CHAPTER ONE

Three women anda goose makea marketplace.
ITALIAN PROVERB

1Marketing and theConcept of Planningand StrategyOver the years marketers have been presented with a series of philosophicalapproaches to marketing decision making. One widely used approach is themarketing concept approach, which directs the marketer to develop the productoffering, and indeed the entire marketing program, to meet the needs of the customer base. A key element in this approach is the need for information flow fromthe market to the decision maker. Another approach is the systems approach, which
instructs the marketer to view the product not as an individual entity but as justone aspect of the customer’s total need-satisfaction system. A third approach, theenvironmental approach, portrays the marketing decision maker as the focal pointof numerous environments within which the firm operates and that affect the success of the firm’s marketing program. These environments frequently bear suchlabels as legal-political, economic, competitive, consumer, market structure,social, technological, and international.
Indeed, these and other philosophical approaches to marketing decision
making are merely descriptive frameworks that stress certain aspects of the firm’srole vis-à-vis the strategic planning process. No matter what approach a firm follows, it needs a reference point for its decisions that is provided by the strategy
and the planning process involved in designing the strategy. Thus, the strategicplanning process is the guiding force behind decision making, regardless of theapproach one adopts. This relationship between the strategic planning process
and approaches to marketing decision making is depicted in Exhibit 1-1.
Planning perspectives develop in response to needs that arise internally orthat impinge on the organization from outside. During the 1950s and 1960s,
growth was the dominant fact of the economic environment, and the planning
processes developed during that time were typically geared to the discovery andexploitation of entrepreneurial opportunities. Decentralized planning was theorder of the day. Top management focused on reviewing major investment proposals and approving annual operating budgets. Long-range corporate plans

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EXHIBIT 1-1
Relationship between the Strategic Planning Process and Approaches to Marketing
Decision Making

were occasionally put together, but they were primarily extrapolations and wererarely used for strategic decision making.
Planning perspectives changed in the 1970s. With the quadrupling of energy
costs and the emergence of competition from new quarters, followed by a recession and reports of an impending capital crisis, companies found themselves surrounded by new needs. Reflecting these new management needs and concerns, a
process aimed at more centralized control over resources soon pervaded planning
efforts. Sorting out winners and losers, setting priorities, and conserving capital
became the name of the game. A new era of strategic planning dawned over corporate America.
The value of effective strategic planning is virtually unchallenged in today’s
business world. A majority of the Fortune 1000 firms in the United States, forinstance, now have senior executives responsible for spearheading strategic planning efforts.
Strategic planning requires that company assets (i.e., resources) be managed
to maximize financial return through the selection of a viable business in accordance with the changing environment. One very important component of strategic planning is the establishment of the product/market scope of a business. It is
within this scope that strategic planning becomes relevant for marketers.1 Thus,

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as companies adopted and made progress in their strategic planning capabilities,
a new strategic role for marketing emerged. In this strategic role, marketing concentrates on the markets to serve, the competition to be tackled, and the timing ofmarket entry/exit.

CONCEPT OF PLANNING
Throughout human history, people have tried to achieve specific purposes, and in
this effort some sort of planning has always found a place. In modern times, theformer Soviet Union was the first nation to devise an economic plan for growthand development. After World War II, national economic planning became a popular activity, particularly among developing countries, with the goal of systematicand organized action designed to achieve stated objectives within a given period.
Among market economies, France has gone the furthest in planning its economic
affairs. In the business world, Henri Fayol, the French industrialist, is creditedwith the first successful attempts at formal planning.
Accomplishments attributed to planning can be summarized as follows:
1. Planning leads to a better position, or standing, for the organization.
2. Planning helps the organization progress in ways that its management considers
most suitable.
3. Planning helps every manager think, decide, and act more effectively andprogress in the desired direction.
4. Planning helps keep the organization flexible.
5. Planning stimulates a cooperative, integrated, enthusiastic approach to organizational problems.
6. Planning indicates to management how to evaluate and check up on progress
toward planned objectives.
7. Planning leads to socially and economically useful results.

Planning in corporations emerged as an important activity in the 1960s. Several
studies undertaken during that time showed that companies attached significant
importance to planning. A Conference Board survey of 420 firms, for example,
revealed that 85 percent had formalized corporate planning activity.2 A 1983 survey
by Coopers & Lybrand and Yankelovich, Skelly, and White confirmed the central
role played by the planning function and the planner in running most large businesses.3 Although the importance of planning had been acknowledged for sometime, the executives interviewed in 1983 indicated that planning was becoming
more important and was receiving greater attention. A 1991 study by McDonald’s
noted that marketing planning is commonly practiced by companies of all sizes,
and there is wide agreement on the benefits to be gained from such planning.4 A
1996 survey by the Association of Management Consulting Firms found that business persons, academics, and consultants expect business planning to be their mostpressing management issue as they prepare to enter the next century.5
Some companies that use formal planning believe that it improves profits andgrowth, finding it particularly useful in explicit objective setting and in monitoring results.6 Certainly, the current business climate is generating a new posture3

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among executives, with the planning process being identified by eight out of ten
respondents as a key to implementing the chief executive officer’s (CEO) chosen
strategy.7 Today most companies insist on some sort of planning exercise to meetthe rapidly changing environment. For many, however, the exercise is cathartic
rather than creative.
Growth is an accepted expectation of a firm; however, growth does not
happen by itself. Growth must be carefully planned: questions such as how much,when, in which areas, where to grow, and who will be responsible for different
tasks must be answered. Unplanned growth will be haphazard and may fail toprovide desired levels of profit. Therefore, for a company to realize orderly
growth, to maintain a high level of operating efficiency, and to achieve its goals
fully, it must plan for the future systematically. Products, markets, facilities, personnel, and financial resources must be evaluated and selected wisely.
Today’s business environment is more complex than ever. In addition to thekeen competition that firms face from both domestic and overseas companies, avariety of other concerns, including environmental protection, employee welfare,consumerism, and antitrust action, impinge on business moves. Thus, it is desirable
for a firm to be cautious in undertaking risks, which again calls for a planned effort.
Many firms pursue growth internally through research and development.
This route to growth is not only time-consuming but also requires a heavy commitment of resources with a high degree of risk. In such a context, planning isneeded to choose the right type of risk.
Since World War II, technology has had a major impact on markets and marketers. Presumably, the trend of accelerating technological change will continue
in the future. The impact of technological innovations may be felt in any industry
or in any firm. Therefore, such changes need to be anticipated as far in advanceas possible in order for a firm to take advantage of new opportunities and to
avoid the harmful consequences of not anticipating major new developments.
Here again, planning is significant.
Finally, planning is required in making a choice among the many equallyattractive alternative investment opportunities a firm may have. No firm canafford to invest in each and every “good’’ opportunity. Planning, thus, is essential
in making the right selection.
Planning for future action has been called by many different names:
long-range planning, corporate planning, comprehensive planning, and formalplanning. Whatever its name, the reference is obviously to the future.
Definition ofPlanning

Planning is essentially a process directed toward making today’s decisions withtomorrow in mind and a means of preparing for future decisions so that they may bemade rapidly, economically, and with as little disruption to the business as possible.

