRODUCT-MARKET STRATEGIES 11 by all of the buyers it is going to attract in an existing market, opportunities for growth beyond replacement purchases are reduced. This situation would indicate a need to search out new buyers (markets) or to develop new products or services for present markets. The probabilities of success of the various strategies must then be considered. A. T. Kearney, a management consulting firm, has provided rough probability estimates of success for each of the four basic strategies.17 The probability of a successful diversification is 1 in 20. The probability of successfully introducing an existing product into a new market (market-development strategy) is 1 in 4. There is a 50–50 chance of success for a new product being introduced into an existing market (product-development strategy). Finally, minor modification of an offering directed toward its existing market (market- penetration strategy) has the highest probability of success. A useful technique for gauging potential outcomes of alternative marketing strategies is to array possible actions, the response to these actions, and the outcomes in the form of a decision tree, so named because of the branching out of responses from action taken. This implies that for any action taken, certain responses can be anticipated, each with its own specific outcomes. Exhibit 1.3 shows a decision tree. As an example, consider a situation in which a marketing manager must decide between a market-penetration strategy and a market-development strategy. Suppose the manager recognizes that competitors may react aggressively or passively to either strategy. This situation can be displayed vividly using the decision-tree scheme, as shown in Exhibit 1.4. This representation allows the manager to consider actions, responses, and outcomes simultaneously. The decision tree shows that the highest profits will result if a E X H I B I T 1 . 3 Decision-Tree Format Action Response Outcome R1 O1 A1 R2 O2 R1 O3 A2 R2 O4 E X H I B I T 1 . 4 Sample Decision Tree Action Response Outcome Aggressive competition Estimated profit Market-penetration of $2 million strategy Passive competition Estimated profit of $3 million Aggressive competition Estimated profit Market-development of $1 million strategy Passive competition Estimated profit of $4 million 11 12 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT market-development strategy is enacted and competitors react passively. The manager must resolve the question of competitive reaction because an aggressive response will plunge the profit to $1 million, which is less than either outcome under the marketpenetration strategy. The manager must rely on informed judgment to assess subjectively the likelihood of competitive response. Chapter 3 provides a more detailed description of decision analysis and its application. The Marketing Mix Matching offerings and markets requires recognition of the other marketing activities available to the marketing manager. Combined with the offering, these activities form the marketing mix. A marketing mix typically encompasses activities controllable by the organization. These include the kind of product, service, or idea offered (product strategy), how it will be communicated to buyers (communication strategy), the method for distributing the offering to buyers (channel strategy), and the amount buyers will pay for the offering (price strategy). Each of these individual strategies is described later in this book. Here it is sufficient to note that each element of the marketing mix plays a complementary role in stimulating a market’s (buyers’) willingness and ability to buy and creating customer value. For example,communications—personal selling, advertising, sales promotion, and public relations—inform and assure buyers that the offering will meet their needs. Marketing channels satisfy buyers’ shopping patterns and purchase requirements in terms of point-of-purchase information and offering availability. Price represents the value or benefits provided by the offering to buyers. Formulating the Marketing Mix The appropriate marketing mix for a product or service depends on the success requirements of the market at which it is directed. The “rightness” of the marketing mix depends on the market served. Consider the case of Cover Girl Cosmetics in China. The marketing mix for Cover Girl in China shares only one common element with its marketing mix in other countries—the brand name. All product shades, textures, and colors had to be adjusted to ensure they looked appealing on Chinese skin. Products have been packaged in small containers that resemble pieces of colorful candy, unlike other markets. The advertising and sales effort is localized expressly for the Chinese and on-site beauty consultants assist buyers in Chinese department stores—not in self-service drug or grocery stores as in Cover Girl’s other markets. Cover Girl pricing reflects local competitive conditions. According to Cover Girl’s marketing director, “You can’t just import cosmetics here. Companies have to understand what beauty means to Chinese women and what they look for, and product offerings, distribution, pricing and communication has to be adjusted accordingly to be right for the market.”18 Internet-based technologies have created another market setting, called the marketspace. Companies that succeed in the new marketspace deliver customer value through the interactive capabilities of these technologies, which allow for greater flexibility in managing marketing mix elements. For example, online sellers routinely adjust prices to changing environmental conditions, purchase situations, and purchase behaviors of online buyers. Also, interactive two-way Internet-enabled capabilities in marketspace allow a customer to tell a seller exactly what his or her buying interests and requirements are, making possible the transformation of a product or service into a customized solution for the buyer. In addition, the purpose and role of marketing communications and marketing channels in this market setting change as described in Chapters 6 and 7, respectively. In addition to being consistent with the needs of markets served, a marketing mix must be consistent with the organization’s capacity, and the individual activities must complement one another. Several questions offer direction in evaluating an 12 BUDGETING MARKETING, FINANCIAL, AND PRODUCTION RESOURCES 13 organization’s marketing mix. First, is the marketing mix internally consistent? Do the individual activities complement one another to form a whole, as opposed to fragmented pieces? Does the mix fit the organization, the market, and the environment into which it will be introduced? Second, are buyers more sensitive to some marketing mix activities than to others? For example, are they more likely to respond favorably to a decrease in price or an increase in advertising or sales promotion? Third, what are the costs of performing marketing mix activities and the costs of attracting and retaining buyers? Do these costs exceed their benefits? Can the organization afford the marketing mix expenditures? Finally, is the marketing mix properly timed? For example, are communications scheduled to coincide with product availability? Is the entire marketing mix timely with respect to the buying cycle of consumers, competitor actions, and the ebb and flow of environmental forces? Implementing the Marketing Mix Implementation of the marketing mix is as much an art as a science. Successful implementation requires an understanding of markets, environmental forces, organizational capacity, and marketing mix activities with a healthy respect for competitor reactions. These topics are raised again in Chapter 10. An example of an implementation with less than successful results is that of A&P’s WEO (Where Economy Originates) program. Prior to implementing the program, A&P had watched its sales volume plateau with shrinking profits, while other grocery retailers continued to increase sales volume and profits. When the WEO program was initiated, it emphasized discount pricing (price strategy) with heavy promotional expenditures (communication strategy). The program increased sales volume by $800 million but produced a profit loss of over $50 million. In the words of one industry observer at the time: Its competitors are convinced that A&P’s assault with WEO was doomed from the start. Too many of its stores are relics of a bygone era. Many are in poor locations [distribution strategy]. . . . They are just not big enough to support the tremendous volume that is necessary to make a discounting operation profitable [capacity] . . . stores lack shelf space for stocking general merchandise items, such as housewares and children’s clothing [product strategy].19 The product-market strategy employed by A&P could be classified as a market-penetration strategy. Its implementation, however, could be questioned in terms of internal consistency, costs of the marketing mix activities, and fit with organizational capacity. Moreover, the retail grocery industry was plagued at the time by rising food and energy costs. Both environmental factors had a destructive effect on A & P’s strategy success. ¦ BUDGETING MARKETING, FINANCIAL, AND PRODUCTION RESOURCES The fourth phase in the strategic marketing management process is budgeting. A budget is a formal, quantitative expression of an organization’s planning and strategy initiatives expressed in financial terms. A well-prepared budget meshes and balances an organization’s financial, production, and marketing resources so that overall organizational goals or objectives are attained. An organization’s master budget consists of two parts: (1) an operating budget and (2) a financial budget. The operating budget focuses on an organization’s income statement. Since the operating budget projects future revenues and expenses, it is sometimes referred to as a pro forma income statement or profit plan. The financial budget focuses on the effect that the operating budget and other initiatives (such as capital expenditures) will have on the organization’s cash position. For example, the 13 14 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT master budget for General Motors includes an income statement that details revenues, expenses, and profit for existing Hummer models. Its financial budget included the capital expenditures for the new midsize Hummer H3 model. In addition to the operating and financial budget, many organizations prepare supplemental special budgets, such as an advertising and sales budget, and related reports tied to the master budget. For example, a report showing how revenues, costs, and profits change under different marketing decisions and competitive and economic conditions is often prepared. As indicated, budgeting is more than an accounting and finance function. It is an essential element of strategic marketing management as well. A complete description of the budgetary process is beyond the scope of this section. However, Chapter 2,“Financial Aspects of Marketing Management,”provides an overview of cost concepts and behavior. It also describes useful analytical tools for dealing with the financial dimensions of strategic marketing management, including cost-volume-profit analysis, discounted cash flow, customer lifetime value analysis, and the preparation of pro forma income statements. ¦ DEVELOPING REFORMULATION AND RECOVERY STRATEGIES Reformulation and recovery strategies form the cornerstone of adaptive behavior in organizations. Strategies are rarely timeless. Changing markets, economic conditions, and competitive behavior require periodic, if not sudden, adjustments in marketing strategy. Marketing audit and control procedures are fundamental to the development of reformulation and recovery strategies. The marketing audit has been defined as follows: A marketing audit is a comprehensive, systematic, independent, and periodic examination of a company’s—or business unit’s—marketing environment, objectives, strategies and activities with a view of determining problem areas and opportunities and recommending a plan of action to improve the company’s marketing performance.20 The audit process directs the manager’s attention to both the strategic fit of the organization with its environment and the operational aspects of the marketing program. Strategic aspects of the marketing audit address the synoptic question,“Are we doing the right things?” Operational aspects address an equally synoptic question— “Are we doing things right?” The distinction between strategic and operational perspectives, as well as the implementation of each, is examined in Chapter 9. Suffice it to say here that marketing audit and control procedures underlie the processes of defining the organization’s business, mission, and goals or objectives, identifying external opportunities and threats and internal strengths and weaknesses, formulating product-market strategies and marketing mix activities, and budgeting resources. The intellectual process of developing reformulation and recovery strategies during the planning process serves two important purposes. First, it forces the manager to consider the “what if” questions. For example,“What if an unexpected environmental threat arises that renders a strategy obsolete?” or “What if competitive and market response to a strategy is inconsistent with what was originally expected?” Such questions focus the manager’s attention on the sensitivity of results to assumptions made in the strategy-development process. Second, preplanning of reformulation and recovery strategies, or contingency plans, leads to a faster reaction time in implementing remedial action. Marshaling and reorienting resources is a time- consuming process itself without additional time lost in planning. 14 MARKETING ETHICS AND SOCIAL RESPONSIBILITY 15 ¦ DRAFTING A MARKETING PLAN A marketing plan embodies the strategic marketing management process. It is a formal, written document that describes the context and scope of an organization’s marketing effort to achieve defined goals or objectives within a specific future time period. Marketing plans go by a variety of names depending on their particular focus. For example, there are business marketing plans, product marketing plans, and brand marketing plans. At Frito-Lay, Inc., for instance, a marketing plan is drafted for a particular business (snack chips), for a product class (potato chips, tortilla chips, corn chips), and for specific brands (Lay’s potato chips, Doritos tortilla chips, Fritos corn chips). Marketing plans also have a time dimension. Short-run marketing plans typically focus on a one-year period and are called annual marketing plans. Long-run marketing plans often have a three- to five-year planning horizon. A formal, written marketing plan represents a distillation of and the attention and thought given the five interrelated analytical processes in this chapter. It is the tangible result of an intellectual effort. As a written document, a marketing plan also exhibits certain stylistic elements. Although there is no “generic”marketing plan that applies to all organizations and all situations, marketing plans follow a general format. The appendix at the end of this chapter provides an actual example of a condensed marketing plan for Paradise Kitchens®, Inc., a company that produces and markets a unique line of single-serve and microwavable Southwestern/Mexican-style frozen chili products. This example illustrates both the substance and style of a five-year marketing plan. ¦ MARKETING ETHICS AND SOCIAL RESPONSIBILITY On a final note, it must be emphasized that matters of ethics and social responsibility permeate every aspect of the strategic marketing management process. Indeed, most marketing decisions involve some degree of moral judgment and reflect an organization’s orientation toward the publics with which it interacts. Enlightened marketing executives no longer subscribe to the view that if an action is legal, then it is also ethical and socially responsible. These executives are sensitive to the fact that the marketplace is populated by individuals and groups with diverse value systems. Moreover, they recognize that their actions will be judged publicly by others with different values and interests. Enlightened ethical and socially responsible decisions arise from the ability of marketers to discern the precise issues involved and their willingness to take action even when the outcome may negatively affect their standing in an organization or the company’s financial interests. Although the moral foundations on which marketing decisions are made will vary among individuals and organizations, failure to recognize issues and take appropriate action is the least ethical and most socially irresponsible approach. A positive approach to ethical and socially responsible behavior is illustrated by Anheuser-Busch, which has spent more than $500 million since 1982 to promote responsible drinking of alcoholic beverages through community-based programs and national advertising campaign. Anheuser-Busch executives acknowledge the potential for alcohol abuse and are willing to forgo business generated by misuse of the company’s products. These executives have discerned the issues and have recognized an ethical obligation to present and potential customers. They have also recognized the company’s social responsibility to the general public by encouraging safe driving and responsible drinking habits.21 15 16 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT N O T E S 1. Roger A. Kerin, “Strategic Marketing and the CMO,” Journal of Marketing (October 2005):12–14;and Gail McGovern and John A. Quelch,“The Fall and Rise of the CMO,”Strategy & Business (Winter 2004):44–48ff. 2. Derek E. Abell, Defining the Business: The Starting Point of Strategic Planning (Upper Saddle River, NJ: Prentice Hall, 1980); and Roger A. Kerin, Vijay Mahajan, and P. Rajan Varadarajan, Contemporary Perspectives on Strategic Market Planning (Boston: Allyn and Bacon, 1990). 3. “New Britannica Keeps Pace with Change,” Encyclopaedia Britannica News Release, March 23, 2005. 4. Eric von Hippel, Stephan Thomke, and Mary Sonnack,“Creating Breakthroughs at 3M,” Harvard Business Review (September–October 1999):47–56. 5. Robert A. Pitts and David Lei, Strategic Management: Building and Sustaining Competitive Advantage, 4th ed. (St. Paul, MN:West Publishing Company, 2006): 6. 6. “Gillette Safety Razor Division,” Harvard Business School case #9-574-058; and “Gillette’s Edge,”BRANDWEEK (May 28, 2001): 5. 7. “Exxon’s Flop in Field of Office Gear Shows Diversification Perils,”Wall Street Journal (September 3, 1985): 1ff. 8. “Hanes Expands L’eggs to the Entire Family,”Business Week (June 14, 1975): 57ff. 9. This classification is adapted from H. Igor Ansoff, Corporate Strategy (New York: McGraw-Hill, 1964): Chapter 6. For an extended discussion on product-market strategies, see Roger A. Kerin,Vijay Mahajan, and P. Rajan Varadarajan, Contemporary Perspectives on Strategic Market Planning (Boston: Allyn and Bacon, 1990): Chapter 6. 10. “In Lean Times, Big Companies Make a Grab for Market Share,”Wall Street Journal (September 5, 2003): A1, A6. 11. H. Menzies,“Why Folger’s Is Getting Creamed Back East,”Fortune (July 17, 1978): 69. 12. Philip R. Cateora and John L. Graham, International Marketing, 12th ed. (Burr Ridge, IL:McGraw-Hill/Irwin, 2005): Chapter 11. 13. “Hasbro, Inc.,” in Eric N. Berkowitz, Roger A. Kerin, Steven N. Hartley, and William Rudelius (eds.), Marketing, 5th ed. (Chicago: Richard D. Irwin, 1997):656–657. 14. Greg Burns,“Has General Mills Had Its Wheaties?”Business Week (May 8, 1995):68–69; and Julie Forster,“The Lucky Charm of Steve Sanger,”Business Week (March 26, 2001):75–76. 15. “Gillette’s New Edge,”Business Week (February 6, 2006): 44. 16. Failed diversification attempts, along with advice on diversification, are detailed in Chris Zook with James Allen, Profit from the Core (Cambridge, MA: Harvard Business School Press, 2001). 17. These estimates were reported in “The Breakdown of U.S. Innovation,”Business Week (February 16, 1976): 56ff. 18. “P&G Introduces Cover Girl: U.S. Beauty Brand Gets Local Color,” AdAgeChina.com, downloaded October 25, 2005. 19. Robert F. Hartley, Marketing Mistakes, 5th ed. (New York: John Wiley & Sons, 1992). Items in brackets added for illustrative purposes. 20. Philip Kotler and Kevin Lane Keller, Marketing Management, 12th ed. (Upper Saddle River, NJ: Prentice Hall, 2006): 719. 21. “Our Commitment to Preventing Alcohol Abuse and Underage Drinking,” beeresponsible.com, downloaded January 10, 2006. 16 17 A P P E N D I X A A Sample Marketing Plan Crafting a marketing plan is hard but satisfying work. When completed, a marketing plan serves as a roadmap that details the context and scope of marketing activities including, but not limited to, a mission statement, goals and objectives, a situation analysis, growth opportunities, target market(s) and marketing (mix) program, a budget, and an implementation schedule. As a written document, the plan conveys in words the analysis, ideas, and aspirations of its author pertaining to a business, product, and/or brand marketing effort. How a marketing plan is written communicates not only the substance of the marketing effort but also the professionalism of the author.Writing style will not overcome limitations in substance. However, a poorly written marketing plan can detract from the perceived substance of the plan. ¦ WRITING AND STYLE CONSIDERATIONS Given the importance of a carefully crafted marketing plan, authors of marketing plans adhere to certain guidelines. The following writing and style guidelines generally apply: • Use a direct, professional writing style. Use appropriate business and marketing terms without jargon. Present and future tenses with active voice are generally better than past tense and passive voice. • Be positive and specific. At the same time, avoid superlatives (“terrific,” “wonderful”). Specifics are better than glittering generalities. Use numbers for impact, justifying computations and projections with facts or reasonable quantitative assumptions where possible. • Use bullet points for succinctness and emphasis. As with the list you are reading, bullets enable key points to be highlighted effectively and with great efficiency. • Use “A-level”(the first level) and “B-level”(the second level) headings under major section headings to help readers make easy transitions from one topic to another. This also forces the writer to organize the plan more carefully. Use these headings liberally, at least once every 200 to 300 words. • Use visuals where appropriate. Illustrations, graphs, and charts enable large amounts of information to be presented succinctly. • Shoot for a plan 15 to 35 pages in length, not including financial projections and appendices. An uncomplicated small business may require only 15 pages, while a new business startup may require more than 35 pages. • Use care in layout, design, and presentation. Laser or ink-jet printers give a more professional look than do dot matrix printers. A bound report with a cover and clear title page adds professionalism. This appendix is adapted from Roger A. Kerin, Steven W. Hartley, Eric N. Berkowitz, and William Rudelius, Marketing, 8th ed. (Burr Ridge, IL:McGraw-Hill/Irwin, 2006). Used with permission. 17 18 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT ¦ SAMPLE FIVE-YEAR ANNOTATED MARKETING PLAN FOR PARADISE KITCHENS®, INC. The marketing plan that follows for Paradise Kitchens®, Inc. is based on an actual plan developed by the company. To protect proprietary information about the company, a number of details and certain data have been altered, but the basic logic of the plan has been preserved.Various appendices are omitted due to space limitations. Notes in the margins next to the Paradise Kitchens®, Inc. marketing plan fall into two categories: 1. Substantive notes elaborate on the rationale or significance of an element in the marketing plan. 2. Writing style, format, and layout notes explain the editorial or visual rationale for the element. As you read the marketing plan, you might consider adding your own notes in the margins related to the discussion in the text. For example, you may wish to compare the application of SWOT analysis and reference to “points of difference” in the Paradise Kitchens®, Inc. marketing plan with the discussion in Chapter 1. As you read additional chapters in the text, you may return to the marketing plan and insert additional notes pertaining to terminology used and techniques employed. 18 A SAMPLE MARKETING PLAN 19 FIVE-YEAR MARKETING PLAN Paradise Kitchens?, Inc. Table of Contents 1. Executive Summary 2. Company Description Paradise Kitchens®, Inc. was started by cofounders Randall F. Peters and Leah E. Peters to develop and market Howlin’Coyote® Chili, a unique line of single serve and microwavable Southwestern/ Mexican style frozen chili products. The Howlin’Coyote? line of chili was first introduced into the Minneapolis–St. Paul market and expanded to Denver two years later and Phoenix two years after that. To the Company’s knowledge, Howlin’Coyote? is the only premium-quality, authentic Southwestern/Mexican-style, frozen chili sold in U.S. grocery stores. Its high quality has gained fast, widespread acceptance in these markets. In fact, same-store sales doubled in the last year for which data are available. The Company believes the Howlin’Coyote? brand can be extended to other categories of Southwestern/Mexican food products such as tacos, enchiladas, and burritos. Paradise Kitchens believes its high-quality, high-price strategy has proven successful. This marketing plan outlines how the Company will extend its geographic coverage from 3 markets to 20 markets by the year 2010. 3. Strategic Focus and Plan This section covers three aspects of corporate strategy that influence the marketing plan: (1) the mission, (2) goals, and (3) core competence/sustainable competitive advantage of Paradise Kitchens. MISSION The mission and vision of Paradise Kitchens are to market lines of high-quality Southwestern/Mexican food products at premium prices that satisfy consumers in this fast-growing food segment while providing challenging career opportunities for employees and above-average returns to stockholders. The Table of Contents provides quick access to the topics in the plan, usually organized by section and subsection headings. Seen by many experts as the single most important element in the plan, the Executive Summary, with a maximum of two pages, “sells”the document to readers through its clarity and brevity. The Company Description highlights the recent history and recent successes of the organization. The Strategic Focus and Plan sets the strategic direction for the entire organization, a direction with which proposed actions of the marketing plan must be consistent. This section is not included in all marketing plans. The Mission Statement focuses the activities of Paradise Kitchens for the stakeholder groups to be served. 