Though there are as many definitions of planning as there are writers on thesubject, the emphasis on the future is the common thread underlying all planning theory. In practice, however, different meanings are attached to planning.
A distinction is often made between a budget (a yearly program of operations)and a long-range plan. Some people consider planning as something done by

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staff specialists, whereas budgeting is seen to fall within the purview of line
managers.
It is necessary for a company to be clear about the nature and scope of theplanning that it intends to adopt. A definition of planning should then be basedon what planning is supposed to be in an organization. It is not necessary forevery company to engage in the same style of comprehensive planning. The basisof all planning should be to design courses of action to be pursued for achieving
stated objectives such that opportunities are seized and threats are guarded
against, but the exact planning posture must be custom-made (i.e., based on thedecision-making needs of the organization).
Operations management, which emphasizes the current programs of an organization, and planning, which essentially deals with the future, are two intimately
related activities. Operations management or budgeted programs should emerge
as the result of planning. In the outline of a five-year plan, for example, years two
through five may be described in general terms, but the activities of the first year
should be budgeted and accompanied by detailed operational programs.
A distinction should also be made between planning and forecasting.
Forecasting considers future changes in areas of importance to a company andtries to assess the impact of these changes on company operations. Planning takes
over from there to set objectives and goals and develop strategy.
Briefly, no business, however small or poorly managed, can do without planning. Although planning per se may be nothing new for an organization, the current emphasis on it is indeed different. No longer just one of several importantfunctions of the organization, planning’s new role demands linkage of various
parts of an organization into an integrated system. The emphasis has shifted fromplanning as an aspect of the organization to planning as the basis of all efforts anddecisions, the building of an entire organization toward the achievement of designated objectives.
There is little doubt about the importance of planning. Planning departments are key in critiquing strategies, crystallizing goals, setting priorities, andmaintaining control;8 but to be useful, planning should be done properly.
Planning just for the sake of it can be injurious; half-hearted planning can cause
more problems than it solves. In practice, however, many business executives
simply pay lip service to planning, partly because they find it difficult to incorporate planning into the decision-making process and partly because they are
uncertain how to adopt it.
Requisites for
Successful PlanningIf planning is to succeed, proper arrangements must be made to put it into operation. The Boston Consulting Group suggests the following concerns for effectiveplanning:• There is the matter of outlook, which can affect the degree to which functional
and professional viewpoints, versus corporate needs, dominate the work of planning.
• There is the question of the extent of involvement for members of the management. Who should participate, and to what extent?

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7• There is the problem of determining what part of the work of planning should beaccomplished through joint effort and how to achieve effective collaboration
among participants in the planning process.
• There is the matter of incentive, of making planning an appropriately emphasized and rewarded kind of managerial work.
• There is the question of how to provide staff coordination for planning, whichraises the issue of how a planning unit should be used in the organization.
• And there is the role of the chief executive in the planning process. What should
it be?9

Though planning is conceptually rather simple, implementing it is far fromeasy. Successful planning requires a blend of many forces in different areas, notthe least of which are behavioral, intellectual, structural, philosophical, and managerial. Achieving the proper blend of these forces requires making difficult decisions, as the Boston Consulting Group has suggested. Although planning is
indeed complex, successful planning systems do have common fundamental
characteristics despite differing operational details. First, it is essential that the
CEO be completely supportive. Second, planning must be kept simple, in agreement with the managerial style, and unencumbered by detailed numbers andfancy equations. Third, planning is a shared responsibility, and it would be wrong
to assume that the president or vice president of planning, staff specialists, or line
managers can do it single-handedly. Fourth, the managerial incentive systemshould give due recognition to the fact that decisions made with long-term implications may not appear good in the short run. Fifth, the goals of planning shouldbe achievable without excessive frustration and work load and with widespread
understanding and acceptance of the process. Sixth, overall flexibility should be
encouraged to accommodate changing conditions.
Initiating Planning
Activities

There is no one best time for initiating planning activities in an organization;
however, before developing a formal planning system, the organization should be
prepared to establish a strong planning foundation. The CEO should be a central
participant, spearheading the planning job. A planning framework should be
developed to match the company’s perspective and should be generally acceptedby its executives. A manual outlining the work flow, information links, format ofvarious documents, and schedules for completing various activities should be
prepared by the planner. Once these foundations are completed, the company can
initiate the planning process anytime.
Planning should not be put off until bad times prevail; it is not just a cure forpoor performance. Although planning is probably the best way to avoid bad
times, planning efforts that are begun when operational performance is at an ebb(i.e., at low or no profitability) will only make things worse, since planning efforts
tend initially to create an upheaval by challenging the traditional patterns of decision making. The company facing the question of survival should concentrate on
alleviating the current crisis.
Planning should evolve gradually. It is wishful thinking to expect full-scaleplanning to be instituted in a few weeks or months. Initial planning may beMarketing and the Concept of Planning and Strategy

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formalized in one or more functional areas; then, as experience is gained, a company-wide planning system may be designed. IBM, a pioneer in formalized planning, followed this pattern. First, financial planning and product planning wereattempted in the post-World War II period. Gradual changes toward increased
formality were made over the years. In the later half of 1960s, increased attention
was given to planning contents, and a compatible network of planning data systems was initiated. Corporate-wide planning, which was introduced in the 1970s,
forms the backbone of IBM’s current global planning endeavors. Beginning in
1986, the company made several changes in its planning perspectives in responseto the contingencies created by deteriorating performance. In the 1990s, planning
at IBM became more centralized to fully seek resource control and coordination.
Philosophies ofPlanning

In an analysis of three different philosophies of planning, Ackoff established thelabels satisfying, optimizing, and adaptivizing.10 Planning on the basis of thesatisfying philosophy aims at easily achievable goals and molds planning efforts
accordingly. This type of planning requires setting objectives and goals that are“high enough’’ but not as “high as possible.’’ The satisfying planner, therefore,
devises only one feasible and acceptable way of achieving goals, which may notnecessarily be the best possible way. Under a satisfying philosophy, confrontations
that might be caused by conflicts in programs are diffused through politicking,underplaying change, and accepting a fall in performance as unavoidable.
The philosophy of optimizing planning has its foundation in operations
research. The optimizing planner seeks to model various aspects of the organization and define them as objective functions. Efforts are then directed so that an
objective function is maximized (or minimized), subject to the constraints
imposed by management or forced by the environment. For example, an objective
may be to obtain the highest feasible market share; planning then amounts tosearching for different variables that affect market share: price elasticity, plant
capacity, competitive behavior, the product’s stage in the life cycle, and so on. The
effect of each variable is reduced to constraints on the market share. Then an
analysis is undertaken to find out the optimum market share to target.
Unlike the satisfying planner, the optimizer endeavors, with the use of mathematical models, to find the best available course to realize objectives and goals.
The success of an optimizing planner depends on how completely and accurately
the model depicts the underlying situation and how well the planner can figureout solutions from the model once it has been built.
The philosophy of adaptivizing planning is an innovative approach not yet
popular in practice. To understand the nature of this type of planning, let uscompare it to optimizing planning. In optimization, the significant variables
and their effects are taken for granted. Given these, an effort is made to achieve
the optimal result. With an adaptivizing approach, on the other hand, planningmay be undertaken to produce changes in the underlying relationships themselves and thereby create a desired future. Underlying relationships refer to anorganization’s internal and external environment and the dynamics of thevalues of the actors in these environments (i.e., how values relate to needs and78Marketing and the Concept of Planning and Strategy

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9to the satisfaction of needs, how changes in needs produce changes in values,and how changes in needs are produced).

CONCEPT OF STRATEGY
Strategy in a firm isthe pattern of major objectives, purposes, or goals and essential policies and plans forachieving those goals, stated in such a way as to define what business the company isin or is to be in and the kind of company it is or is to be.

Any organization needs strategy (a) when resources are finite, (b) when there
is uncertainty about competitive strengths and behavior, (c) when commitment of
resources is irreversible, (d) when decisions must be coordinated between
far-flung places and over time, and (e) when there is uncertainty about control of
the initiative.
An explicit statement of strategy is the key to success in a changing businessenvironment. Strategy provides a unified sense of direction to which all membersof the organization can relate. Where there is no clear concept of strategy, decisions rest on either subjective or intuitive assessment and are made without
regard to other decisions. Such decisions become increasingly unreliable as thepace of change accelerates or decelerates rapidly. Without a strategy, an organization is like a ship without a rudder going around in circles.
Strategy is concerned with the deployment of potential for results and thedevelopment of a reaction capability to adapt to environmental changes. Quite
naturally, we find that there are hierarchies of strategies: corporate strategy andbusiness strategy. At the corporate level, strategy is mainly concerned with defining the set of businesses that should form the company’s overall profile.
Corporate strategy seeks to unify all the business lines of a company and point
them toward an overall goal. At the business level, strategy focuses on defining
the manner of competition in a given industry or product/market segment. A
business strategy usually covers a plan for a single product or a group of related
products. Today, most strategic action takes place at the business unit level, where
sophisticated tools and techniques permit the analysis of a business; the forecasting of such variables as market growth, pricing, and the impact of government
regulation; and the establishment of a plan that can sidestep threats in an erraticenvironment from competitors, economic cycles, and social, political, and consumer changes.
Each functional area of a business (e.g., marketing) makes its own uniquecontribution to strategy formulation at different levels. In many firms, the marketing function represents the greatest degree of contact with the external environment, the environment least controllable by the firm. In such firms, marketingplays a pivotal role in strategy development.
In its strategic role, marketing consists of establishing a match between the firm
and its environment. It seeks solutions to problems of deciding (a) what businessthe firm is in and what kinds of business it may enter in the future and (b) how theMarketing and the Concept of Planning and Strategy

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chosen field(s) of endeavor may be successfully run in a competitive environment
by pursuing product, price, promotion, and distribution perspectives to servetarget markets. In the context of strategy formulation, marketing has two dimensions: present and future. The present dimension deals with the existing relationships of the firm to its environments. The future dimension encompasses intended
future relationships (in the form of a set of objectives) and the action programs necessary to reach those objectives. The following example illustrates the point.
McDonald’s, the hamburger chain, has among its corporate objectives thegoal of increasing the productivity of its operating units. Given the high proportion of costs in fixed facilities, McDonald’s decided to increase facility utilization
during off-peak hours, particularly during the morning hours. The program
developed to accomplish these goals, the Egg McMuffin, was followed by abreakfast menu consistent with the limited product line strategy of McDonald’s
regular fare. In this example, the corporate goal of increased productivity led tothe marketing perspective of breakfast fare (intended relationship), which wasbuilt over favorable customer attitudes toward the chain (existing relationship).
Similarly, a new marketing strategy in the form of McDonald’s Chicken Fajita(intended relationship) was pursued over the company’s ability to serve food fast(existing relationship) to meet the corporate goal of growth.
Generally, organizations have identifiable existing strategic perspectives;
however, not many organizations have an explicit strategy for the intended
future. The absence of an explicit strategy is frequently the result of a lack of top
management involvement and commitment required for the development ofproper perspectives of the future within the scope of current corporate activities.
Marketing provides the core element for future relationships between thefirm and its environment. It specifies inputs for defining objectives and helps formulate plans to achieve them.

CONCEPT OF STRATEGIC PLANNING
Strategy specifies direction. Its intent is to influence the behavior of competitors
and the evolution of the market to the advantage of the strategist. It seeks tochange the competitive environment. Thus, a strategy statement includes a
description of the new competitive equilibrium to be created, the cause-and-effectrelationships that will bring it about, and the logic to support the course of action.
Planning articulates the means of implementing strategy. A strategic plan specifies the sequence and the timing of steps that will alter competitive relationships.
The strategy and the strategic plan are quite different things. The strategy
may be brilliant in content and logic; but the sequence and timing of the plan,
inadequate. The plan may be the laudable implementation of a worthless strategy.
Put together, strategic planning concerns the relationship of an organization to its
environment. Conceptually, the organization monitors its environment, incorporates the effects of environmental changes into corporate decision making, andformulates new strategies. Exhibit 1-2 provides a scorecard to evaluate the viability of a company’s strategic planning effort.

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EXHIBIT 1-2
A Strategic Planning Scorecard• Is our planning really strategic?
Do we try to anticipate change or only project from the past?
• Do our plans leave room to explore strategic alternatives?
Or do they confine us to conventional thinking?
• Do we have time and incentive to investigate truly important things?
Or do we spend excessive planning time on trivia?
• Have we ever seriously evaluated a new approach to an old market?
Or are we locked into the status quo?
• Do our plans critically document and examine strategic assumptions?
Or do we not really understand the implications of the plans we review?
• Do we consistently make an attempt to examine consumer, competitor, and distributor responses to our programs?
Or do we assume the changes will not affect the relationships we have seen in the past?
Source: Thomas P. Justad and Ted J. Mitchell, “Creative Market Planning in a Partisan Environment,”
Business Horizons (March–April 1982): 64, copyright 1982 by the Foundation for the School ofBusiness at Indiana University. Reprinted by permission.

Companies that do well in strategic planning define their goals clearly anddevelop rational plans to implement them. In addition, they take the following
steps to make their strategic planning effective:• They shape the company into logical business units that can identify markets,
customers, competitors, and the external threats to their business. These business
units are managed semi-autonomously by executives who operate under corporate financial guidelines and with an understanding of the unit’s assigned role inthe corporate plan.
• They demonstrate a willingness at the corporate level to compensate line managers on long-term achievements, not just the yearly bottom line; to fund research
programs that could give the unit a long-term competitive edge; and to offer theunit the type of planning support that provides data on key issues and encourages and teaches sophisticated planning techniques.
• They develop at the corporate level the capacity to evaluate and balance competing requests from business units for corporate funds, based on the degree of risk
and reward.
• They match shorter-term business unit goals to a long-term concept of the company’s evolution over the next 15 to 20 years. Exclusively the CEO’s function,effectiveness in matching business unit goals to the firm’s evolution may betested by the board of directors.

Strategic Planning:
An Example

The importance of strategic planning for a company may be illustrated by theexample of the Mead Corporation. The Mead Corporation is basically in the forest
products business. More than 75 percent of its earnings are derived from trees,Marketing and the Concept of Planning and Strategy

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from the manufacture of pulp and paper, to the conversion of paperboard to beverage carriers, to the distribution of paper supplies to schools. Mead also has anarray of businesses outside the forest products industry and is developing newtechnologies and businesses for its future, primarily in storing, retrieving, andreproducing data electronically. In short, Mead is a company growing in theindustries in which it started as well as expanding into areas that fit the capabilities and style of its management.
Although Mead was founded in 1846, it did not begin to grow rapidly until
around 1955, reaching the $1 billion mark in sales in the late 1960s. Unfortunately,
its competitive position did not keep pace with this expansion. In 1972 the company ranked 12th among 15 forest products companies. Clearly, if Mead was tobecome a leading company, its philosophy, its management style and focus, andits sense of urgency—its whole corporate culture—had to change. The vehicle forthat change was the company’s strategic planning process.
When top managers began to discuss ways to improve Mead, they quickly
arrived at the key question: What kind of performing company should Mead be?
They decided that Mead should be in the top quartile of those companies withwhich it was normally compared. Articulation of such a clear and simple objective provided all levels of management with a sense of direction and with a frameof reference within which to make and test their own decisions. This objective wastranslated into specific long-term financial goals.
In 1972 a rigorous assessment of Mead’s businesses was made. The results ofthis assessment were not comforting—several small units were in very weak competitive positions. They were substantial users of cash that was needed elsewherein businesses where Mead had opportunities for significant growth. Mead’sboard decided that by 1977 the company should get out of certain businesses,
even though some of those high cash users were profitable.
Setting goals and assessing Mead’s mix of businesses were only the firststeps. Strategic planning had to become a way of life if the corporate culture wasgoing to be changed. Five major changes were instituted. First, the corporate
goals were articulated throughout the company—over and over and over again.
Second, the management system was restructured. This restructuring wasmuch easier said than done. In Mead’s pulp and paper businesses, the culture
expected top management to be heavily involved in the day-to-day operation ofmajor facilities and intimately involved in major construction projects, a style that
had served the company well when it was simply a producer of paper. By theearly 1970s, however, Mead was simply too large and too diverse for such ahands-on approach. The nonpulp and paper businesses, which were managedwith a variety of styles, needed to be integrated into a more balanced management system. Therefore, it was essential for top management to stay out of
day-to-day operations. This decision allowed division managers to become
stronger and to develop a greater sense of personal responsibility for their operations. By staying away from major construction projects, top managers allowed
on-site managers to complete under budget and ahead of schedule the largest andmost complex programs in the company’s history.