19 20 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT The Situation Analysis is a snapshot to answer the question,“Where are we now?” GOALS For the coming five years, Paradise Kitchens seeks to achieve the following goals: • Nonfinancial goals 1. To retain its present image as the highest-quality line of Southwestern/Mexican products in the food categories in which it competes. 2. To enter 17 new metropolitan markets. 3. To achieve national distribution in two convenience store or supermarket chains by 2005 and five by 2006. 4. To add a new product line every third year. 5. To be among the top three chili lines—regardless of packaging (frozen, canned) in one-third of the metro markets in which it competes by 2006 and two-thirds by 2008. • Financial goals 1. To obtain a real (inflation adjusted) growth in earnings per share of 8 percent per year over time. 2. To obtain a return on equity of at least 20 percent. 3. To have a public stock offering by the year 2006. CORE COMPETENCY AND SUSTAINABLE COMPETITIVE ADVANTAGE In terms of core competency, Paradise Kitchens seeks to achieve a unique ability (1) to provide distinctive, high-quality chilies and related products using Southwestern/Mexican recipes that appeal to and excite contemporary tastes for these products and (2) to deliver these products to the customer’s table using effective manufacturing and distribution systems that maintain the Company’s quality standards. To translate these core competencies into a sustainable competitive advantage, the Company will work closely with key suppliers and distributors to build the relationships and alliances necessary to satisfy the high taste standards of our customers. 4. Situation Analysis This situation analysis starts with a snapshot of the current environment in which Paradise Kitchens finds itself by providing a brief SWOT (strengths,weaknesses, opportunities, threats) analysis. After this overview, the analysis probes ever-finer levels of detail: industry, competitors, company, and consumers. The Goals section sets both the financial and nonfinancial targets— where possible in quantitative terms—against which the company’s performance will be measured. Lists use parallel construction to improve readability—in this case a series of infinitives starting with “To . . .” 20 A SAMPLE MARKETING PLAN 21 SWOT ANALYSIS Figure 1 shows the internal and external factors affecting the market opportunities for Paradise Kitchens. Stated briefly, this SWOT analysis highlights the great strides taken by the Company since its products first appeared on grocers’ shelves. In the Company’s favor internally are its strengths of an experienced management team and board of directors, excellent acceptance of its lines in the three metropolitan markets in which it competes, and a strong manufacturing and distribution system to serve these limited markets. Favorable external factors (opportunities) include the increasing appeal of Southwestern/Mexican foods, the strength of the upscale market for the Company’s products, and food-processing technological breakthroughs that make it easier for smaller food producers to compete. Figure 1. SWOT Analysis for Paradise Kitchens Internal Factors Strengths Weaknesses Management Experienced and Small size can entrepreneurial restrict options management and board Offerings Unique, high-quality, Many lower-quality, high-price lower-price products competitors Marketing Distribution in three No national markets with awareness or excellent acceptance distribution;restricted shelf space in the freezer section Personnel Good work force, Big gap if key though small; employee leaves little turnover Finance Excellent growth in Limited resources sales revenues may restrict growth opportunities when compared to giant competitors Manufacturing Sole supplier ensures Lack economies of high quality scale of huge competitors R&D Continuing efforts to Lack of canning and ensure quality microwavable foodin delivered products processing expertise The SWOT Analysis identifies strengths, weaknesses, opportunities, and threats to provide a solid foundation as a springboard to identify subsequent actions in the marketing plan. Each long table, graph, or photo is given a figure number and title. It then appears as soon as possible after the first reference in the text, accommodating necessary page breaks. This also avoids breaking long tables like this one in the middle. Short tables or graphs that are less than 11/2 inches are often inserted in the text without figure numbers because they don’t cause serious problems with page breaks. 21 22 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT Figure 1. SWOT Analysis for Paradise Kitchens (continued ) External Factors Opportunities Threats Consumer/Social Upscale market, likely Premium price may to be stable; limit access to Southwestern/Mexican mass markets; food category is consumers value a fast-growing segment strong brand name due to growth in Hispanic American population and desire for spicier foods Competitive Distinctive name and Not patentable; packaging in competitors can its markets attempt to duplicate product;others better able to pay slotting fees Technological Technical break- Competitors have throughs enable gained economies smaller food produ- in canning and cers to achieve many microwavable economies available to food processing large competitors Economic Consumer income is Many households high;convenience im- “eating out,”and portant to U.S. bringing prepared households take-out into home Legal/Regulatory High U.S. Food & Mergers among large Drug Admin. standards competitors being eliminate fly-by-night approved by competitors government Among unfavorable factors, the main weakness is the limited size of Paradise Kitchens relative to its competitors in terms of the depth of the management team, available financial resources, and national awareness and distribution of product lines. Threats include the danger that the Company’s premium prices may limit access to mass markets and competition from the “eating-out”and “take-out”markets. INDUSTRY ANALYSIS: TRENDS IN SPICY AND MEXICAN FOODS Frozen Foods. According to Grocery Headquarters, consumers are flocking to the frozen-food section of grocery retailers. The reasons: hectic lifestyles demanding increased convenience and an abundance of new, tastier, and nutritious products. By 2004, total sales of frozen food in grocery retailers, drugstores, and mass merchandisers, such as Target and Costco (excluding Wal-Mart), reached $27.6 billion. Prepared frozen meals, which are defined as meals or entrees that are frozen and require minimal preparation, accounted for $7.3 billion, or 26 percent of the total frozen-food market, which is shown in Figure 2. The Industry Analysis section provides the backdrop for the sub-sequent, more detailed analysis of competition, the company, and the company’s customers.Without an in-depth understanding of the industry, the remaining analysis may be misdirected. Even though relatively brief, this in-depth treatment of the Spicy Southwestern/Mexican food industry in the United States demonstrates to the plan’s readers the company’s understanding of the industry in which it competes. It gives readers confidence that the company thoroughly understands its own industry. 22 A SAMPLE MARKETING PLAN 23 Figure 2. Some Frozen Entrees Included in the Prepared Frozen- Food Product Category, 2004 Frozen dinners $1,323 18% Italian entrees 1,231 17 Meat entrees 721 10 Mexican entrees 506 7 Oriental entrees 479 7 Poultry entrees 1,617 22 Seafood entrees 190 3 Other entrees 1,281 16 Total $7,348 100% Handheld entrees, such as Hot Pockets ($1.1 billion), comprise a significant portion of the “Other entrees”category. However, frozen pizza/snacks, which are not included in this category, accounted for an additional $3.3 billion in frozen-food sales in 2004. Heavy consumers of frozen meals, those who eat five or more meals every two weeks, tend to be kids, teens, and young adults 35–44 years old. Mexican Foods. Currently, Mexican foods such as burritos, enchiladas, and tacos are used in two-thirds of American households. These trends reflect a generally more favorable attitude on the part of all Americans toward spicy foods that include red chili peppers. Grocery marketers and retailers have tried to capitalize on this trend by developing meals targeted to those who desire this type of food. Considering the current desire for convenience, several major food processors, such as Hormel,Tyson Foods, and ConAgra, as well as Hispanic-owned firms, such as Goya (Mission Foods), Ruiz Foods, and Don Miguel’s, have introduced many new frozen Mexican food entrees over the past few years. The growing Hispanic population in the U.S., about 36 million and almost $600 billion in purchasing power in 2004, partly explains the increasing demand for Mexican food. COMPETITORS IN THE CHILI MARKET The chili market represents over $500 million in annual sales. On average, consumers buy five to six servings annually. The products fall primarily into two groups:canned chili (70 percent of sales) and dry chili (25 percent of sales). The remaining 5 percent of sales go to frozen chili products. Besides Howlin’Coyote®, Stouffer’s offers a frozen chili product (Slowfire Classic’s Chunky Beef & Bean Chili) as part of its broad line of frozen dinners and entrees. Major canned chili brands include Hormel,Wolf, Dennison, Stagg, Austin’s, and Castleberry’s. Their retail prices range from $1.49 to $2.49. In the fall of 2004, Campbell’s, the world’s largest maker of soup, and Bush Brothers, a privately held marketer of baked beans, will enter the canned chili market. However, Bush will use a glass bottle to package its Homestyle Chili brand. As with the Industry Analysis, the Competitor Analysis demonstrates that the company has a realistic understanding of who its major competitors are and what their marketing strategies are. Again, a realistic assessment gives confidence to readers that subsequent marketing actions in the plan rest on a solid foundation. This summary of sales of key entrees in the prepared frozen-food product category, showing Mexican entrees are significant, provides a variety of future opportunities for Paradise Kitchens. 23 24 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT Bluntly put, the major disadvantage of the segment’s dominant product, canned chili, is that it does not taste very good. A taste test described in an issue of Consumer Reports magazine ranked 26 canned chili products “poor”to “fair” in overall sensory quality. The study concluded,“Chili doesn’t have to be hot to be good. But really good chili, hot or mild, doesn’t come out of a can.” Dry mix brands include such familiar spice brands as McCormick (which has 40 percent of this market), Lawry’s, French’s, and Durkee, along with smaller offerings such as Wick Fowler’s and Carroll Shelby’s. Their retail prices range from $0.99 to $1.49. The Consumer Reports study was more favorable about dry chili mixes, ranking them from “fair” to “very good.” COMPANY ANALYSIS Currently, Howlin’Coyote? products compete in the chili and Mexican frozen entree segments of the Southwestern/Mexican food market. While the chili obviously competes as a stand-alone product, its exceptional quality means it can complement such dishes as burritos, nachos, and enchiladas and can be readily used as a smothering sauce for pasta, rice, or potatoes. This flexibility of use is relatively rare in the prepared food marketplace.With Howlin’Coyote®, Paradise Kitchens is broadening the position of frozen chili in a way that can lead to impressive market share for the new product category. The Company now uses a single outside producer with which it works closely to maintain the consistently high quality required in its products. The greater volume has increased production efficiencies, resulting in a steady decrease in the cost of goods sold. The Company Analysis provides details of the company’s strengths and marketing strategies that will enable it to achieve the mission and goals identified earlier. 24 A SAMPLE MARKETING PLAN 25 CUSTOMER ANALYSIS In terms of customer analysis, this section describes (1) the characteristics of customers expected to buy Howlin’Coyote? products and (2) health and nutrition concerns of Americans today. Customer Characteristics. Demographically, chili products in general are purchased by consumers representing a broad range of socioeconomic backgrounds. Howlin’Coyote? chili is purchased chiefly by consumers who have achieved higher levels of education and whose income is $50,000 and higher. These consumers represent 50 percent of canned and dry mix chili users. The household buying Howlin’Coyote? has one to three people in it. Among married couples, Howlin’Coyote? is predominantly bought by households in which both spouses work. While women are a majority of the buyers, single men represent a significant segment. Anecdotally, Howlin’Coyote? has heard from fathers of teenaged boys who say they keep a freezer stocked with the chili because the boys devour it. Because the chili offers a quick way to make a tasty meal, the product’s biggest users tend to be those most pressed for time. Howlin’Coyote?’s premium pricing also means that its purchasers are skewed toward the higher end of the income range. Buyers range in age from 25 to 54. Because consumers in the western United States have adopted spicy foods more readily than the rest of the country, Howlin’Coyote?’s initial marketing expansion efforts will be concentrated in that region. This “introductory overview” sentence tells the reader the topics covered in the section—in this case customer characteristics and health and nutrition concerns. While this sentence may be omitted in short memos or plans, it helps readers see where the text is leading. These sentences are used throughout this plan. The higher-level “A heading”of Customer Analysis has a more dominant typeface and position than the lower-level “B heading”of Customer Characteristics. These headings introduce the reader to the sequence and level of topics covered. Satisfying customers and providing genuine value to them is why organizations exist in a market economy. This section addresses the question of “Who are the customers for Paradise Kitchens’products?” 25 26 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT Health and Nutrition Concerns. Coverage of food issues in the U.S. media is often erratic and occasionally alarmist. Because Americans are concerned about their diets, studies from organizations of widely varying credibility frequently receive significant attention from the major news organizations. For instance, a study of fat levels of movie popcorn was reported in all the major media. Similarly, studies on the healthfulness of Mexican food have received prominent “play”in print and broadcast reports. The high caloric levels of much Mexican and Southwestern-style food had been widely reported and often exaggerated. Some Mexican frozen-food competitors, such as Don Miguel, Mission Foods, Ruiz Foods, and Jose Ole, plan to offer or have recently offered more “carb-friendly” and “fat-friendly”products in response to this concern. Howlin’Coyote® is already lower in calories, fat, and sodium than its competitors, and those qualities are not currently being stressed in its promotions. Instead, in the space and time available for promotions, Howlin’Coyote®’s taste, convenience, and flexibility are stressed. 5. Product-Market Focus This section describes the five-year marketing and product objectives for Paradise Kitchens and the target markets, points of difference, and positioning of its lines of Howlin’Coyote? chilies. MARKETING AND PRODUCT OBJECTIVES Howlin’Coyote?’s marketing intent is to take full advantage of its brand potential while building a base from which other revenue sources can be mined—both in and out of the retail grocery business. These are detailed in four areas below: • Current markets. Current markets will be grown by expanding brand and flavor distribution at the retail level. In addition, same-store sales will be grown by increasing consumer awareness and repeat purchases.With this increase in same-store sales, the more desirable broker/warehouse distribution channel will become available, increasing efficiency and saving costs. The chances of success for a new product are significantly increased if objectives are set for the product itself and if target market segments are identified for it. This section makes these explicit for Paradise Kitchens. The objectives also serve as the planned targets against which marketing activities are measured in program implementation and control. This section demonstrates the company’s insights into a major trend that has a potentially large impact. 26 A SAMPLE MARKETING PLAN 27 • New markets. By the end of Year 5, the chili, salsa, burrito, and enchilada business will be expanded to a total of 20 metropolitan areas. This will represent 70 percent of U.S. food store sales. • Food service. Food service sales will include chili products and smothering sauces. Sales are expected to reach $693,000 by the end of Year 3 and $1.5 million by the end of Year 5. • New products. Howlin’Coyote?’s brand presence will be expanded at the retail level through the addition of new products in the frozen-foods section. This will be accomplished through new product concept screening in Year 1 to identify new potential products. These products will be brought to market in Years 2 and 3. Additionally, the brand may be licensed in select categories. TARGET MARKETS The primary target market for Howlin’Coyote? products is households with one to three people, where often both adults work, with household income typically above $50,000 per year. These households contain more experienced, adventurous consumers of Southwestern/Mexican food and want premium quality products. POINTS OF DIFFERENCE The “points of difference”—characteristics that make Howlin’ Coyote? chilies unique relative to competitors—fall into three important areas: • Unique taste and convenience. No known competitor offers a high-quality,“authentic”frozen chili in a range of flavors. And no existing chili has the same combination of quick preparation and home-style taste. • Taste trends. The American palate is increasingly intrigued by hot spices, and Howlin’Coyote? brands offer more “kick” than most other prepared chilies. • Premium packaging. Howlin’Coyote?’s high-value packaging graphics convey the unique, high-quality product contained inside and the product’s nontraditional positioning. This section identifies the specific niches or target markets toward which the company’s products are directed.When appropriate and when space permits, this section often includes a product-market matrix. An organization cannot grow by offering only “me-too products.” The greatest single factor in a new product’s failure is the lack of significant “points of difference”that set it apart from competitors’ substitutes. This section makes these points of difference explicit. 27 28 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT POSITIONING In the past chili products have been either convenient or tasty, but not both. Howlin’Coyote? pairs these two desirable characteristics to obtain a positioning in consumers’ minds as very highquality “authentic Southwestern/Mexican tasting”chilies that can be prepared easily and quickly. 6. Marketing Program The four marketing mix elements of the Howlin’Coyote? chili marketing program are detailed below. Note that “chile” is the vegetable and “chili” is the dish. PRODUCT STRATEGY After first summarizing the product line, the approach to product quality and packaging is covered. Product Line. Howlin’Coyote? chili, retailing for $3.99 for an 11-ounce serving, is available in five flavors. The five are: • Green Chile Chili: braised extra-lean pork with fire-roasted green chilies, onions, tomato chunks, bold spices, and jalapeno peppers, based on a Southwestern favorite. • Red Chile Chili:extra-lean cubed pork, deep-red acho chilies, and sweet onions;known as the “Texas Bowl of Red.” • Beef and Black Bean Chili: lean braised beef with black beans, tomato chunks, and Howlin’Coyote?’s own blend of red chilies and authentic spicing. • Chicken Chunk Chili:hearty chunks of tender chicken, fireroasted green chilies, black beans, pinto beans, diced onions, and zesty spices. • Mean Bean Chili:vegetarian, with nine distinctive bean varieties and fire-roasted green chilies, tomato chunks, onion, and a robust blend of spices and rich red chilies. Unique Product Quality. The flavoring systems of the Howlin’ Coyote? chilies are proprietary. The products’ tastiness is due to extra care lavished upon the ingredients during production. The ingredients used are of unusually high quality. Meats are low-fat cuts and are fresh, not frozen, to preserve cell structure and moistness. Chilies are fire-roasted for fresher taste, not the canned variety used by more mainstream products. Tomatoes and vegetables are select quality. No preservatives or artificial flavors are used. Using parallel structure, this bulleted list presents the product line efficiently and crisply. A positioning strategy helps communicate the company’s unique points of difference of its products to prospective customers in a simple, clear way. This section describes this positioning. Everything that has gone before in the marketing plan sets the stage for the marketing mix actions covered in the marketing program. This section describes in detail three key elements of the company’s product strategy: the product line, its quality and how this is achieved, and its “cutting edge”packaging. 28 A SAMPLE MARKETING PLAN 29 Packaging. Reflecting the “cutting edge”marketing strategy of its producers, Howlin’Coyote? bucks conventional wisdom in packaging. It avoids placing predictable photographs of the product on its containers. (Head to any grocer’s freezer and you will be hardpressed to find a product that does not feature a heavily stylized photograph of the contents.) Instead, Howlin’Coyote?’s package shows a Southwestern motif that communicates the product’s out-of-the-ordinary positioning. This approach signals the product’s nontraditional qualities: “adventurous”eating with minimal fuss—a frozen meal for people who do not normally enjoy frozen meals. PRICE STRATEGY Howlin’Coyote? chili is, at $3.99 for an 11-ounce package, priced comparably to the other frozen offerings and higher than the canned and dried chili varieties. However, the significant taste advantages it has over canned chilies and the convenience advantages over dried chilies justify this pricing strategy. PROMOTION STRATEGY Key promotion programs feature in-store demonstrations, recipes, and cents-off coupons. In-Store Demonstrations. In-store demonstrations will be conducted to give consumers a chance to try Howlin’Coyote? products and learn about their unique qualities. Demos will be conducted regularly in all markets to increase awareness and trial purchases. Recipes. Because the products’flexibility of use is a key selling point, recipes will be offered to consumers to stimulate use. The recipes will be given at all in-store demonstrations, on the back of packages, and through a mail-in recipe book offer. In addition, recipes will be included in coupons sent by direct-mail or freestanding inserts. For new markets, recipes will be included on inpack coupon inserts. Cents-Off Coupons. To generate trial and repeat-purchase of Howlin’Coyote? products, coupons will be distributed in four ways: • In Sunday newspaper inserts. Inserts are highly read and will help generate awareness. Coupled with in-store Elements of the Promotion Strategy are highlighted here with B-headings in terms of the three key promotional activities the company is emphasizing for its product line: in-store demonstrations, recipes featuring its Howlin’ Coyote? chilies, and cents-off coupons. This Price Strategy section makes the company’s price point very clear, along with its price position relative to potential substitutes.When appropriate and when space permits, this section might contain a break-even analysis. 29 30 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT demonstrations, this has been a very successful technique so far. • In-pack coupons. Inside each box of Howlin’Coyote? chili will be coupons for $1 off two more packages of the chili. These coupons will be included for the first three months the product is shipped to a new market. Doing so encourages repeat purchases by new users. • Direct-mail chili coupons. Those households that fit the Howlin’Coyote? demographics described above will be mailed coupons. This is likely to be an efficient promotion due to its greater audience selectivity. • In-store demonstrations. Coupons will be passed out at in-store demonstrations to give an additional incentive to purchase. DISTRIBUTION STRATEGY Howlin’Coyote? is distributed in its present markets through a food distributor. The distributor buys the product,warehouses it, and then resells and delivers it to grocery retailers on a store-by-store basis. This is typical for products that have moderate sales— compared with, say, staples like milk or bread. As sales grow,we will shift to a more efficient system using a broker who sells the products to retail chains and grocery wholesalers. 