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Third, simultaneously with the restructuring of its management system, seminars were used to teach strategic planning concepts and techniques. These seminars, sometimes week-long sessions, were held off the premises with groups of
5 to 20 people at a time. Eventually, the top managers in the company became
graduates of Mead’s approach to strategic planning.
Fourth, specific and distinctly different goals were developed and agreed
upon for each of Mead’s two dozen or so business units. Whereas the earlier
Mead culture had charged each operation to grow in any way it could, each business unit now had to achieve a leadership position in its markets or, if a leadership position was not practical, to generate cash.
Finally, the board began to fund agreed-upon strategies instead of approving
capital projects piecemeal or yielding to emotional pleas from favorite managers.
The first phase of change was the easiest to accomplish. Between 1973 and1976, Mead disposed of 11 units that offered neither growth nor significant cash
flow. Over $100 million was obtained from these divestitures, and that money
was promptly reinvested in Mead’s stronger businesses. As a result, Mead’s mix
of businesses showed substantial improvement by 1977. In fact, Mead achieved
its portfolio goals one year ahead of schedule.
For the remaining businesses, developing better strategies and obtaining
better operating performance were much harder to achieve. After all, on a relative basis, the company was performing well. With the exception of 1975, 1984,
1989, and 1994, the years from 1973 to 1997 set all-time records for performance.
The evolution of Mead’s strategic planning system and the role it played inhelping the good businesses of the company improve their relative performance are public knowledge. The financial results speak for themselves. In
spite of the divestitures of businesses with sales of over $500 million, Mead’s
sales grew at a compound rate of 9 percent from 1973 to reach $5.1 billion in
1997. In addition, by the end of 1993, Mead’s return on total capital (ROTC)
reached 11.2 percent. More important, among 15 forest products companies
with which Mead is normally compared, it had moved from twelfth place in1972 to second place in 1983, a position it continued to maintain in 1994. These
were the results of using a strategic planning system as the vehicle for improving financial performance.
During the period from 1988 to 1993, Mead took additional measures toincrease its focus in two areas: (a) its coated paper and board business and (b) its
value-added, less capital-intensive businesses (the distribution and conversion of
paper and related supplies and electronic publishing). Today Mead is a well-managed, highly focused, aggressive company. It is well positioned to be exceptionally successful in the rest of 1990s, and beyond.
Strategic Planning:
Emerging
Perspectives

Many forces affected the way strategic planning developed in the 1970s andearly 1980s. These forces included slower growth worldwide, intense global
competition, burgeoning automation, obsolescence due to technological change,
deregulation, an explosion in information availability, more rapid shifts in raw
material prices, chaotic money markets, and major changes in macroeconomic

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and sociopolitical systems. As a result, destabilization and fluidity have become
the norm in world business.
Today there are many, many strategic alternatives for all types of industries.
Firms are constantly coming up with new ways of making products and getting
them to market. Comfortable positions in industry after industry (e.g., in banking, telecommunications, airlines, automobiles) are disappearing, and barriers toentry are much more difficult to maintain. Markets are open, and new competitors are coming from unexpected directions.
To steadily prosper in such an environment, companies need new strategicplanning perspectives. First, top management must assume a more explicit role instrategic planning, dedicating a large amount of time to deciding how things
ought to be instead of listening to analyses of how they are. Second, strategicplanning must become an exercise in creativity instead of an exercise in forecasting. Third, strategic planning processes and tools that assume that the future will
be similar to the past must be replaced by a mindset obsessed with being first torecognize change and turn it into competitive advantage. Fourth, the role of theplanner must change from being a purveyor of incrementalism to that of a crusader for action. Finally, strategic planning must be restored to the core of line
management responsibilities.
These perspectives can be described along six action-oriented dimensions:managing a business for competitive advantage, viewing change as an opportunity, managing through people, shaping the strategically managed organization, managing for focus and flexibility, and managing fit across all functions.
Considering these dimensions can make strategic planning more relevant andeffective.
Managing for Competitive Advantage. Organizations in a market economy
are concerned with delivering a service or product in the most profitable way. The
key to profitability is to achieve a sustainable competitive advantage based onsuperior performance relative to the competition. Superior performance requires
doing three things better than the competition. First, the firm must clearly designate the product/market, based on marketplace realities and a true understanding of its strengths and weaknesses. Second, it must design a winning businesssystem or structure that enables the company to outperform competitors in producing and delivering the product or service. Third, management must do a
better job of managing the overall business system, by managing not only relationships within the corporation but also critical external relationships with suppliers, customers, and competitors.11
In turn, the notion of white-space opportunities is proving especially compelling for highly decentralized companies such as Hewlett-Packard Co. HP
Chairman Lewis E. Platt now believes his most important role in strategy formulation is to build bridges among the company’s various operations. “I don’t createbusiness strategies,” argues Platt. “My role is to encourage discussion of the whitespaces, the overlap and gap among business strategies, the important areas thatare not addressed by the strategies of individual HP businesses.”12

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As an example, Hewlett-Packard Co. brings its customers and suppliers
together with the general managers of its many business units in strategy sessions
aimed at creating new market opportunities. In each case, HP defines a “businessecosystem,” the framework for its managers to explore and analyze. In an ecosystem, companies sometimes compete and often cooperate to come up with innovations, create new products, and serve customers. Most of the business
managers are so busy minding their current businesses that is is hard to step out
and see threats or opportunities. But by looking at the entire ecosystem, it provides a broad perspective to them. It gets people out of their boxes.
A session on the ecosystem for the automotive industry saw HP assembling
managers from divisions that make service-bay diagnostic systems for Ford
Motor Co., workstations in auto manufacturing plants, and electronic components for cars. The company also invited customers and suppliers. What could allthese divisions do together to create new value for the industry? “Many of theopportunities came right out of the mouth of customers.” Possibilities included
creating “smart” highway systems or building integrated systems that would collect service problems and immediately feed them back to Detroit. It changes thevision of the business future and managers start thinking about how they can getincreased value from all the pieces of the company.
By inviting such a broad range of people to the strategy table, HP gained
viewpoints that would normally not be heard. Yet those opinions are critical tocreating future products and markets.12
Viewing Change as an Opportunity. A new culture should be created within
the organization such that managers look to change as an opportunity and adapt
their business system to continuously emerging conditions. In other words,
change should not be viewed as a problem but as a source of opportunity, providing the potential for creativity and innovation.
Managing through People. Management’s first task is to create a vision of theorganization that includes (a) where the organization should be going, again
based on a clear examination of the company’s strengths and weaknesses; (b)what markets it should compete in; (c) how it will compete; and (d) major action
programs required. The next task is to convert vision to reality—to develop thecapabilities of the organization, to expedite change and remove obstacles, and toshape the environment. Central to both the establishment and execution of acorporate vision is the effective recruitment, development, and deployment of
human resources. “In the end, management is measured by the skill and sensitivity with which it manages and develops people, for it is only through the quality of their people that organizations can change effectively.’’13
Electronic Data Systems Corp., which manages large-scale data centers, has
opened its strategic-planning process to a broad range of players. In 1992, EDS
launched a major strategy initiative that involved 2,500 of its 55,000 employees.
The company picked a core group of 150 staffers from around the world for the
yearlong assignment. The group ranged from a 26-year-old systems engineer who
had been with EDS for two years to a sixty-something corporate vice-president

Marketing and the Concept of Planning and Strategy

16PART 1Introduction

with a quarter of a century of EDS experience. The staffers identified potential“discontinuities” that could threaten or pose opportunities for EDS. They isolated
the company’s core competencies—what it does best and how that differentiates
it from the competition. And they crafted a “strategic intent”—a point of view
about its future. As has been said, “We discovered that in order for us to makeinformation technology valuable to people, we had to be able to go into a company and offer consulting to provide more complete solutions, and we couldn’t
do that without building a business strategy.”13 So EDS began to create a management-consulting practice, acquiring A.T. Kearney Inc. for $600 million. Similar
approaches have been used by a wide range of companies, including Marriott
Hotels and Helene Curtis Industries.
Shaping the Strategically Managed Organization. Management should
work toward developing an innovative, self-renewing organization that the
future will demand. Organizational change depends on such factors as structure,
strategy, systems, style, skills, staff, and shared values. Organizations that take anexternally focused, forward-looking approach to the design of these factors havea much better chance of self-renewal than those whose perspective is predominantly internal and historical.
Managing for Focus and Flexibility. Today, strategic planning should beviewed differently than it was viewed in the past. A five-year plan, updated
annually, should be replaced by an ongoing concern for the direction the organization is taking. Many scholars describe an ongoing concern for the direction of
the firm, that is, concern with what a company must do to become smart, targeted, and nimble enough to prosper in an era of constant change, as strategic
thinking.14 The key words in this pursuit are focus and flexibility.
Focus means figuring out and building on what the company does best. It
involves identifying the evolving needs of customers, then developing the key
skills—often called the core competencies—making sure that everyone in the company understands them. Flexibility means sketching rough scenarios of the future(i.e., bands of possibilities) and being ready to pounce on opportunities as theyarise. The point may be illustrated with reference to Sears. From 1985 to 1994,
about $163 billion of stock market value was created in the retail industry. Some25 companies were responsible for creating 85% of that wealth, and many of them
did it with “business designs” that featured stores outside shopping malls, withlow prices, quality merchandise, and broad selection. While Wal-Mart Stores Inc.
generated $42 billion and Home Depot Inc. added $20 billion in value, Sears’s
retail operations captured less that $1 billion in that 10-year period. How did it
happen? Like so many American business icons, Sears lost sight of its customers.
They did not know whom they wanted to serve. That was a huge hole in the company’s strategy. They were also not clear on what basis they thought they could
win against the competition.
A major strategy overhaul led to the disposal of nonretail assets and arenewed focus on Sears’s core business. The company renovated dowdy stores,
upgraded women’s apparel, and launched a new ad campaign to engineer a

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major turnaround at the department-store giant. One of the things that got thecompany in trouble was its lack of focus on the customer. Extensive customer
research discovered high levels of brand loyalty to Sears’s hardware lines. The
research also suggested that by segmenting the do-it-yourself market and focusing on home projects with a low degree of complexity, say, papering a bathroom
or installing a dimmer switch, Sears could avoid a major competitive collision
with Home Depot and other home-improvement giants. Customers, the Sears
research showed, desired convenience more than breadth of category in such
hardware stores.
After successfully testing the concept of hardware outlets, the company is
now making a billion-dollar capital bet that Sears can gain growth in this newmarket. It hopes to have 1,000 freestanding, 20,000-square-foot hardware stores
built in five years, with 200 of them running by 1998, at a cost of $1.25 million peroutlet.15
Managing Fit Across All Functions. Different functions or activities must
reinforce each other for a successful strategy. A productive sales force, for example, confers a greater advantage when the company’s product embodies premium
technology and its marketing approach emphasizes customer assistance and support. A production line with high levels of model variety is more valuable whencombined with an inventory and order-processing system that minimizes theneed for stocking finished goods, a sales process equipped to explain and encourage customization, and an advertising theme that stresses the benefits of productvariations that meet a customer’s special needs. Such complementaries are pervasive in strategy.

STRATEGIC BUSINESS UNITS (SBUS)
Frequent reference has been made in this chapter to the business unit, a unit comprising one or more products having a common market base whose manager has
complete responsibility for integrating all functions into a strategy against an
identifiable competitor. Usually referred to as a strategic business unit (SBU),
business units have also been called strategy centers, strategic planning units, or
independent business units. The philosophy behind the SBU concept has been
described this way:
The diversified firm should be managed as a “portfolio’’ of businesses, with each business unit serving a clearly defined product-market segment with a clearly defined
strategy.
Each business unit in the portfolio should develop a strategy tailored to its capabilities and competitive needs, but consistent with the overall corporate capabilities
and needs.
The total portfolio of businesses should be managed by allocating capital and managerial resources to serve the interests of the firm as a whole—to achieve balanced
growth in sales, earnings, and assets mix at an acceptable and controlled level of risk.
In essence, the portfolio should be designed and managed to achieve an overall corporate strategy.16

Marketing and the Concept of Planning and Strategy

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PART 1Introduction

Identification ofStrategic Business
Units

Since formal strategic planning began to make inroads in corporations in the
1970s, a variety of new concepts have been developed for identifying a corporation’s opportunities and for speeding up the process of strategy development.
These newer concepts create problems of internal organization. In a dynamic
economy, all functions of a corporation (e.g., research and development, finance,and marketing) are related. Optimizing certain functions instead of the company
as a whole is far from adequate for achieving superior corporate performance.
Such an organizational perspective leaves only the CEO in a position to think interms of the corporation as a whole. Large corporations have tried many different
structural designs to broaden the scope of the CEO in dealing with complexities.
One such design is the profit center concept. Unfortunately, the profit center concept emphasizes short-term consequences; also, its emphasis is on optimizing the
profit center instead of the corporation as a whole.
The SBU concept was developed to overcome the difficulties posed by the profit
center type of organization. Thus, the first step in integrating product/market
strategies is to identify the firm’s SBUs. This amounts to identifying natural businesses in which the corporation is involved. SBUs are not necessarily synonymouswith existing divisions or profit centers. An SBU is composed of a product or product lines having identifiable independence from other products or product lines interms of competition, prices, substitutability of product, style/quality, and impact of
product withdrawal. It is around this configuration of products that a business strategy should be designed. In today’s organizations, this strategy may encompass
products found in more than one division. By the same token, some managers may
find themselves managing two or more natural businesses. This does not necessarily mean that divisional boundaries need to be redefined; an SBU can often overlap
divisions, and a division can include more than one SBU.
SBUs may be created by applying a set of criteria consisting of price, competitors, customer groups, and shared experience. To the extent that changes in a
product’s price entail a review of the pricing policy of other products may imply
that these products have a natural alliance. If various products/markets of a company share the same group of competitors, they may be amalgamated into an SBU
for the purpose of strategic planning. Likewise, products/markets sharing acommon set of customers belong together. Finally, products/markets in different
parts of the company having common research and development, manufacturing,and marketing components may be included in the same SBU. For purposes ofillustration, consider the case of a large, diversified company, one division ofwhich manufactures car radios. The following possibilities exist: the car radio
division, as it stands, may represent a viable SBU; alternatively, luxury car radioswith automatic tuning may constitute an SBU different from the SBU for standard
models; or other areas of the company, such as the television division, may be
combined with all or part of the car radio division to create an SBU.
Overall, an SBU should be established at a level where it can rather freely
address (a) all key segments of the customer group having similar objectives; (b)all key functions of the corporation so that it can deploy whatever functional
expertise is needed to establish positive differentiation from the competition in

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the eyes of the customer; and (c) all key aspects of the competition so that the corporation can seize the advantage when opportunity presents itself and, conversely, so that competitors will not be able to catch the corporation off-balanceby exploiting unsuspected sources of strength.
A conceptual question becomes relevant in identifying SBUs: How muchaggregation is desirable? Higher levels of aggregation produce a relatively smaller
and more manageable number of SBUs. Besides, the existing management information system may not need to be modified since a higher level of aggregation
yields SBUs of the size and scope of present divisions or product groups. However,higher levels of aggregation at the SBU level permit only general notions of strategy that may lack relevance for promoting action at the operating level. For example, an SBU for medical care is probably too broad. It could embrace equipment,
service, hospitals, education, self-discipline, and even social welfare.
On the other hand, lower levels of aggregation make SBUs identical toproduct/market segments that may lack “strategic autonomy.’’ An SBU for farm
tractor engines would be ineffective because it is at too low a level in the organization to (a) consider product applications and customer groups other thanfarmers or (b) cope with new competitors who might enter the farm tractor
market at almost any time with a totally different product set of “boundary conditions.’’ Further, at such a low organizational level, one SBU may compete withanother, thereby shifting to higher levels of management the strategic issue of
which SBU should formulate what strategy.
The optimum level of aggregation, one that is neither too broad nor too
narrow, can be determined by applying the criteria discussed above, then further
refining it by using managerial judgment. Briefly stated, an SBU must look andact like a freestanding business, satisfying the following conditions:
1. Have a unique business mission, independent of other SBUs.
2. Have a clearly definable set of competitors.
3. Be able to carry out integrative planning relatively independently of other SBUs.
4. Be able to manage resources in other areas.
5. Be large enough to justify senior management attention but small enough toserve as a useful focus for resource allocation.