7. Financial Data and Projections PAST SALES REVENUES Historically, Howlin’Coyote? has had a steady increase in sales revenues since its introduction in 1997. In 2001, sales jumped, due largely to new promotion strategies. Sales have continued to rise, but at a less dramatic rate. The trend in sales revenues appears in Figure 3. Figure 3. Sales Revenues for Paradise Kitchens®, Inc. Another bulleted list adds many details for the reader, including methods of gaining customer awareness, trial, and repeat purchases as Howlin’ Coyote? enters new metropolitan areas. The Distribution Strategy is described here in terms of both (1) the present method and (2) the new one to be used when the increased sales volume makes it feasible. All the marketing mix decisions covered in the marketing program have both revenue and expense effects. These are summarized in this section of the marketing plan. The graph shows more clearly the dramatic growth of sales revenue than data in a table would do. 1997 60 210 360 600 1650 2428 3174 4067 5123 5,500 0 4,000 4,500 5,000 3,500 3,000 2,500 2,000 1,500 1,000 500 1998 1999 2000 2001 Year Sales Revenues ($1,000) 2002 2003 2004 2005 30 A SAMPLE MARKETING PLAN 31 FIVE-YEAR PROJECTIONS Five-year financial projections for Paradise Kitchens®, Inc. appear below: Projections Financial Actual Year 1 Year 2 Year 3 Year 4 Year 5 Element Units 2006 2006 2007 2008 2009 2010 Cases sold 1,000 353 684 889 1,249 1,499 1,799 Net sales $1,000 5,123 9,913 12,884 18,111 21,733 26,080 Gross profit $1,000 2,545 4,820 6,527 8,831 10,597 12,717 Selling and general and admin. expenses $1,000 2,206 3,835 3,621 6,026 7,231 8,678 Operating profit (loss) $1,000 339 985 2,906 2,805 3,366 4,039 These projections reflect the continuing growth in number of cases sold (with 8 packages of Howlin’Coyote? chili per case) and increasing production and distribution economies of scale as sales volume increases. Because this table is very short, it is woven into the text, rather than given a table number and title. The Five-Year Financial Projections section starts with the judgment forecast of cases sold and the resulting net sales. Gross profit and then operating profit—critical for the company’s survival—are projected. An actual plan often contains many pages of computer-generated spreadsheet projections, usually shown in an appendix to the plan. 31 32 CHAPTER 1 FOUNDATIONS OF STRATEGIC MARKETING MANAGEMENT 8. Implementation Plan Introducing Howlin’Coyote? chilies to 17 new metropolitan areas is a complex task and requires that creative promotional activities gain consumer awareness and initial trial among the target market households identified earlier. The anticipated rollout schedule to enter these metropolitan markets appears in Figure 4. Figure 4. Rollout Schedule to Enter New U.S. Markets New Markets Cumulative Cumulative Percentage Year Added Markets of U.S.Market Today (2005) 2 5 16 Year 1 (2006) 3 8 21 Year 2 (2007) 4 12 29 Year 3 (2008) 2 14 37 Year 4 (2009) 3 17 45 Year 5 (2010) 3 20 53 The diverse regional tastes in chili will be monitored carefully to assess whether minor modifications may be required in the chili recipes. For example, what is seen as “hot”in Boston may not be seen as “hot”in Dallas. As the rollout to new metropolitan areas continues, Paradise Kitchens will assess manufacturing and distribution trade-offs. This is important in determining whether to start new production with selected high-quality regional contract packers. 9. Evaluation and Control Monthly sales targets in cases have been set for Howlin’ Coyote? chili for each metropolitan area. Actual case sales will be compared with these targets and tactical marketing programs modified to reflect the unique sets of factors in each metropolitan area. The speed of the roll out program may increase or decrease, depending on Paradise Kitchens’ performance in the successive metropolitan markets it enters. Similarly, as described above in the section on the implementation plan, Paradise Kitchens may elect to respond to variations in regional tastes by using contract packers, which will reduce transportation and warehousing costs but will require special efforts to monitor production quality. 10. Appendices The Implementation Plan shows how the company will turn plans into results. Gantt charts are often used to set deadlines and assign responsibilities for the many tactical marketing decisions needed to enter a new market. The essence of Evaluation and Control is comparing actual sales with the targeted values set in the plan and taking appropriate actions. Note that the section briefly describes a contingency plan for alternative actions, depending on how successful the entry into a new market turns out to be. Various appendices may appear at the end of the plan, depending on the purpose and audience for them. For example, detailed financial spreadsheets often appear in an appendix. 32 C H A P T E R 2 Financial Aspects of Marketing Management Marketing managers are accountable for the impact of their actions on profit and cash flow. Therefore, they need a working knowledge of basic accounting and finance concepts. This chapter provides an overview of several concepts from accounting and finance that are useful in marketing management:(1) variable and fixed costs, (2) relevant and sunk costs, (3) margins, (4) contribution analysis, (5) liquidity, (6) operating leverage, (7) discounted cash flow, and (8) customer lifetime value analysis. In addition, considerations when preparing pro forma income statements are described. ¦ VARIABLE AND FIXED COSTS An organization’s costs divide into two broad categories: variable costs and fixed costs. Variable Costs Variable costs are expenses that are uniform per unit of output within a relevant time period (usually defined as a budget year); yet total variable costs fluctuate in direct proportion to the output volume of units produced. In other words, as volume increases, total variable costs increase. Variable costs are divided into two categories, one of which is cost of goods sold. For a manufacturer or a provider of a service, cost of goods sold covers materials, labor, and factory overhead applied directly to production. For a reseller (wholesaler or retailer), cost of goods sold consists primarily of the cost of merchandise. The second category of variable costs consists of expenses that are not directly tied to production but that nevertheless vary directly with volume. Examples include sales commissions, discounts, and delivery expenses. Fixed Costs Fixed costs are expenses that do not fluctuate with output volume within a relevant time period (the budget year) but become progressively smaller per unit of output as volume increases. The decrease in per-unit fixed cost results from the increase in the 33 33 number of output units over which fixed costs are allocated. Note, however, that no matter how large volume becomes, the absolute size of fixed costs remains unchanged. Fixed costs divide into two categories: programmed costs and committed costs. Programmed costs result from attempts to generate sales volume. Marketing expenditures are generally classified as programmed costs. Examples include advertising, sales promotion, and sales salaries. Committed costs are those required to maintain the organization. They are usually nonmarketing expenditures such as rent and administrative and clerical salaries. It is important to understand the concept of fixed cost. Remember that total fixed costs do not change during a budget year, regardless of changes in volume. Once fixed expenditures for a marketing program have been made, they remain the same whether or not the program causes unit volume to change. Despite the clear-cut classification of costs into variable and fixed categories suggested here, cost classification is not always apparent in actual practice. Many times costs have a fixed and a variable component. For example, selling expenses often have a fixed component (such as salary) and a variable component (such as commissions or bonus) that are not always evident at first glance. ¦ RELEVANT AND SUNK COSTS Relevant Costs Relevant costs are expenditures that (1) are expected to occur in the future as a result of some marketing action and (2) differ among marketing alternatives being considered. In short, relevant costs are future expenditures unique to the decision alternatives under consideration. The concept of relevant cost can best be illustrated by an example. Suppose a manager considers adding a new product to the product mix. Relevant costs include potential expenditures for manufacturing and marketing the product, plus salary costs arising from the time sales personnel give to the new product at the expense of other products. If this additional product does not affect the salary costs of sales personnel, salaries are not a relevant cost. As a general rule, opportunity costs are also relevant costs. Opportunity costs are the forgone benefits from an alternative not chosen. Sunk Costs Sunk costs are the direct opposite of relevant costs. Sunk costs are past expenditures for a given activity and are typically irrelevant in whole or in part to future decisions. In a marketing context, sunk costs include past research and development expenditures (including test marketing) and last year’s advertising expense. These expenditures, although real, will neither recur in the future nor influence future expenditures.When marketing managers attempt to incorporate sunk costs into future decisions affecting new expenditures, they often fall prey to the sunk cost fallacy—that is, they attempt to recoup spent dollars by spending still more dollars in the future. ¦ MARGINS Another useful concept for marketing managers is that of margin, which refers to the difference between the selling price and the “cost” of a product or service. Margins are expressed on a total volume basis or on an individual unit basis, in dollar terms or as percentages. The three described here are gross, trade, and net profit margins. 34 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT 34 Gross Margin Gross margin, or gross profit, is the difference between total sales revenue and total cost of goods sold, or, on a per-unit basis, the difference between unit selling price and unit cost of goods sold. Gross margin may be expressed in dollar terms or as a percentage. Total Gross Margin Dollar Amount Percentage Net sales $100 100% Cost of goods sold 40 40 Gross profit margin $60 60% Unit Gross Margin Unit sales price $1.00 100% Unit cost of goods sold 0.40 40 Unit gross profit margin $0.60 60% Gross margin analysis is a useful tool because it implicitly includes unit selling prices of products or services, unit costs, and unit volume. A decrease in gross margin is of immediate concern to a marketing manager because such a change has a direct impact on profits, providing that other expenditures remain unchanged. Changes in total gross margin should be examined in depth to determine whether the change was brought about by fluctuations in unit volume, changes in unit price or unit cost of goods sold, or a modification in the sales mix of the firm’s products or services. Trade Margin Trade margin is the difference between unit sales price and unit cost at each level of a marketing channel (for example, manufacturer ? wholesaler ? retailer). A trade margin is frequently referred to as a markup or mark-on by channel members, and it is often expressed as a percentage. Trade margins are occasionally confusing, since the margin percentage can be computed on the basis of cost or selling price. Consider the following example. Suppose a retailer purchases an item for $10 and sells it at a price of $20—that is, a $10 margin. What is the retailer’s margin percentage? Retailer margin as a percentage of cost is Retailer margin as a percentage of selling price is Differences in margin percentages show the importance of knowing the base (cost or selling price) on which the margin percentage is determined. Trade margin percentages are usually determined on the basis of selling price, but practices do vary among firms and industries. Trade margins affect the pricing of individual items in two ways. First, suppose a wholesaler purchases an item for $2.00 and seeks to achieve a 30 percent margin on this item based on selling price.What would be the selling price? $2.00 70 percent of selling price or Selling price $2.00/0.70 $2.86 $ $ 10 20 × 10050 percent $ $ 10 10 × 100100 percent MARGINS 35 35 Second, suppose a manufacturer suggests a retail list price of $6.00 on an item for ultimate resale to the consumer. The item will be sold through retailers whose policy is to obtain a 40 percent margin based on selling price. For what price must the manufacturer sell the item to the retailer? where x is the retailer margin. Solving for x indicates that the retailer must obtain $2.40 for this item. Therefore, the manufacturer must set the price to the retailer at $3.60 ($6.00 $2.40). The manufacturer’s problem of suggesting a price for ultimate resale to the consumer becomes more complex as the number of intermediaries between the manufacturer and the final consumer increases. This complexity can be illustrated by expanding the above example to include a wholesaler between the manufacturer and retailer. The retailer receives a 40 percent margin on the sales price. If the retailer must receive $2.40 per unit, the wholesaler must sell the item for $3.60 per unit. In order for the wholesaler to receive a 20 percent margin, for what price must the manufacturer sell the unit to the wholesaler? where x is the wholesaler margin. Solving for x shows that the wholesaler’s margin is $0.72 for this item. Therefore, the manufacturer must set the price to the wholesaler at $2.88. This example shows that a manager must work backward from the ultimate price to the consumer through the marketing channel to arrive at a product’s selling price. Assuming that the manufacturer’s cost of goods sold is $2.00,we can calculate the following margins, which incidentally show the manufacturer’s gross margin of 30.6 percent. Gross Margin Unit Cost of Unit Selling as a Percentage Goods Sold Price of Selling Price Manufacturer $2.00 $2.88 30.6% Wholesaler 2.88 3.60 20.0 Retailer 3.60 6.00 40.0 Consumer 6.00 Net Profit Margin (Before Taxes) The last margin to be considered is the net profit margin before taxes. This margin is expressed as a dollar figure or a percentage. Net profit margin is the remainder after cost of goods sold, other variable costs, and fixed costs have been subtracted from sales revenue. The place of net profit margin in an organization’s income statement is illustrated by the following: Dollar Amount Percentage Net sales $100,000 100% Cost of goods sold 30,000 30 Gross profit margin $70,000 70% Selling expenses 20,000 20 Fixed expenses 40,000 40 Net profit margin $10,000 10% x $36.60 20 percent wholesaler margin on selling price x $6.00 40 percent of selling price 36 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT 36 Net profit margin dollars represent a major source of funding for the organization. As will be shown later, net profit influences the working capital position of the organization; hence, the dollar amount ultimately affects the organization’s ability to pay its cost of goods sold plus its selling and administrative expenses. Furthermore, net profit also affects the organization’s cash flow position. ¦ CONTRIBUTION ANALYSIS Contribution analysis is an important concept in marketing management. Contribution is the difference between total sales revenue and total variable costs, or, on a per-unit basis, the difference between unit selling price and unit variable cost. Contribution analysis is particularly useful in assessing relationships among costs, prices, and volumes of products and services with respect to profit. Break-Even Analysis Break-even analysis is one of the simplest applications of contribution analysis. Breakeven analysis identifies the unit or dollar sales volume at which an organization neither makes a profit nor incurs a loss. Stated in equation form: Total revenue total variable costs total fixed costs Since break-even analysis identifies the level of sales volume at which total costs (fixed and variable) and total revenue are equal, it is a valuable tool for evaluating an organization’s profit goals and assessing the riskiness of actions. Break-even analysis requires three pieces of information: (1) an estimate of unit variable costs, (2) an estimate of the total dollar fixed costs to produce and market the product or service unit (note that only relevant costs apply), and (3) the selling price for each product or service unit. The formula for determining the number of units required to break even is as follows: The denominator in this formula (unit selling price minus unit variable costs) is called contribution per unit. Contribution per unit is the dollar amount that each unit sold “contributes”to the payment of fixed costs. Consider the following example. A manufacturer plans to sell a product for $5.00. The unit variable costs are $2.00, and total fixed costs assigned to the product are $30,000. How many units must be sold to break even? Fixed costs $30,000 Contribution per unit unit selling price unit variable cost $5 $2 $3 Unit break-even volume $30,000/$3 10,000 units This example shows that for every unit sold at $5.00, $2.00 is used to pay variable costs. The balance of $3.00 “contributes”to fixed costs. A related question is what the manufacturer’s dollar sales volume must be to break even. The manager need only multiply unit break-even volume by the unit selling price to determine the dollar break-even volume:10,000 units × $5 $50,000. Unit break-even volume total dollar fixed costs unit selling priceunit variable costs CONTRIBUTION ANALYSIS 37 37 A manager can calculate a dollar break-even point directly without first computing unit break-even volume. First, the contribution margin must be determined from the formula: Using the figures from our example,we find that the contribution margin is 60 percent: Then the dollar break-even point is computed as follows: Break-even dollar volume total fixed costs $30,000 $50,000 contribution margin 0.60 In many cases it is useful to develop a graphic representation of a break-even analysis. Exhibit 2.1 provides a visual solution to the problem posed previously. The horizontal line at $30,000 represents fixed costs. The upward-sloping line beginning at $30,000 represents the total cost, which is equal to the sum of fixed plus variable costs. This line has a slope equal to $2.00—each unit increase in volume results in a $2.00 increase in the total cost. The upward-sloping line beginning at zero represents revenue and has a slope of $5.00—each unit increase in sales produces a $5.00 increase in revenue. The distance between the revenue line and the total cost line represents dollars of profit (above the break-even point) or loss (below the breakeven point). Contribution margin $5 2 percent $ $5 60 Contribution margin unit selling price unit variable cost unit selling price 38 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT E X H I B I T 2 . 1 Break-Even Analysis Chart $100 90 80 70 60 50 40 30 20 10 0 5 10 Unit Volume (thousands of units) Total Revenue or Total Cost ($ thousands) Fixed Costs Total Cost (fixed and variable) Total Revenue Variable Costs Profit 15 20 Loss Break-Even Point 38 Sensitivity Analysis Contribution analysis can be applied in a number of different ways, depending on the manager’s needs. The following illustrations show how the break-even points in our example can be varied by changing selling price, variable costs, and fixed costs. 1. What would break-even volume be if fixed costs were increased to $40,000 while the selling price and variable costs remained unchanged? Fixed costs $40,000 Contribution per unit $3 Unit break-even volume $40,000/$3 13,333 units Dollar break-even volume $40,000/0.60 $66,667 Note that the difference between the dollar break-even volume calculated from the contribution margin and the result of simply multiplying unit selling price by unit break-even volume (13,333 × $5 $66,665) is due to rounding. 2. What would break-even volume be if selling price were dropped from $5.00 to $4.00 while fixed and variable costs remained unchanged? Fixed costs $30,000 Contribution per unit $2 Unit break-even volume $30,000/$2 15,000 units Dollar break-even volume $30,000/0.50 $60,000 3. Finally, what would break-even volume be if the unit variable cost per unit were reduced to $1.50, selling price remained at $5.00, and fixed costs were $30,000? Fixed costs $30,000 Contribution per unit $3.50 Unit break-even volume $30,000/$3.50 8,571 units Dollar break-even volume $30,000/0.70 $42,857 Contribution Analysis and Profit Impact No manager is content to operate at the break-even point in unit or dollar sales volume. Profits are necessary for the continued operation of an organization. A modified break-even analysis is used to incorporate a profit goal. To modify the break-even formula to incorporate a dollar profit goal, we need only regard the profit goal as an additional fixed cost, as follows: Suppose a firm has fixed costs of $200,000 budgeted for a product or service, the unit selling price is $25.00, and the unit variable costs are $10.00. How many units must be sold to achieve a dollar profit goal of $20,000? Fixed costs profit goal $200,000 $20,000 $220,000 Contribution per unit $25 $10 $15 Unit volume to achieve dollar profit goal $220,000/$15 $14,667 units total dollar fixed costsdollar profit goal contribution per unit Unit volume to achieve dollar profit goal CONTRIBUTION ANALYSIS 39 39 Many firms specify their profit goal as a percentage of sales rather than as a dollar amount (“Our profit goal is a 20 percent profit on sales”). This objective can be incorporated into the break-even formula by subtracting the profit goal from the contribution-per-unit. If the goal is to achieve a 20 percent profit on sales, each dollar of sales must “contribute” $0.20 to profit. In our example, each unit sold for $25.00 must contribute $5.00 to profit (.20 × $25.00). The break-even formula incorporating a percent profit on sales goal is as follows: The unit volume break-even point to achieve a 20 percent profit goal is 20,000 units: Fixed costs $200,000 Contribution per unit unit profit goal $25 $10 $5 $10 Unit volume to achieve profit goal $200,000/$10 20,000 units Contribution Analysis and Market Size An important consideration in contribution analysis is the relationship of break-even unit or dollar volume to market size. Consider the situation in which a manager has conducted a break-even analysis and found the unit volume break-even point to be 50,000 units. This number has meaning only when compared with the potential size of the market segment sought. If the market potential is 100,000 units, the manager’s product or service must capture 50 percent of the market sought to break even. An important question to be resolved is whether such a percentage can be achieved. A manager can assess the feasibility of a venture by comparing the break-even volume with market size and market-capture percentage. Contribution Analysis and Performance Measurement A second application of contribution analysis lies in performance measurement. For example, a marketing manager may wish to examine the performance of products. Consider an organization with two products, X and Y. A description of each product’s financial performance follows: Product X Product Y Total (10,000 volume) (20,000 volume) (30,000 volume) Unit price $ 10 $ 3 Sales revenue 100,000 60,000 $160,000 Unit variable cost 4 1.50 Total variable cost 40,000 30,000 70,000 Unit contribution 6 1.50 Total contribution 60,000 30,000 90,000 Fixed costs 45,000 10,000 55,000 Net profit $ 15,000 $20,000 $ 35,000 The net profit figure shows that Product Y is more profitable than Product X. Product X is four times more profitable than Product Y on a unit-contribution basis, however, and generates twice the contribution dollars to overhead. The difference in profitability comes from the allocation of fixed costs to the products. In measuring Unit volume to achieve profit goal total do llar fixed costs contribution per unitunit profit goal 40 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT 40 performance, it is important to consider which products contribute most heavily to the organization’s total fixed costs ($55,000 in this example) and then to total profit. Should a manager look only at net profit, a decision might be made to drop Product X. Product Y would then have to cover total fixed costs, however. If the fixed costs remain at $55,000 and only Product Y is sold, this organization will experience a net loss of $25,000, assuming no change in Product Y volume. Assessment of Cannibalization A third application of contribution analysis is in the assessment of cannibalization effects. Cannibalization is the process by which one product or service sold by a firm gains a portion of its revenue by diverting sales from another product or service also sold by the firm. For example, sales of Brand X’s new gel toothpaste may be at the expense of sales of Brand X’s existing opaque white toothpaste. The problem facing a marketing manager is to assess the financial effect of cannibalization. Consider the following data: Existing Opaque New Gel White Toothpaste Toothpaste Unit selling price $1.00 $1.10 Unit variable costs 0.20 0.40 Unit contribution $0.80 $0.70 The gel toothpaste can be sold at a slightly higher price, given its formulation and taste, but the variable costs are also higher. Hence, the gel toothpaste has a lower contribution per unit. Therefore, for every unit of the gel toothpaste sold instead of a unit of the opaque white toothpaste, the firm “loses” $0.10. Suppose further that the company expects to sell 1 million units of the new gel toothpaste in the first year after introduction and that, of that amount, 500,000 units will be diverted from the opaque white toothpaste, of which the company had expected to sell 1 million units. The task of the marketing manager is to determine how the introduction of the new gel toothpaste will affect Brand X’s total contribution dollars. One approach to assessing the financial impact of cannibalization is shown here: 1. Brand X expects to lose $0.10 for each unit diverted from the opaque white toothpaste to the gel toothpaste. 2. Given that 500,000 units will be cannibalized from the opaque white toothpaste, the total contribution lost is $50,000 ($0.10 × 500,000 units). 3. However, the new gel toothpaste will sell an additional 500,000 units at a contribution per unit of $0.70, which means that $350,000 ($0.70 × 500,000 units) in additional contribution will be generated. 4. Therefore, the net financial effect is a positive increase in contribution dollars of $300,000 ($350,000 $50,000). Another approach to assessing the cannibalization effect is as follows: 1. The opaque white toothpaste alone had been expected to sell 1 million units with a unit contribution of $0.80. Therefore, contribution dollars without the gel would equal $800,000 ($0.80 × 1,000,000 units). 2. The gel toothpaste is expected to sell 1 million units with a unit contribution of $0.70. 