The definition of an SBU always contains gray areas that may lead to dispute.
It is helpful, therefore, to review the creation of an SBU, halfway into the strategy
development process, by raising the following questions:• Are customers’ wants well defined and understood by the industry and is themarket segmented so that differences in these wants are treated differently?
• Is the business unit equipped to respond functionally to the basic wants andneeds of customers in the defined segments?
• Do competitors have different sets of operating conditions that could give theman unfair advantage over the business unit in question?

If the answers give reason to doubt the SBU’s ability to compete in themarket, it is better to redefine the SBU with a view to increasing its strategic freedom in meeting customer needs and competitive threats.

Marketing and the Concept of Planning and Strategy

20

PART 1Introduction

The SBU concept may be illustrated with an example from Procter &Gamble.17 For more than 50 years the company’s various brands were pitted
against each other. The Camay soap manager competed against the Ivory soap
manager as fiercely as if each were in different companies. The brand management system that grew out of this notion has been used by almost every
consumer-products company.
In the fall of 1987, however, Procter & Gamble reorganized according to the
SBU concept (what the company called “along the category lines’’). The reorganization did not abolish brand managers, but it did make them accountable to a
new corps of mini-general managers who were responsible for an entire productline—all laundry detergents, for example. By fostering internal competition
among brand managers, the classic brand management system established strong
incentives to excel. It also created conflicts and inefficiencies as brand managers
squabbled over corporate resources, from ad spending to plant capacity. The
system often meant that not enough thought was given to how brands could
work together. Despite these shortcomings, brand management worked finewhen markets were growing and money was available. But now, most packaged-goods businesses are growing slowly (if at all), brands are proliferating, theretail trade is accumulating more clout, and the consumer market is fragmenting.
Procter & Gamble reorganized along SBU lines to cope with this bewildering
array of pressures.
Under Procter & Gamble’s SBU scheme, each of its 39 categories of U.S. businesses, from diapers to cake mixes, is run by a category manager with direct
responsibility. Advertising, sales, manufacturing, research, engineering, andother disciplines all report to the category manager. The idea is to devise marketing strategies by looking at categories and by fitting brands together rather thanby coming up with competing brand strategies and then dividing up resourcesamong them. The paragraphs that follow discuss how Procter & Gamble’s reorganization impacted select functions.
Advertising. Procter & Gamble advertises Tide as the best detergent for
tough dirt. But when the brand manager for Cheer started making the same
claim, Cheer’s ads were pulled after the Tide group protested. Now the category
manager decides how to position Tide and Cheer to avoid such conflicts.
Budgeting. Brand managers for Puritan and Crisco oils competed for a shareof the same ad budget. Now a category manager decides when Puritan can benefit from stepped-up ad spending and when Crisco can coast on its strong market
position.
Packaging. Brand managers for various detergents often demanded packages at the same time. Because of these conflicting demands, managers complained that projects were delayed and nobody got a first-rate job. Now thecategory manager decides which brand gets a new package first.
Manufacturing. Under the old system, a minor detergent, such as Dreft, had
the same claim on plant resources as Tide—even if Tide was in the midst of a big

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promotion and needed more supplies. Now a manufacturing staff person who
helps to coordinate production reports to the category manager.
Problems in
Creating SBUs

The notion behind the SBU concept is that a company’s activities in a marketplace
ought to be understood and segmented strategically so that resources can be allocated for competitive advantage. That is, a company ought to be able to answer
three questions: What business am I in? Who is my competition? What is my position relative to that competition? Getting an adequate answer to the first question
is often difficult. (Answers to the other two questions can be relatively easy.) In
addition, identifying SBUs is enormously difficult in organizations that shareresources (e.g., research and development or sales).
There is no simple, definitive methodology for isolating SBUs. Although thecriteria for designating SBUs are clear-cut, their application is judgmental andproblematic. For example, in certain situations, real advantages can accrue tobusinesses sharing resources at the research and development, manufacturing, ordistribution level. If autonomy and accountability are pursued as ends in themselves, these advantages may be overlooked or unnecessarily sacrificed.

SUMMARY

This chapter focused on the concepts of planning and strategy. Planning is theongoing management process of choosing the objectives to be achieved during acertain period, setting up a plan of action, and maintaining continuous surveillance of results so as to make regular evaluations and, if necessary, to modify theobjectives and plan of action. Also described were the requisites for successfulplanning, the time frame for initiating planning activities, and various philosophies of planning (i.e., satisfying, optimizing, and adaptivizing). Strategy, thecourse of action selected from possible alternatives as the optimum way to attainobjectives, should be consistent with current policies and viewed in light of anticipated competitive actions.
The concept of strategic planning was also examined. Most large companies
have made significant progress in the last 10 or 15 years in improving their strategic planning capabilities. Two levels of strategic planning were discussed: corporate and business unit level. Corporate strategic planning is concerned with the
management of a firm’s portfolio of businesses and with issues of firm-wide
impact, such as resource allocation, cash flow management, government regulation, and capital market access. Business strategy focuses more narrowly on the
SBU level and involves the design of plans of action and objectives based on
analysis of both internal and external factors that affect each business unit’s performance. An SBU is defined as a stand-alone business within a corporation thatfaces (an) identifiable competitor(s) in a given market.
For strategic planning to be effective and relevant, the CEO must play a central role, not simply as the apex of a multilayered planning effort, but as a strategic thinker and corporate culture leader.

Marketing and the Concept of Planning and Strategy

22PART 1Introduction

DISCUSSIONQUESTIONS

1. Why is planning significant?
2. Is the concept of strategic planning relevant only to profit-making organizations? Can nonprofit organizations or the federal government also embraceplanning?
3. Planning has always been considered an important function of management.
How is strategic planning different from traditional planning?
4. What is an SBU? What criteria may be used to divide businesses into SBUs?
5. What are the requisites for successful strategic planning?
6. Differentiate between the planning philosophies of satisfying, optimizing, andadaptivizing.

NOTES

Gordon E. Greenley, “Perceptions of Marketing Strategy and Strategic Marketing in
UK Companies,” Journal of Strategic Marketing (September 1993): 189–210.
2 James Brown, Saul S. Sands, and G. Clark Thompson, “The Status of Long Range
Planning,’’ Conference Board Record (September 1966): 11.
3 Business Planning in the Eighties: The New Competitiveness of American Corporations(New York: Coopers & Lybrand, 1984).
4 Malcolm McDonald, The Marketing Audit: Translating Marketing Theory Into Practice(Oxford, U.K.: Butterworth-Heinemann, 1991).
5 The Economist, (March 1997): 65. Also see: Myung-su Chae and John S. Hill, “High
Versus Low Formality Marketing Planning in Global Industries: Determinants andConsequences,” Journal of Strategic Marketing, Vol. 5, No. 1, (March 1997): 3–22.
6 “Strategic Planning,” Business Week, (August 26, 1998): 46.
7 Bryson, J.M. and P. Bromiley, “Critical Factors Affecting the Planning and
Implementation of Major Products,” Strategic Management Journal, (July, 1993):
319–338.
8 See Lawrence C. Rhyne, “The Relationship of Strategic Planning to Financial
Performance,’’ Strategic Management Journal (1986): 423–36.
9 Perspectives on Corporate Planning (Boston: Boston Consulting Group, 1968): 48.
10 Russell L. Ackoff, A Concept of Corporate Planning (New York: John Wiley & Sons,
1970): 13.
11 Henry Mintzberg, “The Fall and Rise of Strategic Planning,” Harvard Business Review(January–February 1994): 107.
12 Michael E. Porter, “What Is Strategy?” Harvard Business Review, (November–December,
1996): 61–80.
13 Fred Gluck, “A Fresh Look at Strategic Management,’’ Journal of Business Strategy (Fall1985): 18–21.
14 Clayton M. Christensen, “Strategy: Learning by Doing,” Harvard Business School,(November–December, 1997): 141–160.
15 “Strategic Planning,” Business Week, (26 August 1998): 46.
16 William K. Hall, “SBU: Hot New Topic in the Management of Diversification,’’Business Horizons (February 1978): 17.
17 “The Marketing Revolution at Procter & Gamble,’’ Business Week (25 July 1988): 72.
1