3. Given the cannibalism rate of 50 percent (that is, one-half of the gel’s volume is diverted from the opaque white toothpaste), the combined contribution can be calculated as follows: CONTRIBUTION ANALYSIS 41 41 Unit Unit Contribution Product Volume Contribution Dollars Opaque white toothpaste 500,000 $0.80 $400,000 Gel toothpaste: Cannibalized volume 500,000 0.70 350,000 Incremental volume __5__0_0_,0_0_0_ 0.70 ____3_5_0_,0_0_0_ Total 1,500,000 $1,100,000 Less original forecast volume for opaque white toothpaste 1_,_0__0_0_,0_0_0_ 0.80 ____8_0_0_,0_0_0_ Total 500,000 $300,000 Both approaches arrive at the same conclusion: Brand X will benefit by $300,000 from the introduction of the gel toothpaste. The manager should use whichever approach he or she is more comfortable with in an analytic sense. It should be emphasized, however, that the incremental fixed costs associated with advertising and sales promotion or any additions or changes in manufacturing capacity must be considered to complete the analysis. If the fixed costs approximate or exceed $300,000, the new product should be viewed in a very different light. ¦ LIQUIDITY Liquidity refers to an organization’s ability to meet short-term (usually within a budget year) financial obligations. A key measure of an organization’s liquidity position is its working capital. Working capital is the dollar value of an organization’s current assets (such as cash, accounts receivable, prepaid expenses, inventory) minus the dollar value of current liabilities (such as short-term accounts payable for goods and services, income taxes). A manager should be aware of the impact of marketing actions on working capital. Marketing expenditures precede sales volume; therefore, cash outlays for marketing efforts reduce current assets. If marketing expenditures cannot be met out of cash, accounts payable are incurred. In either case, working capital is reduced. In a positive vein, a marketing manager’s creation of sales volume, with corresponding increases in net profit, contributes to working capital. Since the timing of marketing expenditures and sales volume is often lagged, a marketing manager must be wary of marketing efforts that unnecessarily deplete working capital and must assess the likelihood of potential sales, given a specified expenditure level. ¦ OPERATING LEVERAGE A financial concept closely akin to break-even analysis is operating leverage. Operating leverage refers to the extent to which fixed costs and variable costs are used in the production and marketing of products and services. Firms that have high total fixed costs relative to total variable costs are defined as having high operating leverage. Examples of firms with high operating leverage include airlines and heavyequipment manufacturers. Firms with low total fixed costs relative to total variable costs are defined as having low operating leverage. Firms typically having low operating leverage include residential contractors and wholesale distributors. The higher a firm’s operating leverage, the faster its total profits will increase once sales exceed break-even volume. By the same token, however, those firms with high operating leverage will incur losses at a faster rate once sales volume falls below the break-even point. 42 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT 42 Exhibit 2.2 illustrates the effect of operating leverage on profit. The base case shows two firms that have identical break-even sales volumes. The cost structures of the two firms differ, however, with one having high fixed and low variable costs and the other having low fixed and high variable costs. Note that when sales volume is increased 10 percent, the firm with high fixed and low variable costs achieves a much higher profit than the firm with low fixed and high variable costs. When sales volume declines, however, just the opposite is true. That is, the firm with high fixed and low variable costs incurs losses at a faster rate than the firm with high variable and low fixed costs once sales fall below the break-even point. The message of operating leverage should be clear from this example. Firms with high operating leverage benefit more from sales gains than do firms with low operating leverage. At the same time, firms with high operating leverage are more sensitive to sales-volume declines, since losses will be incurred at a faster rate. Knowledge of a firm’s cost structure will, therefore, prove valuable in assessing the gains and losses from changes in sales volume brought about by marketing efforts. ¦ DISCOUNTED CASH FLOW Another useful concept from finance is discounted cash flow. Discounted cash flow incorporates the theory of the time value of money, or present-value analysis. The idea behind the present value of money is that a dollar received next year is not equivalent to a dollar received today because the use of money has a value reflected by risk, inflation, and opportunity cost.To illustrate, if $500 can be invested today at 10 percent, $550 will be received a year later ($500 10% of $500). In other words, $550 to be received next year has a present value of $500 if 10 percent can be earned ($550/1.10 = $500). Following this line of reasoning, the estimated results of an investment (e.g., a business) can be stated as a cash equivalent at the present time (i.e., its present value). Discounted cash flows are future cash flows expressed in terms of their present value. The discounted cash flow technique employs this reasoning by evaluating the present value of a business’s net cash flow (cash inflows minus cash outflows). A simplified view of cash flow is “cash flow from operations,”which is net income plus depreciation charges, because depreciation is a noncash charge against sales to determine net income. The present value of a stream of cash flows is obtained by selecting an interest or discount rate at which these flows are to be valued, or discounted, and the timing of each. The interest or discount rate is often defined by the opportunity cost of capital— the cost of earnings opportunities forgone by investing in a business with its attendant risk as opposed to investing in risk-free securities such as U.S. Treasury bills. DISCOUNTED CASH FLOW 43 E X H I B I T 2 . 2 Effect of Operating Leverage on Profit Base Case 10% Increase in Sales 10% Decrease in Sales High-Fixed- High-Variable- High-Fixed- High-Variable- High-Fixed- High-Variable- Cost Firm Cost Firm Cost Firm Cost Firm Cost Firm Cost Firm Sales $100,000 $100,000 $110,000 $110,000 $90,000 $90,000 Variable costs 20,000 80,000 22,000 88,000 18,000 72,000 Fixed costs ___8_0_,0_0_0_ ___2_0_,0_0_0_ ___8_0_,0_0_0_ ___2_0_,0_0_0_ ___8_0_,0_0__0_ __2_0_,_0_0_0_ Profit $0 $0 $8,000 $2,000 ($8,000) ($2,000) 43 A simple application of discounted cash flow analysis illustrates the mechanics involved. Suppose, for example, that a firm is considering investing $105,000 in one of two businesses. The firm has forecast cash flows for each business over the next five years. The discount rate adopted by the firm is 15 percent. Given the discount rate of 15 percent, the cash flow when the investment is made is a negative $105,000 (no cash inflows, only outflows). The first-year cash flow for Business A is discounted by the factor 1/(1 0.15),1 or $25,000 × 0.870 $21,750. The second-year cash flow for Business A is discounted by the factor 1/(1 0.15),2 or $35,000 × 0.756 $26,460, and so forth. Exhibit 2.3 shows the complete analysis for Businesses A and B for the five-year planning horizon. Three points are of particular interest. First, an important series of numbers is the cumulative cash flow. This series shows that the cumulative cash flows from Business B are greater than from Business A. Second, the payback period is two years for Business B, as opposed to about three years for Business A. In other words, Business B will recover its investment sooner than will Business A. Finally, the discounted cash flows incorporating the time value of money are clearly indicated. Business A will produce a higher cash flow in later years than will Business B. However, the present value of these cash flows, when discounted, is less than the value of the cash flows that Business B will produce. From a decision-making perspective, both businesses produce a positive net present value. This is important given the decision rule when interpreting net present value: An investment should be accepted if the net present value is positive and rejected if it is negative. In which business should the firm invest its capital? Assuming that the firm wishes to create value for its shareholders, the option with the higher net present value (Business B) is preferred. A valuable characteristic of present-value analysis is that the discount factors and discounted cash are additive. If the projected cash flows from an investment are equal over a specified time period, summing the discount factors for each of the time periods (say three years) and multiplying this figure by the annual cash flow estimate will give the present value. Suppose, for example, that a firm can expect a constant cash flow of $10 million per year for three years, and the discount rate is 15 percent. The present value of this cash flow can be computed as follows (in millions of dollars): 0.870 $10 $8.70 0.756 $10 $7.56 0.658 $10 $6.58 2.284 $10 $22.84 44 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT E X H I B I T 2 . 3 Application of Discounted Cash Flow Analysis with a 15 Percent Discount Factor Business A Business B Discount Cumulative Discounted Cumulative Discounted Year Factor Cash Flow Cash Flow Cash Flow Cash Flow Cash Flow Cash Flow 0 1.000 ($105,000) ($105,000) ($105,000) ($105,000) ($105,000) ($105,000) 1 0.870 25,000 (80,000) 21,750 50,000 (55,000) 43,500 2 0.756 35,000 (45,000) 26,460 55,000 0 41,580 3 0.658 50,000 5,000 32,900 60,000 60,000 39,480 4 0.572 70,000 75,000 40,040 65,000 125,000 37,180 5 0.497 90,000 165,000 ____4_4__,7_3_0_ 70,000 195,000 _____3_4_,7_9_0_ Totals $60,880 $91,530 44 Any basic finance textbook covers discounted cash flow in depth and should be consulted for further study. As a word of caution, the application of discounted cash flow analysis is deceptively simple. Determining appropriate discount rates and projecting future cash flows is not an easy task. Conservative estimates and the use of several “what if”scenarios will ensure that the discounted cash flow technique will highlight investment opportunities that create value for the firm and its shareholders. ¦ CUSTOMER LIFETIME VALUE Many contemporary marketing managers apply present-value analysis to identify the financial consequences of an organization’s long-term customer relationships. They do this by estimating customer lifetime value. Customer lifetime value (CLV) is the present value of future cash flows arising from a customer relationship. Recall from the previous discussion on present-value analysis, the present value of any stream of future cash flows is designed to measure the single lump-sum dollar value today of future cash flows. CLV is simply that lump-sum dollar value of a customer relationship. Once known, the estimated CLV sets the upper bound for how much a company would be willing to pay to attract and retain a customer. A variety of approaches are used to estimate CLV. The approach described here includes the basic variables used and their relationships in arriving at CLV. The CLV calculation requires three pieces of information: (1) the per-period (month or year) cash margin per customer ($M), defined as sales revenue minus variable costs and other traceable cash expenditures necessary to keep the customer; (2) the retention rate (r), defined as the per-period probability that the customer will be retained, and (3) the interest rate (i ) used for discounting future cash flows. A formula for calculating CLV, assuming a constant per-period margin, a constant per-period retention rate, and an infinite time horizon, can be written as follows: Customer Lifetime Value M $ 1 1 i r ? ? ? ? ? ? CUSTOMER LIFETIME VALUE 45 These simplifying assumptions are made for expository purposes. More complex CLV formulas incorporate changing margins and retention rates per-period and limited (5-year or 10-year) time horizons. Their description is beyond the scope of this discussion. However, if per-period margins vary little across periods, per-period retention rates are 80 percent or less, and the interest rate for discounting future cash flows is 20 percent or less, the simplifying assumptions result in a CLV estimate that is close to that derived from more complex CLV formulations. To illustrate the CLV calculation, consider a credit card company. It has a cardmember with an annual margin of $2,000. The typical retention rate for cardmembers is 80 percent. The applicable interest rate to discount future cash flows is 10 percent. Therefore, this cardmember has a CLV of $6,666.67: If the credit card company increases the cardmember retention rate to 90 percent (which represents a 12.5 percent increase), then the CLV would almost double to $10,000.00: This example demonstrates the favorable financial effect of increasing the retention rate, or loyalty, among profitable customers. CLV$2,000 $10,000.00 1 1 .10 .90 ? ? ? ? ? ? CLV $2,000 1 1 .10 80 $6.666.67 . ? ? ? ? ? ? 45 Suppose the credit card company observes that cardmember activity grows over time and the margin increases at a constant rate (g) of 6 percent per year. The CLV formula can be modified slightly to include this constant margin growth rate: Customer Lifetime Value with constant $M margin growth Therefore, for a cardmember with an initial $2,000 margin that grows at a constant rate of 6 percent per year, an 80 percent retention rate, and a company discount rate of 10 percent, the CLV is $8,333.33: CLV (constant margin growth) $2,000 $8,333.33 This example illustrates the favorable financial effect of increasing business from a profitable customer. Marketing efforts play a major role in two of the three determinants of CLV: (1) customer margin, including margin growth, and (2) customer retention. For example, margin results from the price(s) paid for a company’s offering(s) as well as the amount purchased. Companies attempt to increase margin by cross-selling related offerings to customers and up-selling; that is, selling customers more expensive offerings. Retention obviously results from customer satisfaction with a company’s offerings. In addition, companies often use loyalty programs that reward loyal customers for buying repeatedly and in substantial amounts. Some companies modify the CLV formula to include the cost of acquiring a customer. In this instance, the acquisition cost (AC) is subtracted to arrive at a net present value CLV as shown below: Customer Lifetime Value including Acquisition $M AC Cost Even though the CLV calculation is straightforward, its application requires considerable insight into a company’s customer relationships. Per-period margin and retention rates can be determined either through analysis of the company’s customer database or industry norms. Still, the task is challenging. For example, while the revenue from a customer is relatively easy to identify, tracing acquisition and retention cash expenditures to a specific customer is often difficult. ¦ PREPARING A PRO FORMA INCOME STATEMENT Because marketing managers are accountable for the profit impact of their actions, they must translate their strategies and tactics into pro forma, or projected, income statements. A pro forma income statement displays projected revenues, budgeted expenses, and estimated net profit for an organization, product, or service during a specific planning period, usually a year. Pro forma income statements include a sales forecast and a listing of variable and fixed costs that can be programmed or committed. Pro forma income statements can be prepared in different ways and reflect varying levels of specificity. Exhibit 2.4 shows a typical layout for a pro forma income statement consisting of six major categories or line items: 1. Sales—forecasted unit volume times unit selling price. 2. Cost of goods sold—costs incurred in buying or producing products and services. Generally speaking, these costs are constant per unit within certain volume ranges and vary with total unit volume. 1 1ir ? ? ? ? ? ? 1 1.10.80.06 ? ? ? ? ? ? 1 1irg ? ? ? ? ? ? 46 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT 46 3. Gross margin (sometimes called gross profit)—represents the remainder after cost of goods sold has been subtracted from sales. 4. Marketing expenses—generally, programmed expenses budgeted to produce sales. Advertising expenses are typically fixed. Sales expenses can be fixed, such as a salesperson’s salary, or variable, such as sales commissions. Freight or delivery expenses are typically constant per unit and vary with total unit volume. 5. General and administrative expenses—generally, committed fixed costs for the planning period, which cannot be avoided if the organization is to operate. These costs are frequently called overhead. 6. Net income before (income) taxes (often called net profit before taxes)—the remainder after all costs have been subtracted from sales. A pro forma income statement reflects a marketing manager’s expectations (sales) given certain inputs (costs). This means that a manager must think specifically about customer response to strategies and tactics and focus attention on the organization’s financial objectives of profitability and growth when preparing a pro forma income statement. ¦ SUMMARY This chapter provides an overview of basic accounting and financial concepts. A word of caution is necessary, however. Financial analysis of marketing actions is a necessary but insufficient criterion for justifying marketing programs. A careful analysis of other variables impinging on the decision at hand is required. Thus, judgment enters the picture. “Numbers”serve only to complement general marketing analysis skills and are not an end in themselves. In this regard, it is wise to consider some words of Albert Einstein:“Not everything that counts can be counted, and not everything that can be counted counts.” SUMMARY 47 E X H I B I T 2 . 4 Pro Forma Income Statement for the 12-Month Period Ended December 31, 2006 Sales $1,000,000 Cost of goods sold 500,000 Gross margin $500,000 Marketing expenses Sales expenses $170,000 Advertising expenses 90,000 Freight or delivery expenses 40,000 300,000 General and administrative expenses Administrative salaries $120,000 Depreciation on buildings and equipment 20,000 Interest expense 5,000 Property taxes and insurance 5,000 Other administrative expenses 5,000 155,000 Net profit before (income) tax $45,000 47 EXERCISES 1. Executives of Studio Recordings, Inc. produced the latest compact disc by the Starshine Sisters Band, titled Sunshine/Moonshine. The following cost information pertains to the new CD: CD package and disc (direct material and labor) $1.25/CD Songwriters’ royalties $0.35/CD Recording artists’ royalties $1.00/CD Advertising and promotion $275,000 Studio Recordings, Inc.’s overhead $250,000 Selling price to CD distributor $9.00 Calculate the following: a. Contribution per CD unit b. Break-even volume in CD units and dollars c. Net profit if 1 million CDs are sold d. Necessary CD unit volume to achieve a $200,000 profit 2. Video Concepts, Inc. (VCI) markets video equipment and film through a variety of retail outlets. Presently, VCI is faced with a decision as to whether it should obtain the distribution rights to an unreleased film titled Touch of Orange. If this film is distributed by VCI directly to large retailers,VCI’s investment in the project would be $150,000.VCI estimates the total market for the film to be 100,000 units. Other data available are as follows: Cost of distribution rights for film $125,000 Label design 5,000 Package design 10,000 Advertising 35,000 Reproduction of copies (per 1,000) 4,000 Manufacture of labels and packaging (per 1,000) 500 Royalties (per 1,000) 500 VCI’s suggested retail price for the film is $20 per unit. The retailer’s margin is 40 percent. a. What is VCI’s unit contribution and contribution margin? b. What is the break-even point in units? In dollars? c. What share of the market would the film have to achieve to earn a 20 percent return on VCI’s investment the first year? 3. The group product manager for ointments at American Therapeutic Corporation was reviewing price and promotion alternatives for two products: Rash- Away and Red-Away. Both products were designed to reduce skin irritation, but Red-Away was primarily a cosmetic treatment whereas Rash-Away also included a compound that eliminated the rash. The price and promotion alternatives recommended for the two products by their respective brand managers included the possibility of using additional promotion or a price reduction to stimulate sales volume. A volume, price, and cost summary for the two products follows: Rash-Away Red-Away Unit price $2.00 $1.00 Unit variable costs 1.40 0.25 48 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT 48 Unit contribution $0.60 $0.75 Unit volume 1,000,000 units 1,500,000 units Both brand managers included a recommendation to either reduce price by 10 percent or invest an incremental $150,000 in advertising. a. What absolute increase in unit sales and dollar sales will be necessary to recoup the incremental increase in advertising expenditures for Rash-Away? For Red-Away? b. How many additional sales dollars must be produced to cover each $1.00 of incremental advertising for Rash-Away? For Red-Away? c. What absolute increase in unit sales and dollar sales will be necessary to maintain the level of total contribution dollars if the price of each product is reduced by 10 percent? 4. After spending $300,000 for research and development, chemists at Diversified Citrus Industries have developed a new breakfast drink. The drink, called Zap, will provide the consumer with twice the amount of vitamin C currently available in breakfast drinks. Zap will be packaged in an 8-ounce can and will be introduced to the breakfast drink market, which is estimated to be equivalent to 21 million 8-ounce cans nationally. One major management concern is the lack of funds available for marketing. Accordingly, management has decided to use newspapers (rather than television) to promote Zap in the introductory year and distribute Zap in major metropolitan areas that account for 65 percent of U.S. breakfast drink volume. Newspaper advertising will carry a coupon that will entitle the consumer to receive $0.20 off the price of the first can purchased. The retailer will receive the regular margin and be reimbursed for redeemed coupons by Diversified Citrus Industries. Past experience indicates that for every five cans sold during the introductory year, one coupon will be returned. The cost of the newspaper advertising campaign (excluding coupon returns) will be $250,000. Other fixed overhead costs are expected to be $90,000 per year. Management has decided that the suggested retail price to the consumer for the 8-ounce can will be $0.50. The only unit variable costs for the product are $0.18 for materials and $0.06 for labor. The company intends to give retailers a margin of 20 percent off the suggested retail price and wholesalers a margin of 10 percent of the retailers’ cost of the item. a. At what price will Diversified Citrus Industries be selling its product to wholesalers? b. What is the contribution per unit for Zap? c. What is the break-even unit volume in the first year? d. What is the first-year break-even share of market? 5. Video Concepts, Inc. (VCI) manufactures a line of DVD recorders (DVDs) that are distributed to large retailers. The line consists of three models of DVDs. The following data are available regarding the models: DVD Selling Price Variable Cost Demand/Year Model per Unit per Unit (units) Model LX1 $175 $100 2,000 Model LX2 250 125 1,000 Model LX3 300 140 500 VCI is considering the addition of a fourth model to its line of DVDs. This model would be sold to retailers for $375. The variable cost of this unit is $225. EXERCISES 49 49 The demand for the new Model LX4 is estimated to be 300 units per year. Sixty percent of these unit sales of the new model is expected to come from other models already being manufactured by VCI (10 percent from Model LX1, 30 percent from Model LX2, and 60 percent from Model LX3).VCI will incur a fixed cost of $20,000 to add the new model to the line. Based on the preceding data, should VCI add the new Model LX4 to its line of VCRs? Why? 6. Max Leonard, vice president of Marketing for Dysk Computer, Inc., must decide whether to introduce a midpriced version of the firm’s DC6900 personal computer product line—the DC6900-X. The DC6900-X would sell for $3,900, with unit variable costs of $1,800. Projections made by an independent marketing research firm indicate that the DC6900-X would achieve a sales volume of 500,000 units next year, in its first year of commercialization. One-half of the first year’s volume would come from competitors’ personal computers and market growth. However, a consumer research study indicates that 30 percent of the DC6900-X sales volume would come from the higherpriced DC6900-Omega personal computer, which sells for $5,900 (with unit variable costs of $2,200). Another 20 percent of the DC6900-X sales volume would come from the economy-priced DC6900-Alpha personal computer, priced at $2,500 (with unit variable costs of $1,200). The DC6900-Omega unit volume is expected to be 400,000 units next year, and the DC6900-Alpha is expected to achieve a 600,000-unit sales level. The fixed costs of launching the DC6900-X have been forecast to be $2 million during the first year of commercialization. Should Mr. Leonard add the DC6900-X model to the line of personal computers? Why? 7. A sports nutrition company is examining whether a new high-performance sports drink should be added to its product line. A preliminary feasibility analysis indicated that the company would need to invest $17.5 million in a new manufacturing facility to produce and package the product. A financial analysis using sales and cost data supplied by marketing and production personnel indicated that the net cash flow (cash inflows minus cash outflows) would be $6.1 million in the first year of commercialization, $7.4 million in year 2, $7.0 million in year 3, and $5.5 million in year 4. Senior company executives were undecided whether to move forward with the development of the new product. They requested that a discounted cash flow analysis be performed using two different discount rates:20 percent and 15 percent. a. Should the company proceed with development of the product if the discount rate is 20 percent? Why? b. Does the decision to proceed with development of the product change if the discount rate is 15 percent? Why? 8. Net-4-You is an Internet Service Provider that charges its 1 million customers $19.95 per month for its service. The company’s variable costs are $.50 per customer per month. In addition, the company spends $.50 per month per customer, or $6 million annually, on a customer loyalty program designed to retain customers. As a result, the company’s monthly customer retention rate was 78.8 percent. Net-4-You has a monthly discount rate of 1 percent. a. What is the customer lifetime value? b. Suppose the company wanted to increase its customers’ monthly retention rate and decided to spend an additional $.20 per month per customer to upgrade its loyalty program benefits. By how much must Net-4-You increase its monthly customer retention rate so as not to reduce customer lifetime value resulting from a lower customer margin? 50 CHAPTER 2 FINANCIAL ASPECTS OF MARKETING MANAGEMENT 50 9. The annual planning process at Century Office Systems, Inc. had been arduous but produced a number of important marketing initiatives for the next year. Most notably, company executives had decided to restructure its product-marketing team into two separate groups: (1) Corporate Office Systems and (2) Home Office Systems. Angela Blake was assigned responsibility for the Home Office Systems group, which would market the company’s word-processing hardware and software for home and office-at-home use by individuals. Her marketing plan, which included a sales forecast for next year of $25 million,was the result of a detailed market analysis and negotiations with individuals both inside and outside the company. Discussions with the sales director indicated that 40 percent of the company sales force would be dedicated to selling products of the Home Office Systems group. Sales representatives would receive a 15 percent commission on sales of home office systems. Under the new organizational structure, the Home Office Systems group would be charged with 40 percent of the budgeted sales force expenditure. The sales director’s budget for salaries and fringe benefits of the sales force and noncommission selling costs for both the Corporate and Home Office Systems groups was $7.5 million. The advertising and promotion budget contained three elements: trade magazine advertising, cooperative newspaper advertising with Century Office Systems, Inc. dealers, and sales promotion materials including product brochures, technical manuals, catalogs, and point-of-purchase displays. Trade magazine ads and sales promotion materials were to be developed by the company’s advertising and public relations agency. Production and media placement costs were budgeted at $300,000. Cooperative advertising copy for both newspaper and radio use had budgeted production costs of $100,000. Century Office Systems, Inc.’s cooperative advertising allowance policy stated that the company would allocate 5 percent of company sales to dealers to promote its office systems. Dealers always used their complete cooperative advertising allowances. Meetings with manufacturing and operations personnel indicated that the direct costs of material and labor and direct factory overhead to produce the Home Office System product line represented 50 percent of sales. The accounting department would assign $600,000 in indirect manufacturing overhead (for example, depreciation, maintenance) to the product line and $300,000 for administrative overhead (clerical, telephone, office space, and so forth). Freight for the product line would average 8 percent of sales. Blake’s staff consisted of two product managers and a marketing assistant. Salaries and fringe benefits for Ms. Blake and her staff were $250,000 per year. a. Prepare a pro forma income statement for the Home Office Systems group given the information provided. b. Prepare a pro forma income statement for the Home Office Systems group given annual sales of only $20 million. c. At what level of dollar sales will the Home Office Systems group break even? EXERCISES 51 51 52 C H A P T E R 3 Marketing Decision Making and Case Analysis Skill in decision making is a prerequisite to being an effective marketing manager. Indeed, Nobel laureate Herbert Simon viewed managing and decision making as being one and the same.1 Another management theorist, Peter Drucker, has said that the burden of decision making can be lessened and better decisions can result if a manager recognizes that “decision making is a rational and systematic process and that its organization is a definite sequence of steps, each of them in turn rational and systematic.”2 One objective of this chapter is to introduce a systematic process for decision making; another is to introduce basic considerations in case analysis. Just as decision making and managing can be viewed as being identical in scope, so the decision-making process and case analysis go hand in hand. For this reason,many companies today use case studies when interviewing an applicant to assess his or her decision-making skills.They have found that the applicant’s approach to the case demonstrates strategic thinking, analytical ability and judgment, along with a variety of communication skills, including listening, questioning, and dealing with confrontation.3 ¦ DECISION-MAKING PROCESS Although no simple formula exists that can assure a correct solution to all problems at all times, use of a systematic decision-making process can increase the likelihood of arriving at better solutions.4 The decision-making process described here is called DECIDE:5 Define the problem. Enumerate the decision factors. Consider relevant information. Identify the best alternative. Develop a plan for implementing the chosen alternative. Evaluate the decision and the decision process. A definition and a discussion of the implications of each step follow. 53 53 54 CHAPTER 3 MARKETING DECISION MAKING AND CASE ANALYSIS Define the Problem The philosopher John Dewey observed that “a problem well defined is half solved.” What this statement means in a marketing setting is that a well-defined problem outlines the framework within which a solution can be derived. This framework includes the objectives of the decision maker, a recognition of constraints, and a clearly articulated success measure, or goal, for assessing progress toward solving the problem. Consider the situation faced by El Nacho Foods, a marketer of Mexican foods. The company had positioned its line of Mexican foods as a high-quality brand and used advertising effectively to convey that message. Shortly after the company’s introduction of frozen dinners, two of its competitors began cutting the price of their frozen dinner entrees. The firm lost market share and sales as a result of these price reductions; this loss led to reductions in the contribution dollars available for advertising and sales promotion. How might the problem be defined in this situation? One definition of the problem leads to the question: “Should we reduce our price?”A much better definition of the problem leads one to ask: “How can we maintain our quality brand image (objective) and regain our lost market share (success measure), given limited funds for advertising and sales promotion (constraint)?” The first problem definition asks for a response to an immediate issue facing the company. It does not articulate the broader and more important considerations of competitive positioning. Hence, the problem statement fails to capture the significance of the issue raised. The second definition provides a broader perspective on the immediate issue posed and allows the manager greater latitude in seeking solutions. In a case study, the analyst is frequently given alternative courses of action to consider. The narrow approach to case analysis is simply to compare these different options. Such an approach often leads to the selection of alternative A or alternative B without regard to the significance of the choice in the broader context of the situation facing the company or the decision maker. Enumerate the Decision Factors Two sets of decision factors must be enumerated in the decision-making process: (1) alternative courses of action, and (2) uncertainties in the competitive environment. Alternative courses of action are controllable decision factors because the decision maker has complete command of them. Alternatives are typically productmarket strategies or changes in the various elements of the organization’s marketing mix (described in Chapter 1). Uncertainties, on the other hand, are uncontrollable factors that the manager cannot influence. In a marketing context, they often include actions of competitors, market size, and buyer response to marketing action. Assumptions often have to be made concerning these factors. These assumptions need to be spelled out, particularly if they will influence the evaluation of alternative courses of action. The experience of Cluett Peabody and Company, the maker of Arrow shirts, illustrates how the combination of an action and uncertainties can spell disaster. Arrow departed from its normal practice of selling classic men’s shirts to offer a new line featuring bolder colors, busier patterns, and higher prices (action). The firm soon realized that men’s tastes had changed to more conservative styles (environmental uncertainties). The result? The company posted a $4.5 million loss. According to the company president,“We tried to be exciting, and we really didn’t look at the market.”6 Case analysis provides an opportunity to relate alternatives to uncertainties, and these factors must be related if decision making is to be effective. No expected outcome, financial or otherwise, of a chosen course of action can realistically be considered apart from the environment into which it is introduced. 54 DECISION-MAKING PROCESS 55 Consider Relevant Information The third step in the decision-making process is the consideration of relevant information. Relevant information, like the relevant costs discussed in Chapter 2, consists of information that relates to the alternatives identified by the manager as being likely to affect future events. More specifically, relevant information might include characteristics of the industry, consumers, or competitive environment, characteristics of the organization (such as competitive strengths and position), and characteristics of the alternatives themselves. Identifying relevant information is difficult both for the practicing manager and for the case analyst. There is frequently an overabundance of facts, figures, and viewpoints available in any decision-making setting. In fact, it has been said that “The truly successful managers and leaders of the [twenty-first] century will . . . be characterized not by how they can access information, but how they can access the most relevant information and differentiate it from the exponentially multiplying masses of nonrelevant information.” 7 Determining what matters and what does not is a skill that is best gained through experience. Analyzing many and varied cases is one way to develop this skill. Two notes of caution are necessary. First, the case analyst must resist the temptation to consider everything in a case as “fact.”Many cases, including actual marketing situations, contain conflicting data. Part of the task in any case analysis is to exercise judgment in assessing the validity of the data presented. Second, in many instances relevant information must be created. An example of creating relevant information is the blending together of several pieces of data, as in the calculation of a simple break-even point. It should be clear at this point that even though the consideration of relevant information is the third step in the decision-making process, relevant information will also affect the two previous steps. As the manager or case analyst becomes more deeply involved in considering and evaluating information, the problem definition may be modified or the decision factors may change. Upon the conclusion of the first three steps, the manager or case analyst has completed a situation analysis. The situation analysis should produce an answer to the synoptic question,“Where are we now?”(Specific questions relating to situation analysis are found in Exhibit 3.4 on page 60.) Identify the Best Alternative Identifying the best alternative is the fourth step in the decision-making process. The selection of a course of action is not simply a matter of choosing Alternative A over other alternatives but, rather, of evaluating identified alternatives and the uncertainties apparent in the problem setting. A framework for identifying the best alternative is decision analysis, which was introduced in Chapter 1. In its simplest form, decision analysis matches each alternative identified by the manager with the uncertainties existing in the environment and assigns a quantitative value to the outcome associated with each match. Managers implicitly use a decision tree and a payoff table to describe the relationship among alternatives, uncertainties, and potential outcomes. The use of decision analysis and the application of decision trees and payoff tables can be illustrated by referring back to the situation faced by El Nacho Foods. Suppose that at the conclusion of Step 2 in the DECIDE process (that is, enumerating decision factors), El Nacho executives identified two alternatives: (1) reduce the price on frozen dinners, or (2) maintain the price. They also recognized two uncertainties: (1) Competitors could maintain the lower price, or (2) competitors could reduce the price further. Suppose further that at the conclusion of Step 3 in the DECIDE process (considering relevant information), El Nacho executives examined the changes in market share and sales volume that would be brought about by the pricing actions. They also calculated the contribution per unit of frozen dinners for each alternative for each competitor response. They performed a contribution analysis because 55 56 CHAPTER 3 MARKETING DECISION MAKING AND CASE ANALYSIS the problem was defined in terms of contribution to advertising and sales promotion in Step 1 of the DECIDE process (defining the problem). Given two alternatives, two competitive responses, and a calculated contribution per unit for each combination, they identified four unique financial outcomes. These outcomes are displayed in the decision tree shown in Exhibit 3.1. It is apparent from the decision tree that the largest contribution will be generated if El Nacho maintains its price on frozen dinners and competitors maintain their lower price. If El Nacho maintains its price and competitors reduce their price further, however, the lowest contribution among the four outcomes identified will be generated. The choice of an alternative obviously depends on the likelihood of occurrence of uncertainties in the environment. A payoff table is a useful tool for displaying the alternatives, uncertainties, and outcomes facing a firm. In addition, a payoff table includes another dimension— management’s subjective determination of the probability of the occurrence of an uncertainty. Suppose, for example, that El Nacho management believes that competitors are also operating with slim contribution margins and, hence, are most likely to maintain the lower price regardless of El Nacho’s action. They believe that there is a 10 percent chance that competitors will reduce the price of frozen dinners even further. 8 Since only two uncertainties have been identified, the subjective probability of competitors’ maintaining their price is 90 percent (note that the probabilities assigned to the uncertainties must total 1.0, or 100 percent). Given these probabilities, the payoff table for El Nacho Foods is shown in Exhibit 3.2. The payoff table allows the manager or case analyst to compute the “expected monetary value” for each alternative. The expected monetary value is calculated by multiplying the outcome for each uncertainty by its probability of occurrence and E X H I B I T 3 . 1 Decision Tree for El Nacho Foods Company Competitive Financial Action Response Outcome Maintain price $150,000 Reduce price Reduce price further $110,000 Maintain price $175,000 Maintain price Reduce price further $90,000 E X H I B I T 3 . 2 Payoff Table for El Nacho Foods Uncertainties Competitors Competitors Maintain Price Reduce Price (Probability = 0.9) (Probability = 0.1) Reduce price $150,000 $110,000 Alternatives Maintain price $175,000 $90,000 56 DECISION-MAKING PROCESS 57 then totaling across the uncertainties for each alternative. The expected monetary value of an alternative can be viewed as the value that would be obtained if the manager were to choose the same alternative many times under the same conditions. The expected monetary value of the price-reduction alternative equals the probability that competitors will maintain prices,multiplied by the financial contribution if competitors maintain prices, plus the probability that competitors will further reduce prices, multiplied by the financial contribution if competitors further reduce prices. The calculation is (0.9)($150,000) (0.1)($110,000) $135,000 $11,000 $146,000 The expected monetary value of maintaining the price is (0.9)($175,000) (0.1)($90,000) $157,500 $9,000 $166,500 The higher average contribution of $166,500 for maintaining the price indicates that El Nacho’s management should maintain the price. The contribution is higher because competitors are expected to maintain their prices nine times out of ten. Under the same conditions (same outcomes, same probability estimates), El Nacho would achieve an average contribution of $146,000 if the price-reduction alternative were chosen. A rational management would, therefore, select the price-maintenance alternative. Familiarity with decision analysis is important for four reasons. First, decision analysis is a fundamental tool for considering “what if” situations. By organizing alternatives, uncertainties, and outcomes in this manner, a manager or case analyst becomes sensitive to the dynamic processes present in a competitive environment. Second, decision analysis forces the case analyst to quantify outcomes associated with specific actions. Third, decision analysis is useful in a variety of settings. For example,Warner-Lambert Canada, Ltd. applied decision analysis when deciding to manufacture and distribute Listerine throat lozenges in Canada; Ford Motor Company used decision analysis in deciding whether to produce its own tires; and Pillsbury used it in determining whether to switch from a box to a bag for a certain grocery product.9 Fourth, an extension of decision analysis can be used in determining the value of “perfect”information. Exhibit 3.3 shows how the expected monetary value of “perfect” information (EMVPI) can be calculated using the El Nacho Foods example. Simply speaking, E X H I B I T 3 . 3 Decision Analysis and the Value of Information Payoff Table Uncertainties Competitors Competitors Maintain Price Reduce Price (Probability = 0.9) (Probability = 0.1) A1:Reduce price $150,000 $110,000 Alternatives A2: Maintain price $175,000 $90,000 Calculation of Expected Monetary Value (EMV): EMVA1 = 0.9($150,000) 0.1($110,000) = $146,000 EMVA2 = 0.9($175,000) 0.1($90,000) = $166,500 Calculation of Expected Monetary Value of Perfect Information (EMVPI): EMVcertainty = 0.9($175,000) 0.1($110,000) = $168,500 EMVPI = EMVcertainty EMVbest alternative EMVPI = $168,500 $166,500 = $2,000 57 58 CHAPTER 3 MARKETING DECISION MAKING AND CASE ANALYSIS EMVPI is the difference between what El Nacho would achieve in contribution dollars if its management knew for certain what competitors would do and the average contribution dollars realized without such information. In other words, if El Nacho knew for certain that competitors would maintain their price, the “maintain price” alternative would be selected. If El Nacho management knew for certain that competitors would reduce their price, however, the “reduce price” alternative would be chosen. Assuming El Nacho management faced this decision 10 times and knew what competitor reaction would be each time, El Nacho management would make the appropriate decision each time. The result would be an expected monetary value of $168,500. The difference of $2,000 between $168,500 and $166,500 (the best alternative without such information) is viewed as the upper limit to pay for “perfect” information. EMVPI is a useful guide for determining how much money should be spent for marketing research information to identify the best alternative or course of action. Develop a Plan for Implementing the Chosen Alternative The selection of a course of action must be followed by development of a plan for its implementation. Simply deciding what to do will not make it happen. The execution phase is critical, and planning for it forces the case analyst to consider resource allocation and timing questions. For example, if a new product launch is recommended, it is important to consider how managerial, financial, and manufacturing resources will be allocated to this course of action. If a price reduction is recommended, it will be important to monitor whether the reduced prices are reaching the final consumer and not being absorbed by resellers in the marketing channel. Timing is crucial, since a marketing plan takes time to develop and implement. As a final note, it is important to recognize that strategy formulation and implementation are not necessarily separate sequential processes. Rather, an interactive give-and-take occurs between formulation and implementation until the case analyst realizes that “what might be done can be done,” given organizational strengths and market requirements. Another reading of the discussion on the marketing mix in Chapter 1 will highlight these points. Evaluate the Decision and the Decision Process The last step in the decision-making process is evaluating the decision made and the decision process itself.With respect to the decision itself, two questions should be asked. First,Was a decision made? This seemingly odd question addresses a common shortcoming of case analyses, whereby a case analyst does not make a decision but, rather,“talks about”the situation facing the organization. The second question is, Was the decision appropriate, given the situation identified in the case setting? This question speaks to the issue of insufficient information on the one hand and the failure to consider and interpret information on the other. In many marketing cases, and indeed in some actual business situations, some of the information needed to make a decision is simply not available. When information is incomplete, assumptions must be made. A case analyst is often expected to make assumptions to fill in gaps, but such assumptions should be logically developed and articulated. Merely making assumptions to make the “solution” fit a preconceived notion of the correct answer is a death knell in case analysis and business practice. The case analyst should constantly monitor how he or she applies the decisionmaking process. The mere fact that one’s decision was right is not a sufficient reason to think that the decision process was appropriate. For example, we have all found 58 PREPARING AND PRESENTING A CASE ANALYSIS 59 ourselves lost while trying to locate a home or business from an address. Eventually we somehow find it but are again at a loss when later asked to direct someone else to the same address. Analogously, the case analyst may arrive at the “correct”solution but be unable to outline (map) the process involved. After completing a class discussion of a case, a written case assignment, or a group presentation, the case analyst should critically examine his or her performance by answering the following questions: 1. Did I define the problem adequately? 2. Did I identify all pertinent alternatives and uncertainties? Were my assumptions realistic? 3. Did I consider all information relevant to the case? 4. Did I recommend the appropriate course of action? If so,was my logic consistent with the recommendation? If not, were my assumptions different from the assumptions made by others? Did I overlook an important piece of information? 5. Did I consider how my recommendation could be implemented? Honest answers to these questions will improve the chances of making better decisions in the future. ¦ PREPARING AND PRESENTING A CASE ANALYSIS How do I prepare and present a case? This question is voiced by virtually every student exposed to the case method for the first time. One of the most difficult tasks in preparing a case for presentation—or, more generally, resolving an actual marketing problem—is structuring your thinking process to address relevant forces confronting the organization in question. The previous discussion of the decision-making process should be of help in this regard. The remainder of this chapter provides some useful hints to assist you in preparing and presenting a marketing case. Approaching the Case On your first reading of a marketing case, you should concentrate on becoming acquainted with the situation in which the organization finds itself. This first reading should provide some insights into the problem requiring resolution, as well as background information on the environment and organization. Then read the case again, paying particular attention to key facts and assumptions. At this point, you should determine the relevance and reliability of the qualitative and quantitative data provided in the context of what you see as the issues or problems facing the organization.Valuable insights often arise from analyzing two or more bits of qualitative and quantitative information concurrently. It is essential that extensive note taking occurs during the second reading.Working by writing is very important; simply highlighting statements or numbers in the case is not sufficient. Behavioral scientists estimate that the human mind can focus on only eight facts at a time and that our mental ability to link these facts in a meaningful way is limited without assistance.10 Experienced analysts and managers always work out ideas on paper—whether they are working alone or in a group. There are three pitfalls you should avoid during the second reading. First, do not rush to a conclusion. If you do so, information is likely to be overlooked or possibly distorted to fit a preconceived notion of the answer. Second, do not “work the numbers” 59 60 CHAPTER 3 MARKETING DECISION MAKING AND CASE ANALYSIS until you understand their meaning and derivation. Third, do not confuse supposition with fact. Many statements are made in a case, such as “Our firm subscribes to the marketing concept.” Is this a fact, based on an appraisal of the firm’s actions and performance, or a supposition? Formulating the Case Analysis The previous remarks should provide some direction in approaching a marketing case. The marketing case analysis worksheet shown in Exhibit 3.4 provides a framework for organizing information. Four analytical categories are shown, with illustrative questions pertaining to each. You will find it useful to consider each analytical category when preparing a case. Nature of the Industry, Market, and Buyer Behavior The first analytical category focuses on the organization’s environment—the context in which the organization operates. Specific topics of interest include (1) an assessment of the structure, conduct, and performance of the industry and competition, and (2) an understanding of who the buyers are and why, where, when, how, what, and how much they buy. The Organization It is important to develop an understanding of the organization’s financial, human, and material resources, its strengths and weaknesses, and the reasons for its success or failure. Of particular importance is an understanding of what the organization wishes to do. The “fit”between the organization and its environment represents the first major link drawn in case analysis. This link is the essence of the E X H I B I T 3 . 