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2
CHAPTER TWO

Strategic MarketingIn its strategic role, marketing focuses on a business’s intentions in a market andthe means and timing of realizing those intentions. The strategic role of marketing is quite different from marketing management, which deals with developing, implementing, and directing programs to achieve designated intentions. To
clearly differentiate between marketing management and marketing in its newrole, a new term—strategic marketing—has been coined to represent the latter. This
chapter discusses different aspects of strategic marketing and examines how it
differs from marketing management. Also noted are the trends pointing to thecontinued importance of strategic marketing. The chapter ends with a plan for the
rest of the book.

Marketing is merely acivilized form of
warfare in whichmost battles are won
with words, ideas,
and disciplined
thinking.
ALBERT W. EMERYCONCEPT OF STRATEGIC MARKETING
Exhibit 2-1 shows the role that the marketing function plays at different levels in
the organization. At the corporate level, marketing inputs (e.g., competitive
analysis, market dynamics, environmental shifts) are essential for formulating a
corporate strategic plan. Marketing represents the boundary between the marketplace and the company, and knowledge of current and emerging happenings in
the marketplace is extremely important in any strategic planning exercise. At theother end of the scale, marketing management deals with the formulation andimplementation of marketing programs to support the perspectives of strategic
marketing, referring to marketing strategy of a product/market. Marketing strategy is developed at the business unit level.
Within a given environment, marketing strategy deals essentially with theinterplay of three forces known as the strategic three Cs: the customer, the competition, and the corporation. Marketing strategies focus on ways in which thecorporation can differentiate itself effectively from its competitors, capitalizing on
its distinctive strengths to deliver better value to its customers. A good marketingstrategy should be characterized by (a) a clear market definition; (b) a good match
between corporate strengths and the needs of the market; and (c) superior performance, relative to the competition, in the key success factors of the business.
23

23

24

Strategic Marketing24

PART 1Introduction

EXHIBIT 2-1
Marketing’s Role in the Organization
Organizational Level

Role of Marketing*Formal Name

Corporate

Provide customer and competitive
perspective for corporate strategicplanning.

Corporate marketing

Business unit

Assist in the development of strategic perspective of the business
unit to direct its future course.

Strategic marketing

Product/market

Formulate and implement marketing programs.

Marketing management*Like marketing, other functions (finance, research and development, production, accounting,and personnel) plan their own unique roles at each organizational level. The business unit strategy
emerges from the interaction of marketing with other disciplines.

Together, the strategic three Cs form the marketing strategy triangle (seeExhibit 2-2). All three Cs—customer, corporation, and competition—aredynamic, living creatures with their own objectives to pursue. If what the customer wants does not match the needs of the corporation, the latter’s long-term
viability may be at stake. Positive matching of the needs and objectives of customer and corporation is required for a lasting good relationship. But such
matching is relative, and if the competition is able to offer a better match, thecorporation will be at a disadvantage over time. In other words, the matchingof needs between customer and corporation must not only be positive, it must
be better or stronger than the match between the customer and the competitor.
When the corporation’s approach to the customer is identical to that of the competition, the customer cannot differentiate between them. The result could be aprice war that may satisfy the customer’s but not the corporation’s needs.
Marketing strategy, in terms of these three key constituents, must be defined as
an endeavor by a corporation to differentiate itself positively from its competitors, using its relative corporate strengths to better satisfy customer needs in agiven environmental setting.
Based on the interplay of the strategic three Cs, formation of marketing strategy requires the following three decisions:
1. Where to compete; that is, it requires a definition of the market (for example, competing across an entire market or in one or more segments).
2. How to compete; that is, it requires a means for competing (for example, introducing a new product to meet a customer need or establishing a new position for an
existing product).
3. When to compete; that is, it requires timing of market entry (for example, being
first in the market or waiting until primary demand is established).

25

Strategic Marketing

CHAPTER 2 Strategic Marketing

25

En

Tec
h

nt
me
n
o
vir

no
lo

gi
ca
n
iro
nv
lE

Customer

nt
me

Pol
itic
al /

Le
ga
l

EXHIBIT 2-2
Key Elements of Marketing Strategy Formulation

Marketing
Strategy:
Achievingmaximum positive
differentiation overcompetition in meetingcustomer needs
Competition

lE

vi
ro
n

me

cia
So

nt

Corporation

nv

iro

nm
en
t

on
Ec

ic
om

En

Thus, marketing strategy is the creation of a unique and valuable position,
involving a different set of activities. Thus, development of marketing strategy
requires choosing activities that are different from rivals.
The concept of strategic marketing may be illustrated with reference to theintroduction by Gillette Company of a new shaving product, Mach 3, in April
1998.1 For some time, Gillette had faced slow growth in its razor’s division, partly
because Schick, its smaller rival, had recently launched a new razor of its own.
Investors had begun to fret about slowing growth and lackluster sales at Gillette.
This threatened its basic business, that is, razor and blades market, in which it had
71% of the North American and European market. Apparently, Gillette needed a26Strategic Marketing

26

PART 1Introduction

new marketing strategy to protect its razor and blades territory. Looking around,
Gillette decided to introduce a new razor that its research laboratory had beendeveloping and that was ready to be launched. Gillette had an unusual approach
to innovation. Most companies tweaked their offerings in response to competition
or demand. Gillette launched a new product only when it had made a genuine
technical advance. To make the Mach 3, Gillette had found a way to bond diamond-hard carbon to slivers of steel. The time was on Gillette’s side. It needed
something revolutionary to strengthen its market position, and its research laboratory had a unique product ready to be launched. Gillette delineated the following marketing strategy:• Market (where to compete)—Gillette decided to introduce Mach 3 throughout the
U.S. on the same day.
• Means (how to compete)—Gillette decided to offer Mach 3 as a premium productthat was priced 35% more than SensorExcel, which itself was 60% more expensive
than Atra, its predecessor. Gillette reasoned: “People never remember what theyused to pay. But they do want to feel they are getting value for money.”• Timing (when to compete)—Gillette decided to introduce the new product before its
CEO, Mr. Al Zein, retired. Mr. Zein’s ability to communicate had been a hit on
both Wall Street and in the company. Much of the Gillette’s recent success was
attributed to Mr. Zein, and the company wanted Mach 3 to adequately settle in adominant position before Mr. Zein retired.

Gillette’s Mach 3 strategy emerged from a thorough consideration of thestrategic three Cs. First, market entry was dictated by customers’ willingness toadopt new products in the toiletry field. Eight years ago, Gillette was losing its
grip on the razor market to cheap throwaways. Sensor, which replaced Atra razor,
saved the company. The company was hopeful that the Mach 3 would have a similar effect. Second, the decision to enter the market was based on full knowledgeof the competition, which included its own substitute products, such as Sensor
and Atra shavers, as well as companies like Schick. The company was more concerned about its own products competing with Mach 3, and, therefore it ran down
stocks of its Sensor and Atra shavers ahead of Mach 3’s launch. Third, Gillette’s
strength as an aggressive successful marketer of packaged goods with its vast
experience in shaving products business and adequate financial resources(Gillette spent over $750 million in developing Mach 3) properly equipped it toenter the market. Finally, the environment (in this case, a trend toward acceptanceof technologically advanced products; Mach 3 was covered by 35 patents) substantiated the opportunity.
This strategy seems to have worked well for Gillette. In nine months ending
1998, Gillette shaving products sales were up 28%. And yet, the company has tointroduce the product in Europe (with 71% market) as well as in developing countries (Latin America, where the company has 91% market for blades, and India
with 69% of the market).
Inasmuch as Gillette did not tailor its product to local peculiarities, it was able
to achieve vast economies of scale in manufacturing. The economies of scale were27

Strategic Marketing

CHAPTER 2 Strategic Marketing27

mirrored on the distribution side as well. The company usually broke into newmarkets with razors and then jumped into batteries, pens, and toiletries throughthe established sales channels.