4 Marketing Case Analysis Worksheet Specific Points of Inquiry Nature of the industry, 1. What is the nature of industry structure, conduct, and performance? market, and buyer 2. Who are the competitors, and what are their strengths and weaknesses? behavior 3. How do buyers buy in this industry or market? 4. Can the market be segmented? How? Can the segments be quantified? 5. What are the requirements for success in this industry? The organization 1. What are the organization’s mission, objectives, and distinctive competency? 2. What is its offering to the market? How can its past and present performance be characterized? What is its potential? 3. What is the situation in which the manager or organization finds itself? 4. What factors have contributed to the present situation? A plan of action 1. What actions are available to the organization? 2. What are the costs and benefits of action in both qualitative and quantitative terms? 3. Is there a disparity between what the organization wants to do, should do, can do, and must do? Potential outcomes 1. What will be the buyer, trade, and competitive response to each course of action? 2. How will each course of action satisfy buyer, trade, and organization requirements? 3. What is the potential profitability of each course of action? 4. Will the action enhance or reduce the organization’s ability to compete in the future? 60 PREPARING AND PRESENTING A CASE ANALYSIS 61 situation analysis, since it is an interpretation of where the organization currently stands. A SWOT analysis like that described in Chapter 1 might be helpful in organizing your thoughts at this point. A Plan of Action You should be prepared to identify possible courses of action on the basis of the situation analysis. More often than not, several alternatives are possible, and each should be fully articulated. Each course of action typically has associated costs and revenues. These should be carefully calculated on the basis of realistic estimates of the magnitude of effort expected in their pursuit. Potential Outcomes Finally, the potential outcomes of all courses of action identified should be evaluated. On the basis of the appraisal of outcomes, one course of action or strategy should be recommended. The evaluation, however,must indicate not only why the recommendation was preferred, but also why other actions were dismissed. Though it is always useful to consider each of the analytical categories just described, the method in which they are arranged may vary. There is no one way to analyze a case, just as there is no single correct way to attack a marketing problem. Just be sure to cover the bases. Formulating the Case Analysis in Teams Just as organizations now rely on teams to examine marketing issues, student teams are often assigned a case to analyze. A case analysis by a team will also consider the four analytical categories just discussed. However, a team-based case analysis introduces additional considerations that can affect the quality of a team experience and the analysis itself. If the instructor asks you to form your own team, care should be taken in choosing team members. Forming teams on the basis of friendships is common but not always wise. Rather, try to create a balanced team where various skills complement one another (financial skills, oral presentation skills, writing skills, and so on). Seek out individuals who are committed and dependable. The behavior of a team can also affect the quality of marketing decision making and a case analysis.11 Care should be taken to avoid “groupthink”—the tendency for groups that work together over a period of time to produce poorly reasoned decisions. Groupthink is evident when social pressures and conflict avoidance overtake the desire to rigorously question analyses and alternatives in favor of seeking conformity and consensus. Common outcomes of groupthink are an incomplete survey of issues and alternatives, failure to consider the risks of the group’s decision, failure to reappraise initially rejected alternatives, limited recognition and evaluation of case information, and failure to work out contingency plans due to overconfidence in the likelihood of success of a chosen course of action and the correctness of a decision.12 Alfred Sloan, the legendary chairman of General Motors, was acutely aware of groupthink in his executive ranks. He was often heard to say,“I take it we are all in complete agreement on the decision here. Then I propose we postpone further discussion of the matter until our next meeting to give ourselves time to develop disagreement and perhaps gain some understanding of what the decision is all about.”13 Case study teams might do the same to avoid the pitfalls of groupthink. Communicating the Case Analysis Three means exist for communicating case analyses: (1) class discussion, (2) oral presentation, and (3) written report. Class Discussion Discussing case studies in the classroom setting can be an exciting experience, provided that each student actively prepares for and participates in the 61 62 CHAPTER 3 MARKETING DECISION MAKING AND CASE ANALYSIS discussion. Preparation involves more than simply reading the case prior to the scheduled class period—the case should be carefully analyzed, using the four analytical categories described earlier. Four to five hours of preparation are usually required for each assigned case. The notes developed during the preparation should be brought to class. Similarly, participation involves more than talking. Other students should be carefully watched and listened to during a class discussion. Attentiveness to the views of others is necessary in order to build on previous comments and analyses. Most class discussions follow a similar format. Class analysis begins with a discussion of the organization and its environment. This discussion is followed first by a discussion of the alternative courses of action and then by a consideration of possible implementation strategies. Knowing where the class is in the discussion is important both for organizing the multitude of ideas and analyses presented and for preparing remarks for the subsequent steps in the class discussion. Immediately after the class discussion, you should prepare a short summary of the analysis developed in class. This summary, which should include the specific facts, ideas, analyses, and generalizations developed, will be useful in comparing and contrasting case situations. Oral Presentation An oral presentation of a case requires a slightly different set of skills. Usually, a group of three to five students conducts a rigorous analysis of a case and presents it to classmates. Role-playing may be featured: Class members may serve as an executive committee witnessing the presentation of a task force or project team. A polished delivery is very important in oral presentations.14 Thus, the group should rehearse its presentation, with group members seriously critiquing one another’s performance. Oral presentations provide an opportunity to verbalize your analysis and recommendations and visually enhance your remarks with carefully crafted and informative transparencies, electronic slides, or other visual aids. At a minimum, slides or transparencies should cover each of the following areas: 1. An opening slide showing the “title” of the presentation and names of the presenters. 2. A slide that outlines the presentation (perhaps with presenters’ names by each topic). 3. One or more slides detailing the key problems and strategic issues that management needs to address. 4. A series of slides covering your analysis of the company’s situation or problem. 5. A series of slides containing your recommendations and the supporting arguments and reasoning for each recommendation—one slide for each recommendation and the associated reasoning has a lot of merit. Remember that slides and transparencies help to communicate your ideas to the audience. They are not meant to substitute for the oral presentation. Slides and transparencies may be referred to but should never be read to the audience. Also keep in mind that too many graphics, images, colors, and transitions may divert the attention of the audience and disrupt the flow of the presentation. Finally, keep in mind that dazzling slides and transparencies will not hide a superficial or flawed case analysis from a perceptive audience. Written Report What you need to do to generate a written analysis of a case assignment is similar to what you should do to prepare for class discussion. The only difference is in the submission of the analysis; a written report should be carefully organized, legible (preferably typed), and grammatically correct. 62 NOTES 63 There is no one correct approach to organizing a written case analysis. However, it is usually wise to think about the report as having three major sections: (1) identification of the strategic issues and problems, (2) analysis and evaluation, and (3) recommendations. The first section should contain a focused paragraph that defines the problem and specifies the constraints and options available to the organization. Material in the second section should provide a carefully developed assessment of the industry, market and buyer behavior, the organization, and the alternative courses of action. Analysis and evaluation should represent the bulk of the written report. This section should not contain a restatement of case information;it should contain an assessment and interpretation of the facts, qualitative and quantitative data, and management views. The last section should consist of a set of recommendations. These recommendations should be documented with references to the previous section and should be operational given the case situation. By all means, commit to a decision! A case and a written student analysis of it are presented in the appendix at the end of the book. It is recommended that you carefully analyze the case before reading the student analysis. N O T E S 1. Leigh Buchanon and Andrew O’Connell,“A Brief History of Decision Making,”Harvard Business Review (January 2006):32–41. 2. “What Executives Should Remember: Classic Advice from Peter Drucker,” Harvard Business Review (February 2006):144–152. 3. Melissa Raffoni, “Use Case Interviewing to Improve Your Hiring,” Harvard Management Update (July 1999): 10. 4. Loren Gary,“Want Better Results? Boost Your Problem-Solving Power,” Harvard Management Update (October 2004): 1–4. 5. DECIDE acronym copyright © by William Rudelius. Used with permission. 6. “Cluett Peabody & Co. Loses Shirt Trying to Jazz Up the Arrow Man,” Wall Street Journal (July 28, 1988): 24. 7. Mark David Nevins and Stephen A. Stumpf, “21st-Century Leadership: Redefining Management Education,”Strategy & Business (Third Quarter, 1999):41–51. 8. An issue that frequently arises in developing these subjective probabilities is how to select them. One source is past experience, in the form of statistics such as A.T. Kearney’s probabilities of success for alternative strategies, presented in Chapter 1. Alternatively, case information can be used to develop probability estimates. At the very least, when two possible uncertainties exist, a subjective probability of .5 can be assigned to each. This means that the two uncertainties have an equal chance of occurring. These probabilities can then be revised up or down, depending on case information. 9. These examples and a further reading on decision analysis can be found in Peter C. Bell, Management Science/Operations Research: A Strategic Perspective (Cincinnati, OH: South-Western Publishing, 1999): Chapter 3. 10. Amitai Etzioni, “Humble Decision Making,” Harvard Business Review (July–August 1989):122–126. 11. Jared Sandberg, “Some Ideas Are So Bad That Only Team Efforts Can Account for Them,”Wall Street Journal (September 29, 2004): B1. 12. Max Bazerman, Judgment in Managerial Decision Making, 6th ed. (New York: John Wiley & Sons, 2006). 13. This quote appears in David A. Garvin and Michael A. Roberto, “What You Don’t Know About Making Decisions,”Harvard Business Review (September 2001):108–116. 14. This discussion is based on material in Arthur A. Thompson Jr. and A. J. Strickland, Strategic Management: Concepts and Cases, 13th ed. (Burr Ridge, IL: McGraw-Hill/Irwin, 2004):C12–C13. 63 64 Mary Ho prepared this case under the supervision of Prof. David Tse for class discussion. This case is not intended to show effective or ineffective handling of decision or business processes. © 2003 by The Asia Case Research Centre, The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise (including the Internet) - without the permission of The University of Hong Kong. Ref. 03/156C 1 DAVID TSE REDISCOVERING MARKET NICHES IN A TRADITIONAL INDUSTRY Jingdezhen, the ?Porcelain Metropolis? of China, was due to mark its 1,000th anniversary in 2004. Situated in the northeastern part of Jiangxi Province in a small basin rich in kaolin, the city was surrounded by beautiful mountains and lakes [see Exhibit  1 for a map of Jiangxi]. For centuries, Jingdezhen produced and exported the finest porcelain treasures in the world. By the late 20th century, however, it was in danger of losing its past glory. Although the city?s factories still churned out more than a million pieces of porcelain a day, it was facing more competitors at home and abroad than at any time in its history. In the domestic market, porcelain productions in Jingdezhen lagged behind other cities such as Tangshan, Liuyang and Chaozhou. In the overseas market, firms in Jingdezhen were losing their price advantage to makers based in Malaysia, Thailand and Vietnam. The declining quality of Jingdezhen porcelain had disappointed a number of porcelain experts and collectors. Jan-Erik Nilsson, a Swedish porcelain expert who ran a Website for collectors, commented: Though fine artistry abounds, Jingdezhen?s quality still lags ? as does its domestic competitors? ? compared with manufacturers in Japan, France, Mexico and elsewhere. Shapes are uneven, designs are outdated and the raw input, mixed porcelain known as paste, is less pure than that used in the past and currently in the West.1 As Jingdezhen?s world dominance succumbed to commercial espionage and competition, a number of state-owned porcelain factories had closed down. Nevertheless, Deng Niandong, a strategic investor from Beijing, was eager to restore the city?s reputation for artistic chinaware. In 1995, he founded Jiangdong Crystal-color Art and Crafts Co. Ltd. (JCAC). The Company partnered with the best porcelain factories in Jingdezhen to produce a new kind of ceramic ware with modern characteristics. These ceramics were unique in their firmness, resilience and fade resistance. Their patterns gave an impression of embroidery, which resembled the sheen of brocade or velvet. JCAC was awarded a patent for this invention from the state 1 Bodeen, C., ?China?s porcelain capital aims to repair its fractured glory?, Associated Press, 2000. HKU249 65 03/156C  Rediscovering Market Niches in a Traditional Industry 2 government. The patent empowered JCAC to take legal action if necessary, to prevent the unlicensed manufacture, use or sale of its high-tech invention. The right also gave JCAC breathing space to further develop its ceramics business based on its invention, and allowed other companies to exploit the invention and pay royalties to JCAC under a licensing agreement. With the state?s endorsement and support, JCAC was poised for further growth in the domestic and overseas markets. The Company?s high-end products were presented by Chinese leaders and officials as gifts to foreign dignitaries, and were exported to many overseas countries. While JCAC was enjoying its success, however, a number of small and medium-sized porcelain manufacturers in Jingdezhen were still struggling to make a profit. Competition among them was intense, and price wars had severely reduced profit margins. Faced with challenges from domestic and foreign rivals, these firms were hard pressed to formulate new marketing strategies and explore market niches in this traditional industry. The Art of Porcelain Types of Porcelain ?As white as jade, as bright as mirror, as thin as paper, and sounding like a chime.? This was how foreign merchants described the porcelain made in the city of Jingdezhen in East China about 2,000 years ago. Porcelain was a kind of ceramic ware highly valued for its beauty and strength. It was often called China, or chinaware, because it was first produced in Jingdezhen (formerly known as Changnanzhen). Porcelain was characterised by its whiteness, delicacy and translucence. Since it was the hardest of all ceramic products, porcelain could be used for electrical insulators and laboratory equipment. However, porcelain was known primarily as a material for high-quality vases and tableware, as well as for figurines and other decorative objects. Porcelain that was used for such purposes produced a bell-like ring when struck. Porcelain differed from other types of ceramics in its ingredients and in the process by which it was made. Unlike earthenware and stoneware, porcelain was basically produced from a mixture of two ingredients ? kaolin and petuntse. This mixture was fired at temperatures of about 1,250°C to 1,450°C. At these high temperatures, the petuntse melted and formed a nonporous, natural glass. The kaolin, which was highly resistant to heat, did not melt and therefore allowed the item to hold its shape. The process was complete when the petuntse fused itself to the kaolin. There were three major types of porcelain: (1) hard-paste porcelain, (2) soft-paste porcelain, and (3) bone china.2 The differences between these types of porcelains were due to the material from which they were made. Hard-paste porcelain, which was sometimes referred to as true porcelain or natural porcelain, had always been the model and ideal of porcelain makers. It was the type of porcelain first developed by the Chinese from kaolin and petuntse, and had far better resistance to heat than other kinds of porcelain. Soft-paste porcelain was sometimes called artificial porcelain. It was first developed in Europe in an attempt to imitate Chinese hard-paste porcelain. Bone china was made by adding bone ash to kaolin and 2 Artistic Tile & Stone, ?A History of Porcelain?, URL: http://www.artistictile.net/pages/Info/Info_Porcelain.html, September 2002. 66 03/156C  Rediscovering Market Niches in a Traditional Industry 3 petuntse. Though not as hard as true porcelain, bone china was more durable than soft-paste porcelain. Nearly all the world?s bone china was produced by English porcelain makers. However, bone china of very good quality could also be found in Tangshan, China. The Production Process A piece of porcelain was shaped on potter?s wheel or in a mould [see Exhibit  2 for a description of how a blue and white porcelain was made]. After this stage, the porcelain worker could decorate it by surface modifications, painting or transfer printing. Porcelain painting in Europe differed greatly from porcelain painting in China. Chinese decorators separated different colours with a dark outline, but European artists blended colours together with no separating line. In addition, Europeans used decorations solely for their artistic value, but Chinese decorations were symbolic. Since 1756, transfer printing was revolutionised and enabled workers to decorate items much faster than they could do manually. In this process, a design was engraved on a copper plate, inked with ceramic colour, and transferred to tissue paper. While the colour was still wet, the tissue paper was pressed against a porcelain object, leaving the design on its surface. The History of Oriental Porcelain For centuries, the Chinese produced the world?s finest porcelain. The first true porcelain was probably made during the Eastern Han Dynasty (25-220). During the Song dynasty (960-1279), Chinese emperors built royal factories in Changnanzhen to produce porcelain for the imperial court. In the Jingde Period (1004-1007), Emperor Zhenzong recognised the significance of the city and renamed it as ?Jingdezhen?. Since then, Jingdezhen became the ?Porcelain Metropolis?. By the 1100s, the Chinese secret of making porcelain had spread to Korea and Europe, and in the 1500s, it also spread to Japan. By the 1700s, porcelain manufactured in many parts of Europe began to compete with Chinese porcelain. At that time, France, Germany, Italy and England were the major production centres for European porcelain. In 20th century, advanced technology enabled the porcelain industry to produce porcelain in large quantities. Extensive porcelain-making was carried out not only in Europe and Japan but also in the United States. Some notable examples of contemporary porcelain were American Lenox, German Rosenthal, Japanese Noritake and English Wedgwood.3 4 The Declining Prominence of Jingdezhen Between 1350 and 1750, Jingdezhen was the centre of world porcelain production. According to Scholar T. Volker, author of a study on the 17th-century porcelain trade, over three million pieces of porcelain reached Europe between 1350 and 1750. 5 At that time, demand from Europe was almost insatiable. Until about 1900, porcelain makers in Jingdezhen had never worried about their businesses. In 1987, the city was the second-largest porcelain exporting base in China. It boasted a ceramics institute, a museum and a number of kaolin quarries and porcelain factories.   By 1993, however, it was not even in the top five. Low technology, a lack of innovation and the small scale of production had hindered the city?s production growth. In 1999, porcelain exports from the city were worth only US$30 million, about onetenth that of Dehua city in Fujian Province. According to a senior researcher at the Jiangxi Academy of Social Sciences, the ceramics industry in Jingdezhen already lagged behind other production bases such as Tangshan in Hebei Province, Liuyang in Hunan Province and 3 Most of the famous English Wedgwood ware was not porcelain, but earthenware or stoneware. Nevertheless, its classical Greek figures and reliefs were very popular and had a great influence on porcelain designs throughout Europe. 4 ARTISTIC, A History of Porcelain Tile to your Imagination, http://www.artistictileandstone.com/(accessed 3 September 2007) 5 Bodeen, C., (2000). 67 03/156C  Rediscovering Market Niches in a Traditional Industry 4 Chaozhou in Guangdong Province. In 2002, Jingdezhen earned only about five per cent of its revenue from ceramics.6 Difficulties and Threats The small scale of operations had often been cited as one of the major reasons for the fall of the porcelain capital. In the 1990s, Jingdezhen saw the closure of all but two of its 32 stateowned porcelain factories. Unlike industrial or construction ceramics, artistic porcelain did not require the same production equipment and entry barriers were low. Thus, workers who were laid off from the state-owned firms could easily start their own businesses, and this had resulted in the emergence of more than 4,000 small porcelain firms in Jingdezhen. In 2000, over half of city?s urban population of 120,000 was engaged in the production and sale of porcelain.7 Influenced by the traditions of porcelain production in state-owned firms, the new porcelain entrepreneurs tended to make exquisite antique-style chinaware. These imitations were accurate reproductions in every detail, ranging from animated figurines to large jars and man-sized vases. Some skilled craftsmen could make high-quality replicas using old pieces of clay found in ancient kilns. According to an article from The Toronto Star, some of these fine reproductions could deceive even the best experts.8 Indeed, porcelain makers in Jingdezhen had been copying their predecessors through the centuries. Lei Rui Chen, a ceramics scholar who ran the Jingdezhen Museum, believed this was a historical cycle. In the Ming dynasty, they did reproductions of the Yuan dynasty, and so on, down the line?You can say it?s trying to capture beauty for the next generation. 9 Most of the porcelain makers in Jingdezhen suffered the same marketing handicaps: they were unable to offer uniquely designed products and differentiate themselves from their competitors. Because of the lack of innovation, products from every porcelain maker in Jingdezhen looked almost the same. There was little noticeable difference between their products, as they all had similar designs, colours and patterns. Many makers continued to spend four to six weeks to produce a ?standard? vase that could only be sold for a very low price.10 Price wars were common and reduced profit margins significantly. This indirectly affected the businesses? ability to upgrade their equipment and techniques, and expand their production. Due to soaring production costs in Japan, Taiwan and South Korea, many overseas buyers still looked for products in Jingdezhen because they were highly competitive in price. To their disappointment, however, a number of these buyers could not find suitable producers for the products they wanted. In one case, a US company was sourcing US$10 million worth of porcelain products from Jingdezhen. To ensure the quality and consistency of the products, the company was hoping that the order could be filled by a single porcelain maker. However, there was no business capable of handling the order so the US company was forced to give the contract to another firm in Liuyang in Hunan Province.11 Poor quality and a lack of consistency had led to the failure of many similar orders. With an objective of competing on price alone, a number of porcelain makers produced low-end products from low-quality 6 Foong, W. F., (2002), ?Culture is Good Business?, Malaysia: Cite (M) Sdn. Bhd., p.97. 7 Anonymous, ?Porcelain Capital Plans to Regain Legendary Lustre?, China Daily, 10 September, 2000. 8 Cohn, M., ?Faking It in Porcelain?, The Toronto Star, 1 October, 2000. 9 Cohn, M., (2000). 10 Foong, W. F., (2002), p.96. 11 China Daily, (2000). 68 03/156C  Rediscovering Market Niches in a Traditional Industry 5 materials. As the Swedish expert Nilsson pointed out, these products often had uneven shapes and outdated designs. Some porcelain makers in Jingdezhen failed to respond to the changes in the expectations of the mass foreign and domestic markets. While the manufacturers were still following the tradition of producing large pieces of antique-style products, domestic customers were looking for household china that could suit the interiors of modern homes. In the early 1990s, a few porcelain makers began to import advanced equipment to produce household china. However, household china from Jingdezhen was of lower quality compared with products from Fujian, Shangdong and Tangshan. The products made in Jingdezhen were often rough to the touch due to their uneven edges or surfaces. If used as tableware, they could scratch the table or damage a lacquer tray; and if they were being stacked, they could scratch the other pieces. Wu Guanzheng, a government official from Guangxi, had the following comment on the quality of porcelain made in Jingdezhen: If we compare the quality of household china piece by piece, Jingdezhen will not lose out to its competitors. However, if we compare the products on a per hundred or per thousand basis, Jingdezhen will certainly lose.12 The Jingdezhen Ceramics Institute, China?s national college of ceramics, was staffed by highly qualified and respected ceramic art teachers and research fellows. The ceramic works of its faculty members were selected for many exhibitions in China and abroad. The Institute offered one of the finest ceramic art and design programmes in the world, and had developed highly skilled graduates for the ceramics industry. Due to low profit margins, however, many porcelain-makers in Jingdezhen were unable to offer attractive remuneration packages for these skilful artists. Consequently, some of the best artists were lured away by more profitable firms in other parts of China. The failure to retain these skilful workers had affected the development of the industry in Jingdezhen. JCAC JCAC was one of the few ceramic-makers in China that had differentiated itself from its rivals by the quality and artistic style of its products. The company manufactured top-of-the-line luxury ceramics in Jingdezhen and limited its distribution to the government and high-end retailers. The pigments imported by JCAC ceramics made the products unique in terms of their firmness, resilience and fade resistance. Their patterns gave an impression of embroidery, which could not be found on traditional ceramics. The use of high-tech equipment ensured that JCAC?s products were of consistently high quality. State endorsement of JCAC?s products had further enhanced the strength of the brand. Chinese state leaders and embassies often presented them as national gifts to foreign dignitaries. JCAC also boasted a huge client base. Most of its products were exported overseas, while some were sold to local high-end retailers and department stores. Because of the special status associated with the products, JCAC had deliberately set a high price to support their perceived value. A number of porcelain-makers in Jingdezhen doubted that JCAC?s success was sustainable. Although JCAC claimed that its products were unique in design and quality, many traditional artists were sceptical about their true artistic value. Some felt that the shapes of its vases were below standard. Others thought the only thing that made the vases valuable was the special meaning attached to them. For example, a vase might have been presented by Premier Jiang 12 Interview with a porcelain expert, Mr. Yiu Hoi Ki, 27 September, 2002. 69 03/156C  Rediscovering Market Niches in a Traditional Industry 6 Zemin to a prominent dignitary in Europe. Without its exclusive arrangement with the state, some experts argued that JCAC would not be able to beat its rivals. Rediscovering Market Niches Porcelain-makers in Jingdezhen had identified risks and limitations to growth in their current market position. A number of them were debating whether and how to change. Could they learn from JCAC and find a way to carve out a market niche? The Mass Market A number of factors affected the prices of porcelain products: production costs, prices charged by competitors, and customer perceptions of product value. Most porcelain-makers in Jingdezhen set minimal profit margin goals to pursue volume pricing strategies in the mass market. Their works could be of mediocre quality, since most of them were intended for daily usage rather than for display purposes. Due to the high uniformity of the products, customers could shift to other suppliers easily if they were not satisfied with prices offered by their original supplier. These customers were likely to be frequent switchers and were pricesensitive. In general, they had little understanding of artistic treasures and could not tell the difference between the good and the bad. Should porcelain-makers in Jingdezhen find a way to gain more committed customers, or should they continue to compete on price in order to secure business from opportunist switchers? Although porcelain products from Jingdezhen were sold at competitive prices, the companies were already losing their price advantage to manufacturers based in Malaysia, Thailand and Vietnam. The Collectors? Market Art collectors represented a stable consuming group that sought out high-quality art treasures. They considered collecting porcelain as a kind of value-guaranteed or value-added investment, and also a symbol of personal identity. Most of the collectors also had a genuine interest in art treasures. Collectors of porcelain looked for products that were intrinsically good. These products had to be of high quality in order to have value. Imperial ware, which was the most prized by collectors, was made by Jingdezhen?s best craftsmen centuries ago. These imperial porcelain products were of the highest quality because the makers had thrown out any pieces with imperfections and submitted only the perfect ones to the court. Therefore, the name ?imperial porcelain? implied quality and rarity, and therefore high value. In the late 20th century, however, some sophisticated art collectors had become dissatisfied with the quality of porcelain made in Jingdezhen. Some of collectors were looking for more stylish products, but were disappointed to find that most of the designs in Jingdezhen still followed the conservative tradition. As contemporary collectors placed more emphasis on design and quality, porcelain firms in Jingdezhen had to find a way to redesign and upgrade the quality of their products. With the existing scale of operation, however, it was difficult for small businesses in Jingdezhen to raise capital and upgrade their technology. Moreover, the small size of the market could not justify huge investments. The Government The Chinese State and provincial governments ordered ceramic products from a limited number of makers, including JCAC and the state-owned Jingdezhen Ceramics Co. Ltd (JCC). JCC produced high-quality artistic porcelain products, many of which were displayed in important government establishments, including Zhongnanhai, Diaoyutai State Guesthouse 70 03/156C  Rediscovering Market Niches in a Traditional Industry 7 and the People?s Great Hall of China. As the government market was monopolised by firms that were strongly backed by the state, it was almost impossible for small-scale firms in Jingdezhen to penetrate that market. The Corporate Market For most of the Jingdezhen porcelain-makers, the largest corporate customers were department stores, furniture stores, restaurants and hotels. These customers looked for dailyused dinnerware and decorative porcelain. Certain customers created their own designs and preferred to have their orders customised. JCAC saw lucrative market opportunities in the corporate market, especially the corporate gift market. The corporate gifts business entailed satisfying corporations? public relations needs by offering a line of gifts suitable for clients and other business partners during holiday seasons and on other occasions. Instead of mass-producing products, JCAC limited the number of its products and put numbers on them. In this way, the products could be presented as art treasures rather than as commercial products. The implied exclusivity also justified a high selling price. Could porcelain makers Jingdezhen copy this marketing technique to boost their sales? How could they expand their distribution network? Given the lower entry barriers, new entries to the corporate gift market could erode profits from this sector. This meant that even the first movers might find it difficult to maintain long-term success. Developing a Global Brand: The Haier Model In 2002, a number of porcelain firms in Jingdezhen were reviewing their marketing plans with an eye towards finding a market niche for their future business. At the same time, JCAC was aiming to build a global brand for its products. There were, however, only a few Chinese companies that had succeeded in developing a global brand. One of these was the Chinese appliance-maker Haier Group, which ranked fifth in global appliance sales behind General Electric, Whirlpool, Electrolux and Siemens. Haier?s strategy blended the theories of ancient Chinese philosophers and Western management gurus. Drawing from Sun Tzu?s The Art of War, Haier focused on niche markets and offered products where it faced less competition. 13 The company had outflanked bigger rivals and prospered in selling products such as dormroom- sized refrigerators and wine cellars. Instead on relying on price competition, Haier based its products on consumers? needs. The company chose to build factories in key markets, even though it had meant surrendering some advantage from China?s low labour costs. The idea was that local managers would know their customers better than far-away Chinese bosses and would be able to respond more swiftly to shifting tastes. 14 To promote quality, Haier Group led a complete overhaul of factory practices. Defective refrigerators were destroyed and employees? pay was linked to the sale of their products. Given the intense competition in the market, JCAC and other porcelain-makers recognised that the road to regaining the past glory of Jingdezhen would be long and tough. One of the obstacles was the stigma attached to Jingdezhen ceramics. Many poor-quality firms had developed products that gave customers a bad impression about Jingdezhen ceramics. How could JCAC craft a marketing strategy to revive the brand identity of Jingdezhen ceramics? 13 The Art of War was written in about 500BC in China by Sun Tzu. It is one of the most famous military treatises written because it is the oldest surviving one and quite possibly the first one ever written. Its principles about military strategy are still valid and useful in the modern business world. 14 CCMAE , (24 June 2004) Qingdao Refrigerator Factory , http://www.ccmae.com (accessed 3 September 2007) 71 03/156C  Rediscovering Market Niches in a Traditional Industry 8 There were a number of alternatives for JCAC to grow its sales volume and enhance its brand name. To establish its brand name, JCAC could contact galleries around the world to establish itself globally. It could also start a few flagship stores in prominent American or European markets or contact large global gift distributors to expand its volume. Once it had gained large sales volume and financial power, JCAC might consider acquiring some quality ceramic- and porcelain-makers in the province. A key question was: Would the Haier model work for JCAC? 72 03/156C  Rediscovering Market Niches in a Traditional Industry 9 EXHIBIT 1 JIANGXI PROVINCE AND THE CITY OF JINGDEZHEN Source:  URL: http://www.travelchinaguide.com/cityguides/jiangxi/jingdezhen/ 73 03/156C  Rediscovering Market Niches in a Traditional Industry John A. Quelch prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1995 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685 or write Harvard Business School Publishing, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 1 Heineken N.V.: Global Branding and Advertising In January 1994, senior managers at Heineken headquarters in Amsterdam were reviewing two research projects commissioned to clarify Heineken's brand identity and the implications for television advertising. Project Comet defined five components of Heineken’s global brand identity and explored how they should be expressed in Heineken brand communications. Project Mosa, which involved a different team of executives, identified the expressions of taste and friendship that had the most appeal and explored how they should be expressed in Heineken television advertising worldwide. Heineken's senior managers were interested in assessing whether or not the conclusions of the two studies were mutually consistent. They also wished to determine how far they should or could standardize Heineken's brand image and advertising worldwide. Company Background The Heineken brewery was founded in Amsterdam in 1863 by Gerard Adriaan Heineken. He was quoted as saying: "I will leave no stone unturned in attempting to continuously supply beer of the highest quality." The strain of yeast which continued through the 1990s to give Heineken beer its special taste was developed in 1886. Heineken beer won a gold medal at the 1889 Paris World's Fair and, by 1893, was one of the largest selling beers in the Netherlands. One hundred years later, in 1993, Heineken N.V. recorded net sales of 9,049 million guilders and a trading profit of 798 million guilders. Beer accounted for 82% of sales, the remainder being derived from soft drinks, spirits and wine. The geographical breakdowns of sales (in litres) for Heinekin and the worldwide beer industry were as follows: Heineken 1993 Sales % % Change vs. 1992 Total 1993 Beer Sales % Netherlands Rest of Europe 24 47 } (1.6) } 38 America 13 5.3 38 Asia/Australasia 8 23.7 19 Africa 6 (1.5) 5 93 596-015 Heineken N.V.: Global Branding and Advertising 2 In 1993, sales of beer brewed under Heineken's supervision reached 5.6 billion litres, second in the world only to Anheuser-Busch with 10 billion litres. World beer production in 1993 totaled 120 billion litres. Sales of the Heineken brand were 1.52 billion litres in 1993. The company's other brands with some international distribution were Amstel (formerly made by the second-largest Dutch brewery, acquired by Heineken in 1968) which sold 630 million litres; Buckler, a nonalcoholic beer, which sold 90 million litres; and Murphy's Stout, recently acquired and sold principally in Ireland and the United Kingdom. As a result of acquisitions, Heineken also oversaw the brewing of many local and regional beer brands marketed by its subsidiaries, such as Bir Bintang, the leading Indonesian brand. International Presence The Heineken brand had long been available in markets outside the Netherlands. In 1937, Heineken granted its first license to a foreign brewer to produce Heineken beer according to the original formula. While licensing agreements also aimed to specify how the Heineken brand should be marketed, Heineken could not influence how a licensee marketed its own brands. In management's view, some licensees did not maintain a sufficient price premium for the Heineken brand over their own national brands. By the 1980s, Heineken was seeking majority equity stakes in its existing and prospective partners to ensure tighter control over production and marketing. The ideal national brewer partner, from Heineken's point of view, was one that did not have international ambitions for its domestic brands. By 1993, Heineken's worldwide brewing interests were as follows: Wholly Owned Subsidiaries Majority Equity Stakes Minority Equity Stakes Licensees Europe 3 5 0 2 American 0 4 10 2 Asia/Australasia 0 2 8 2 Africa 0 4 10 2 In Europe, for example, Heineken owned outright its operations in the Netherlands, France, and Ireland. It held majority interests in breweries in Greece, Hungary, Italy, Spain, and Switzerland and licensed production to breweries in Norway and the United Kingdom (Whitbread). Heineken was not bottled in the large United States market, but was the number one imported beer. In Germany, the heaviest beer-consuming country in Europe (144 litres per capita), national brands still dominated the market and Heineken was available only through imports. In the early 1990s, the brewing industry was becoming increasingly global as the leading brewers scrambled to acquire equity stakes and sign joint ventures with national breweries. This trend was especially evident in the emerging markets where population expansion and increased per-capita consumption promised faster growth than in the developed world. In Europe, in particular, overcapacity and minimal population growth resulted in price competition, margin pressures, and efforts to segment further the market with no- or low-alcohol beers, specialty flavored beers, and "dry" beers. Despite the increasing globalization of the industry, there remained substantial differences in per-capita beer consumption, consumer preferences and behaviors, and the mix of competitors from one market to another. For example, annual per capita consumption ranged from 132 liters in Ireland and 88 liters in the U.S.A. to 56 liters in Japan and 30 liters in Argentina. Heineken executives believed that the beer market in each country followed an evolutionary cycle and that, at any time, 94 Heineken N.V.: Global Branding and Advertising 596-015 3 different countries were at different stages of market development. Exhibit 1 depicts the beer market development cycle while Exhibit 2 notes Heineken's principal marketing objectives in selected markets. At the end of 1993, the Heineken brand held a 24% volume share in the Netherlands, several share points ahead of its main competitor, Grolsch. As the market leader, Heineken was viewed as a mainstream brand. Sales volume was declining and the brand image needed some revitalization. Outside the Netherlands, however, Heineken had consistently been marketed as a premium brand. In some markets, such as the United States and Hong Kong, Heineken had successfully established a distinct image for the brand. The image was sometimes narrowly drawn such that Heineken was seen as appropriate solely for special occasions when making a social statement was important rather than for daily consumption. In other markets, such as in Latin America, Heineken was viewed as just one among many European imported beers. But across all markets, the Heineken brand was acknowledged as a lighter beer of superior quality presented in attractive packaging. Comparative data on the Heineken brand's market position in seven European countries are presented in Exhibit 3. Premium brands accounted for around 25% of beer volume in 1993 and around 30% of measured media beer advertising. Heineken was the most heavily advertised premium brand in Europe and worldwide. Over 90% of Heineken advertising took the form of television commercials. Project Comet Managers at Heineken headquarters were concerned that Heineken's brand image was not being consistently projected in the brand’s communications around the world. Two television advertising executions were used in multiple country markets in 1991, but, particularly in the larger markets, local Heineken managers had the resources to develop their own commercials and justified their decisions to do so on grounds of unique competitive conditions, industry structures, and/or consumption behaviors. Project Comet was established in 1991 by Heineken’s international marketing manager to recommend how to enhance Heineken's competitive advantage by more consistently projecting the brand as "the world's leading premium beer." The project team concluded that Heineken's desired brand image was "good taste": ·  Because of Heineken's flavor, its roots, commitment to and pride in brewing a high-quality lager. ·  Because Heineken is a symbol of premiumness, taste, and tradition around the world. The team believed that no other brand in the world could claim superior good taste with as much credibility as Heineken. The brand's good taste image would be built on five core brand values: ·  Taste ·  Premiumness ·  Tradition ·  Winning spirit ·  Friendship 95 596-015 Heineken N.V.: Global Branding and Advertising 4 Taste and premiumness were regarded as the price of entry. They had to be communicated in advertising messages but would not, in themselves, be enough to differentiate Heineken from its competition. A unique, differentiated image would depend on effective communication of the other three core brand values. Project team members acknowledge the challenge of communicating all five values in each advertisement. However, they thought that all five could be reflected in one way or another through the locations, situations, relationships, casting, lighting, style, and tone used in each commercial. The team detailed how each of the core brand values should be portrayed in Heineken brand commercials: Taste The product should be shown in slow-pouring shots where its golden color, sparkling texture and refreshing coolness would celebrate its taste. Actors should be portrayed genuinely enjoying Heineken with no gulps or "knocking it back." The slogan used should be competitive but not comparative. Premiumness The production quality of every execution should be at the level of excellence to be expected of a premium brand. In some geographies, Heineken's premiumness might be a unique reason for purchase; in such cases, this attribute could be presented as part of the brand promise. Tradition The genuine aura of the brand should be especially evident in the casting and tone of voice of each commercial. Heineken should be the preferred brand of people who believed in true values and whose brand choices reflected their personal value set. Winning spirit Tone of voice was thought to be especially important in conveying this value "because winners are confident and relaxed, take a quiet pride in everything they do and do not shout." Friendship Heineken should not be portrayed as a solitary beer or a "mass-gathering" drink. The Heineken group should be a few (even two) people who clearly enjoy their relationship. The "Heineken moment" should show people as themselves, content, relaxed with each other and confident. Interactions should be sincere, self-confident, warm and balanced, displaying mutual respect and free from game-playing. The project team next tried to develop guidelines for the visual images—the people, the relationships and the settings—to be included in Heineken commercials. The Project Comet report concluded as follows: All of our advertising must be consistent with these guidelines. We also need impactful advertising. Heineken advertising is therefore never safe. It should always be leading edge and state of the art, taking calculated risks and initiatives to achieve the desired effects. Project Mosa In late 1993, Heineken’s international advertising manager commissioned focus groups in eight countries1 to understand (a) what male beer drinkers meant by taste and friendship in relation to premium beer drinking and (b) which expressions of taste and friendship could be used by the Heineken brand in advertising. The project team identified in advance the following expressions of taste which “appealed to the head” and expressions of friendship which “appealed to the heart:” 1The countries were Netherlands, Italy, and Germany in Europe; USA, Argentina and Brazil in the Americas; and Japan and Hong Kong in Asia. 96 Heineken N.V.: Global Branding and Advertising 596-015 5 Taste (Head) Friendship (Heart) Brand vision Trust Quality Sports Brewing skills True friends Tradition You can count on Heineken as a friend Availability Respect Boards with visual and message stimuli depicting each of these expressions were used in the focus groups to elicit reactions. Examples of these boards are presented in Exhibits 4 and 5. Eight focus groups were run in each country, four with 21-27 year olds and four with 28-35 year olds. Four groups in each country explored taste cues, four explored friendship cues. Members of the focus groups dealing with taste were asked to identify which of several factors they perceived as strong or weak indicators of beer taste. These responses are summarized in Exhibit 6 . Members of the other four focus groups dealing with friendship discussed the different social occasions when a standard versus a premium beer would be appropriate. On this issue, there was substantial agreement across national markets. The conclusions are summarized in Exhibit 7. Participants in the focus groups were then exposed to a variety of advertising boards for Heineken, each of them highlighting a particular attribute. Those in the focus groups dealing with taste were exposed to twelve boards while those in the friendship focus groups were exposed to ten. The objective was to elicit consumer reactions to both the visual and message claims presented on each board and to establish each claim's relevance to and overall suitability for promoting the Heineken brand. The overall suitability rankings, first for the four focus groups concentrating on taste cues and, second, for the focus groups concentrating on friendship cues, are presented in Exhibits 8 and 9. 97 596-015 -6- Exhibit 1 Beer Market Evolution for Selected Counties and Regions 98 596-015 -7- Exhibit 2 Key Heineken Marketing Objectives in Eight Countries 99 596-015 Heineken N.V.: Global Branding and Advertising 8 Exhibit 3 Comparative Heineken Usage Data for Seven European Markets Netherlands France Greece Ireland Italy Spain United Kingdom Main brand usagea 17 14 44 25 7 5 11 Trial/awareness ratio 92 89 99 91 86 66 90 Regular/total usage ratio 46 40 54 42 28 25 41 Monthly brand penetrationb 60 48 79 57 53 63 60 Market share positionc 1 2 1 2 3 7 7 Advertising share of voice position d 1 2 4 5 4 6 6 Per capita beer consumption (litres)e 90 41 40 123 24 71 103 aPercentage of beer drinkers naming Heineken as their main brand. bPercentage of beer drinkers who had consumed a Heineken in the previous month. cOverall market share position. In most markets, Heineken was the largest -selling brand in the premium segment. dOverall SOV position among beer brands advertised. In all markets except the United Kingdom, Heineken SOV ranked first or second in the premium segment. eBased on consumption of all beer, not just Heineken. 100 Exhibit 4 Sample Project Mosa Concept Boards: Taste Expressions Heineken N.V.: Global Branding and Advertising 596-015 9 “I consider a bad bottle of Heineken a personal insult” Alfred H. Heineken Chairman Heineken. The clear beer for the purest taste. 101 Exhibit 5 Sample Project Mosa Concept Boards: Friendship Expressions 596-015 Heineken N.V.: Global Branding and Advertising 10 Nevada, USA. Yorkshire, UK. Cameroon, West Africa. Papeete, Tahiti. Wherever you are, you can always count on Heineken Heineken. When true friends get together. 102 Heineken N.V.: Global Branding and Advertising 596-015 11 Exhibit 6 Indications of Beer Taste: Summary of Focus Group Responses Netherlands Germany Italy USA Average 8 Countries Manufacturing Ingredients - + - - - Water quality + + - - 0 Scale of plant + + - + + Product Taste experience + + + + + Balanced taste + + + + + Aftertaste - - + + 0 Freshness + - - + 0 Foam + + 0 + + Drinkability + + - - + Day After + + - - 0 Marketing Price - + - + 0 Advertising + - + + + Packaging - + + + + N ote:A m i nus si gn ( - ) i ndi cates the factor i s an uni m por tant or negative i ndi cator of quali ty. 103 596-015 Heineken N.V.: Global Branding and Advertising 12 Exhibit 7 Standard vs. Premium Beer: Summary of Focus Group Responses Standard Premium Company • nuclear family • intimate friends • large groups • smaller groups • your wife • girlfriend • colleagues • boss Occasions and Moments • after work • meeting people • at meals • fancy meals • at home • away from home • watching TV • new encounters • thirst-quenching • savouring • (popular) bars • traveling • beach • intimate moments and places • to party • elegant parties • daytime • nighttime • after sports • entertaining • sport events • disco/nightclub Role of Beer • social participation • ego enhancement/self-esteem • thirst-quencher • a treat • alcohol effect • a communication tool • problem solver • signal function 104 Heineken N.V.: Global Branding and Advertising 596-015 13 Exhibit 8 Taste Expressions: Overall Heineken Suitability Netherlands Germany Italy USA Average 8 Countries Brand Vision - + + - - Quality Two years Amsterdam training + + + + + 24 quality checks + + + + + Bottles returned to Amsterdam + + + + + Brewing Skills 100% malt 0 + 0 + 0 Smooth taste - + + + 0 Pure taste + - + + 0 Matured longer - 0 - - - Tradition Family since 1863 - + - + 0 Original recipe + + 0 + + Where beer was born + + + + + Availability More bars/more countries + 0 - 0 0 Exhibit 9 Friendship Expressions: Overall Heineken Suitability Netherlands Germany Italy USA Average 8 Countries Friendship Cat and dog 0 0 + - 0 Rugby (sport) + 0 + - 0 True friends + + 0 + + Always count on Heineken + + + + + Respect - - - - - 105 106 Harvard Business School 9-598-097 Rev. August 11, 1998 Professor John A. Quelch prepared this case from published sources as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1998 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 1 Pepsi Blue In late November 1995, Pepsi-Cola International’s (PCI) beverage division announced the global launch of a new brand identity and logo for Pepsi soft drinks. Plans called for a $500 million investment to update the look of Pepsi cans and bottles, point-of-sale signage, trucks and vending machines worldwide. The redesign effort, known as Project Blue, aimed to rejuvenate the Pepsi image by associating the brand with the color blue in contrast to Coca-Cola’s long-standing association with the color red. Company Background With 1995 revenues of $30.4 billion, PepsiCo was a worldwide food and beverage marketer that ranked 20 in the Fortune 500 and 30 in market value among all companies in the world. Of total revenues, 35% were accounted for by beverages, 37% by restaurants (including KFC, Pizza Hut, and Taco Bell) and 28% by snack foods (including Lay’s, Ruffles, and Doritos). PepsiCo beverages included soft drinks (such as Pepsi, Diet Pepsi, Pepsi Max, 7-Up, Slice, and Mountain Dew), teas, bottled water, and juices. Package pictures of PepsiCo beverages are presented in Exhibit 1. In several noncarbonated beverage categories PepsiCo had formed alliances, for example, to distribute the ready-to-drink tea products of Thomas J. Lipton Co. and Ocean Spray fruit juices. In 1995, PepsiCo’s dollar beverage sales in the United States rose 7%. Volume growth accounted for one-quarter of this increase. Retail case sales grew faster than sales through fountains and restaurants (which included the many chains in PepsiCo’s restaurant division). Dollar beverage sales outside the United States rose 14% in 1995. Volume growth accounted for 45% of this increase, the remainder stemming from acquisitions and price increases. In the United States in 1995, PepsiCo accounted for 27% of the retail value of carbonated soft drink sales and held a 23% volume share. The corresponding figures for Coca-Cola were 35% and 30%. Coca-Cola’s share lead in the United States was greater in vending machines and restaurants than in retail stores. Both companies had been subject to share pressure from lower priced own-label carbonated beverages in 1993-95 but had been able to recover short-term share losses through new products, new packaging and stepped up advertising and promotion. Around 29% of PepsiCo’s 1995 beverage revenues and 18% of beverage operating profits were derived from international operations. The three Pepsi brands (Pepsi, Diet Pepsi and Pepsi Max) accounted for 40% of PepsiCo’s U.S. beverage dollar sales (with 4 billion cases of 24 8-oz. cans). 107 598-097 Pepsi Blue 2 Outside the United States, 2 billion cases of the three Pepsi brands were sold in 1995, accounting for 70% of PepsiCo’s international beverage sales. The marketplace rivalry between Pepsi and Coca-Cola was decades old. Pepsi had established itself in the 1930s as Coca-Cola’s main rival with a price oriented campaign, “Twice as much for a nickel, too.” In the 1970s Pepsi gained ground on Coca-Cola by focusing on taste superiority through the Pepsi Challenge. Some 20 million people took the Pepsi Challenge, of whom 60% chose Pepsi over Coca-Cola. In the 1980s, both brands invested heavily in image advertising and celebrity endorsements. Pepsi’s tagline, “The choice of a new generation,” positioned it squarely against a teenage target. Coca-Cola had typically followed a broader and more traditional positioning and, in 1993, reintroduced its classic contour bottle. The classic bottle, when surrounded by the red circle icon, was launched worldwide as the new Coca-Cola logo in conjunction with the “Always Coca-Cola” advertising tagline. Despite exploiting its classic heritage, Coca-Cola was able to successfully target some teenagers with innovative advertising, sports event sponsorships, and celebrity endorsements. Some analysts believed Pepsi was losing its edge over Coca-Cola in the youth market. Outside the United States, the share gap between Coca-Cola and Pepsi was greater than in the domestic market. Pepsi exceeded Coca-Cola in market share in only 5 of the top 50 country markets. PepsiCo spent $500 million on advertising carbonated beverages in the United States in 1995 and $200 million internationally, up 3% and 7% respectively over 1994. Corresponding Coca- Cola expenditures in 1995 were $1.2 billion and $600 million. The Pepsi system’s two most important new product launches in 1993 were Crystal Pepsi and Pepsi Max. Crystal Pepsi, a clear rather than colored version of the classic Pepsi formula, was launched in the United States but failed to achieve more than 2% volume share of carbonated beverage sales. On the other hand, Pepsi Max, a “no sugar, maximum taste” cola targeted at 16- to 29-year-olds in a redesigned blue can and supported by television advertising featuring tennis star Andre Agassi quickly gained a 5% volume share in its launch market, the United Kingdom.1 Pepsi Max was the first PepsiCo soft drink launched first outside the United States. It accounted for 20% of Pepsi sales volume in the United Kingdom by the end of 1995. During 1995, Pepsi Max international sales increased 70% over 1994 as the brand was rolled out in 50 countries. Pepsi Max accounted for one-third of all PCI soft drink volume growth in 1995. Even though it was not yet distributed in the United States, worldwide retail sales of Pepsi Max were expected to reach $450 million in 1995.2 In addition to new product launches, PepsiCo achieved sales growth through several other strategies. First, PepsiCo continued its strong record of packaging innovation. In the United States, the launch of the Cube, an easy-to-store 24-can pack was credited with increasing Pepsi volume 7% in supermarkets, compared to an overall 4% growth in soft drink volume through this channel. In the impulse-driven convenience/gas store channel, Pepsi-Cola became the share leader thanks to its Big Slam (a one-liter, single-serve bottle) and Quick Slam (20-ounce bottle) packaging innovations. In 1995, PepsiCo also pioneered the concept of freshness dating on soft drinks in the United States. Overseas, PepsiCo continued to invest in acquisitions and joint ventures in emerging markets to try to close the share gap with Coca-Cola. In most emerging markets, teens, Pepsi’s core target, accounted for a much higher proportion of the population than in the United States—yet per capita 1 The United Kingdom was chosen in part because acceptance of sugar-free colas (17% market share) was among the highest in the world. 2 Pepsi Max employed an artificial sweetener not yet approved by the Food and Drug Administration for use in the United States. 108 Pepsi Blue 598-097 3 consumption of soft drinks was much lower.3 Between 1993 and 1995, over $500 million was invested in beverage acquisitions and joint ventures. In Hungary and Poland, Pepsi acquired cola market share leadership. In India, Pepsi’s market share rose to nearly 40%. Almost 40% of PCI’s 1995 international soft drink volume growth came from emerging markets. In addition to forging new alliances, PepsiCo continued to use surplus cash to purchase partial or total control of its independent bottlers around the world. Between 1990 and 1995, PCI refranchised, consolidated, or restructured almost 60% of its business. By the end of 1995, PepsiCo had outright ownership or shared equity in bottling operations accounting for 55% of international beverage volume, up from 20% in 1995, and for 70% of United States volume. Corresponding figures for Coca-Cola were 80% and 70%. The Presence Audit The visibility and impact of the Pepsi brand name and logo at the point-of-purchase were considered especially important to sales success in the impulse purchase driven soft drink category. Consumers were exposed to the Pepsi name on signs outside of points-of-sale, on trucks, on vending machines, on “wraparounds” at the bottom of in-store displays, and on packages. By the middle of 1994, there was increasing concern within PCI about inconsistent presentation of the Pepsi brand to consumers. Pepsi had only changed its brand identity seven times in the company’s history, most recently in 1991. However, in many markets, old signs were still being used alongside new ones. In addition, each brand logo had been interpreted slightly differently by Pepsi’s independent bottlers. Although Pepsi and the bottlers shared the cost of point-of-purchase signage and materials on a 50/50 basis, the bottlers decided what was used. As shown in Exhibit 1, Pepsi’s first official logo was created in 1898 when the pharmacist Caleb Bradham changed the name of the original formula, developed as a cure for dyspepsia, from Brad’s Drink to Pepsi-Cola. The first Pepsi Cola logo was red. This was dropped for red, white, and blue in 1941 as Pepsi gave its support to the World War II effort. A “bottle cap” logo was launched in 1950, evolving into the bull’s-eye “swish” logo in 1973. In late 1994, PCI commissioned Landor Associates, a corporate identity consultancy, to evaluate the point-of-sale presence of the Pepsi family of brands. After interviews with PCI executives in seven countries, Landor organized a worldwide photographic audit of Pepsi’s brand presence. About 2,000 photographs were assembled from 34 countries. They showed inconsistencies and lack of integration in the presentation of the Pepsi logo and graphics both within countries as well as across countries. In addition, the photos showed that Pepsi owned no particular color except perhaps white. Pepsi graphics often looked weak, flat, and washed out when compared to Coke’s bold red decal. The graphics did not express the energy and core essence of Pepsi. The long red pedestal and Pepsi ball did not work well on the sides of trucks or vending machines. In the view of some, cans of Pepsi looked like motor oil. A team of consultants and PCI executives set out to develop an improved look for Pepsi graphics in merchandising materials around the world. The team identified blue as a much stronger color than white that Pepsi could own in contrast to Coke’s dominance of red. Consumers viewed blue as modern and cool, exciting and dynamic, and a color that communicated refreshment. The team began to think of blue as a key component of Pepsi’s brand equity. Only then did the team begin to do exploratory work on redesigning Pepsi packaging. At that point, the project needed top 3 For example, per-capita soft drink consumption in the United States of 51 gallons per year compared to 20 gallons in Argentina, 15 gallons in Saudi Arabia, and 5 gallons in Thailand. 109 598-097 Pepsi Blue 4 management approval. PCI’s president saw Project Blue as a big idea that could galvanize the Pepsi system worldwide and refocus managers around the world on restoring Pepsi’s marketing edge. The original mission set out for the design team was to develop a graphics treatment and product line look that would strengthen the Pepsi brand identity and deliver higher impact in-market presence for the Pepsi brand. The team set out to: 1. Develop a flexible design (that could be used effectively on displays and trucks and in a variety of other media). 2. Establish blue as Pepsi’s dominant color. 3. Develop a mnemonic device. 4. Create a modern, even futuristic, look and image to contrast with Coke’s traditional positioning. The project team first worked on developing a two-dimensional icon which retained some of the equity of the current brand identity—principally the Pepsi ball. Exhibit 2 shows the winning design from this phase of the project. The designers noted that the unitalicized logotype added boldness and stature. Spelling Pepsi in white on a blue-and-red background reversed the color architecture of the previous logo and ended up doing the same. The traditional Pepsi ball became a globe. Showing only a quarter of the ball enhanced its larger-than-life personality and effectively transformed it from a ball into a three-dimensional, futuristic globe. The next challenge for the design team was to translate the off-pack design into an execution that would work equally well on three-dimensional cans and bottles. Although bottle volume exceeded can volume in many markets, the design team focused first on cans since they dominated away-from-home consumption and were therefore more often used and seen in public. By combining the toolbox of graphics they had already developed with a grid background on the can surface, the designers were able to produce in June 1995 the final can designs for the Pepsi family of brands shown in Exhibit 2. The final design, following the exploration of over 3,000 design approaches, featured a striking blue “grid” background, bold, vertical typography, and a three-dimensional globe that evoked Pepsi’s well-known “ball” icon. The blue graphics would be carried on all packages of Pepsi- Cola, Pepsi Max, and Diet Pepsi. The Hong Kong Bottler Meeting: May 1995 At PCI’s annual bottler meeting in Hong Kong in May 1995, attended by all company-owned and franchised bottlers worldwide, PCI’s president elected to announce Project Blue. The buzz in the corridors after the speech ranged from enthusiasm to concern. The PCI vice president in charge of Eastern Europe was bullish: “Maybe I can finally paint Red Square blue!” Others, including several franchisee bottlers, were concerned about the expense and management time that the rollout would require and whether Pepsi management would support the rollout of Blue in the United States. The PCI president followed up with a series of internal memos that ensured that Project Blue would be a focus of every country manager’s and bottler’s thinking as their 1996 business plans and budgets were developed and finalized during the period from September to November 1995. 110 Pepsi Blue 598-097 5 The Bahrain Test: October 1995 At the May meeting, it was announced that Project Blue would be launched initially in Bahrain in October. The selection of Bahrain was based on four factors. First, PCI regional management in the Middle East had already been experimenting with blue backgrounds in point-ofsale materials because the standard white background caused the logo to be washed out in the bright sunlight common to the region. Second, the Bahrain market was served by a single franchisee bottler who had, on occasion, been critical of PCI headquarters. The credibility of Project Blue would be enhanced if he could be convinced. Third, as in other Middle Eastern markets, Pepsi sales dominated Coke’s by 3 to 1, so any negative reaction towards Blue among existing Pepsi consumers used to the current logo and signage would surface in the test. Fourth, Bahrain was a small market of 1 million people who lived on two islands connected by a bridge; this enabled PCI to conduct a controlled field test to measure the impact of Blue. A Blue Fund was established at PCI headquarters to cover the cost of the market test and a PCI task force was appointed to spearhead its implementation. The Bahrain bottler’s marketing managers and salesforce were also heavily involved in local execution. However, because the bottler had recently invested heavily in installing new production lines to increase capacity, he was not pressed to cover the cost of production line changes, the new signage and point-of-sale displays. The PCI task force developed and executed a rollout of Blue in 12 weeks. Newly designed cans and bottles for all Pepsi brands were distributed throughout Bahrain. The entire Blue program, including signage and point-of-sale materials, was implemented in one-half of the city (around 500 of the 1,000 retail outlets). Implementation included both converting existing signage and adding new signage. A new advertising slogan, “New look. Same great taste,” was appended to existing television and print advertising executions. Spending on advertising and promotion during the test was sustained at previously planned levels. Tracking research was conducted before, during and after the test. Measures of brand attitudes improved, as did sales volume and market share. Around 70% of consumers believed that there was no change in Pepsi’s taste, 30% thought there was a taste change and, of these, 70% thought the perceived taste change was positive. The November Meeting With the benefit of the positive results from Bahrain, PCI executives were convinced that their enthusiasm for Blue was well-founded. They were asked to present their recommendations for a worldwide rollout of Project Blue at a meeting at PCI headquarters in late November. Their recommendations covered the speed of the worldwide rollout and the sequence of countries in which Blue should be launched. In addition, they proposed a creative and expensive communications program to support the worldwide launch. First, PCI executives recommended that Blue be rolled out in markets accounting for half of brand Pepsi’s international sales volume by July 1996. By the end of the year, they expected more than 20 billion cans and bottles would reach store shelves. However, several executives were unconvinced that the Bahrain execution or results could be replicated on a worldwide basis. They pointed to Pepsi’s unusually high share in Bahrain and the fact that it was a developing rather than mature market. These executives argued for a slower rollout on a region-by-region basis. A second group of executives advocated launching Blue first in a lead market in each region; success in each lead market would then motivate the other bottlers in the region to follow. PCI European executives, for example, argued that the United Kingdom should be a regional lead market for Blue because of the successful launch of Pepsi Max; because Pepsi’s soft drink market share in the United Kingdom trailed CocaCola brands 19% to 50%; and because Pepsi brands were losing share to own labels 111 598-097 Pepsi Blue 6 marketed in red cans by the United Kingdom’s powerful supermarket chains and also to the recently launched Virgin Cola. PCI’s Latin American executives pointed out that the bottlers in their region, especially in Mexico, had made significant capital investments in their infrastructure in the last four years. It would be difficult to demand that they change their signs again so soon. Hence, the Latin American launch would have to be postponed until 1997. Other executives argued that a simultaneous worldwide launch of Project Blue would be a logistical nightmare. Some preferred to wait until each bottler was totally committed than risk halfhearted support from bottlers who might be pushed into going with Blue before they were ready, just for the sake of a global launch. There was skepticism at the meeting about the U.S. organization’s willingness to adopt recommendations from the international side of the business due to the not-invented-here syndrome. The U.S. organization was working on its own package redesign which, though similar, was not the same. The question was raised as to whether bottlers around the world would adopt the PCI plan if the U.S. organization was going in another direction. PCI executives recommended a $500 million marketing program to support the worldwide launch. This investment, to be spent in 1996, included the systemwide conversion of bottles and cans, coolers and vending machines, and trucks. Advertising spending for 1996, originally set at $200 million for Pepsi brand beverages outside the United States, would be increased to $300 million and support a new advertising campaign that targeted younger consumers with the tagline, “Change the Script.” This new tagline, which would replace “The Choice of a New Generation” introduced in 1984, would be launched in early April 1996 in Project Blue lead markets including the United Kingdom; a tentative media schedule called for the advertising to be seen by 300 million people in 20 countries in the first four weeks. The new campaign would include five television spots featuring, among other celebrities, Cindy Crawford (for five years a Pepsi spokesperson), Claudia Schiffer and Andre Agassi. Several public relations initiatives were planned to coincide with the launch of the advertising campaign. These included a ten city tour of Europe and the Middle East by a Concorde jet adorned with Pepsi’s new colors4; sponsorship of the Russian Mir Space Station which would permit the advertising tag line “Even in Space—Pepsi is Changing the Script;” and a three-year alliance with Viacom’s MTV Network to include cosponsorship in July 1996 of the Global Dance Connection, Europe’s largest-ever interactive dance party to be held simultaneously in three European cities. Executives at the November meeting were impressed but, in some cases, awed by the magnitude of the proposed worldwide communications campaign to launch Blue. Some argued that spending the money to support tactical marketing efforts, sales promotion and additional sales coverage worldwide might be less glamorous but would be more effective and less controversial. Others worried that funds might be diverted from the faster growing non-Pepsi brands to support the weaker links in the brand portfolio. Pepsi Max executives were concerned that extending the Blue idea to the main Pepsi brand would dilute its impact on their sales. A third group acknowledged that Pepsi Blue represented a huge bet on the future but, they argued, the sales and share trends versus Coke gave Pepsi no choice. For them, Pepsi Blue represented the long-needed big, new idea. 4 According to PepsiCo public relations, the Concorde “changed the script” of air travel over 20 years ago. 112 Pepsi Blue 598-097 7 References Guy de Jonquières, “Clash of the cans,” Financial Times, March 4, 1993, p. 14. M. Gleason and D. Britt, “Pepsi to be soft drinks’ big blue,” Advertising Age, March 18, 1996, p. 4. PepsiCo Press Release, “Project Blue Fact Sheet,” April 2, 1996. PepsiCo Press Release, “Pepsi-Cola eyes millennium with launch of revolutionary blue look,” April 2, 1996. Sharon Marshall, “Will revamp put the fizz back into Pepsi?”, Marketing, March 14, 1996, p. 10. Peter Martin, “Back to business as usual,” Financial Times, April 6, 1996, p. 12. Patricia Sellers, “How Coke is kicking Pepsi’s can,” Fortune, October 28, 1996, pp. 70-81. “Turning Pepsi Blue,” The Economist, April 13, 1996, p. 15. 113 598-097 Pepsi Blue 8 Exhibit 1 Chronology of Pepsi-Cola Logos 114 Pepsi Blue 598-097 9 Exhibit 2 Winning Logo Design and Final Can Designs ` 115 116 Bibliography "Chapter 1: Foundations of Strategic Marketing Management." In Strategic Marketing Problems: Cases and Comments, 11e, by Kerin, Roger A; Peterson, Robert A. 11th ed. pp. 1-32. Prentice Hall /Pearson Education (Upper Saddle River, NJ)*, 2007. 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