ASPECTS OF STRATEGIC MARKETING
Strategic thinking represents a new perspective in the area of marketing. In thissection we will examine the importance, characteristics, origin, and future ofstrategic marketing.
Importance ofStrategic
MarketingMarketing plays a vital role in the strategic management process of a firm. The
experience of companies well versed in strategic planning indicates that failure inmarketing can block the way to goals established by the strategic plan. A primeexample is provided by Texas Instruments, a pioneer in developing a system ofstrategic planning called the OST system. Marketing negligence forced Texas
Instruments to withdraw from the digital watch business. When the external
environment is stable, a company can successfully ride on its technological lead,manufacturing efficiency, and financial acumen. As the environment shifts, however, lack of marketing perspective makes the best-planned strategies treacherous. With the intensification of competition in the watch business and the loss of
uniqueness of the digital watch, Texas Instruments began to lose ground. Its experience can be summarized as follows:
The lack of marketing skills certainly was a major factor in the . . . demise of its watch
business. T.I. did not try to understand the consumer, nor would it listen to the marketplace. They had the engineer’s attitude.2

Philip Morris’s success with Miller Beer illustrates how marketing’s elevatedstrategic status can help in outperforming competitors. If Philip Morris had
accepted the conventional marketing wisdom of the beer industry by basing its
strategy on cost efficiencies of large breweries and competitive pricing, its Miller
Beer subsidiary might still be in seventh place or lower. Instead, Miller Beer
leapfrogged all competitors but Anheuser-Busch by emphasizing market and customer segmentation supported with large advertising and promotion budgets. A
case of true strategic marketing, with the marketing function playing a crucialrole in overall corporate strategy, Philip Morris relied on its corporate strengths
and exploited its competitors’ weaknesses to gain a leadership position in thebrewing industry.
Indeed, marketing strategy is the most significant challenge that companies of all types and sizes face. As a study by Coopers & Lybrand andYankelovich, Skelly, and White notes, “American corporations are beginning toanswer a ‘new call to strategic marketing,’ as many of them shift their businessplanning priorities more toward strategic marketing and the market planning
function.’’3

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PART 1Introduction

Characteristics ofStrategic
Marketing

Strategic marketing holds different perspectives from those of marketing management. Its salient features are described in the paragraphs that follow.
Emphasis on Long-Term Implications. Strategic marketing decisions usually
have far-reaching implications. In the words of one marketing strategist, strategic
marketing is a commitment, not an act. For example, a strategic marketing decision would not be a matter of simply providing an immediate delivery to afavorite customer but of offering 24-hour delivery service to all customers.
In 1980 the Goodyear Tire Company made a strategic decision to continue its
focus on the tire business. At a time when other members of the industry were
deemphasizing tires, Goodyear opted for the opposite route. This decision had
wide-ranging implications for the company over the years. Looking back,Goodyear’s strategy worked. In the 1990s, it continues to be a globally dominant
force in the tire industry.
The long-term orientation of strategic marketing requires greater concern for
the environment. Environmental changes are more probable in the long run thanin the short run. In other words, in the short run, one may assume that the environment will remain stable, but this assumption is not at all likely in the long run.
Proper monitoring of the environment requires strategic intelligence inputs.
Strategic intelligence differs from traditional marketing research in requiringmuch deeper probing. For example, simply knowing that a competitor has a costadvantage is not enough. Strategically, one ought to find out how much flexibility the competitor has in further reducing price.
Corporate Inputs. Strategic marketing decisions require inputs from three
corporate aspects: corporate culture, corporate publics, and corporate resources.
Corporate culture refers to the style, whims, fancies, traits, taboos, customs, andrituals of top management that over time have come to be accepted as intrinsic tothe corporation. Corporate publics are the various stakeholders with an interestin the organization. Customers, employees, vendors, governments, and society
typically constitute an organization’s stakeholders. Corporate resources include
the human, financial, physical, and technological assets/experience of the company. Corporate inputs set the degree of freedom a marketing strategist has indeciding which market to enter, which business to divest, which business toinvest in, etc. The use of corporate-wide inputs in formulating marketing strategy
also helps to maximize overall benefits for the organization.
Varying Roles for Different Products/Markets. Traditionally it has been heldthat all products exert effort to maximize profitability. Strategic marketing starts
from the premise that different products have varying roles in the company. For
example, some products may be in the growth stage of the product life cycle,
some in the maturity stage, others in the introduction stage. Each position in thelife cycle requires a different strategy and affords different expectations. Productsin the growth stage need extra investment; those in the maturity stage should
generate a cash surplus. Although conceptually this concept—different products
serving different purposes—has been understood for many years, it has been

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articulated for real-world application only in recent years. The lead in this regard
was provided by the Boston Consulting Group, which developed a portfolio
matrix in which products are positioned on a two-dimensional matrix of market
share and growth rate, both measured on a continuous scale from high to low.
The portfolio matrix essentially has two properties: (a) it ranks diverse businesses according to uniform criteria, and (b) it provides a tool to balance a company’s resources by showing which businesses are likely to be resource providers
and which are resource users.4
The practice of strategic marketing seeks first to examine each product/market before determining its appropriate role. Further, different products/markets
are synergistically related to maximize total marketing effort. Finally, each product/market is paired with a manager who has the proper background and experience to direct it.
Organizational Level. Strategic marketing is conducted primarily at thebusiness unit level in the organization. At General Electric, for example, major
appliances are organized into separate business units for which strategy is separately formulated. At Gillette Company, strategy for the Duracell batteries isdeveloped at the batteries business unit level.
Relationship to Finance. Strategic marketing decision making is closely
related to the finance function.5 The importance of maintaining a close relationship between marketing and finance and, for that matter, with other functional
areas of a business is nothing new. But in recent years, frameworks have beendeveloped that make it convenient to simultaneously relate marketing to financein making strategic decisions.6
Origin of Strategic
Marketing

Strategic marketing did not originate systematically. As already noted, the difficult environment of the early 1970s forced managers to develop strategic plans formore centralized control of resources. It happened that these pioneering efforts at
strategic planning had a financial focus. Certainly, it was recognized that marketing inputs were required, but they were gathered as needed or were simply
assumed. For example, most strategic planning approaches emphasized cash
flow and return on investment, which of course must be examined in relation tomarket share. Perspectives on such marketing matters as market share, however,were either obtained on an ad hoc basis or assumed as constant. Consequently,
marketing inputs, such as market share, became the result instead of the cause: atypical conclusion that was drawn was that market share must be increased tomeet cash flow targets. The financial bias of strategic planning systems demoted
marketing to a necessary but not important role in the long-term perspective of
the corporation.
In a few years’ time, as strategic planning became more firmly established,corporations began to realize that there was a missing link in the planning
process. Without properly relating the strategic planning effort to marketing, thewhole process tended to be static.7 Business exists in a dynamic setting, and by
and large, it is only through marketing inputs that perspectives of changing

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PART 1Introductionsocial, economic, political, and technological environments can be brought into
the strategic planning process.
In brief, while marketing initially got lost in the emphasis on strategic planning, currently the role of marketing is better understood and has emerged in theform of strategic marketing.
Future ofStrategic
Marketing

A variety of factors point to an increasingly important role for strategic marketing in future years.8 First, the battle for market share is intensifying in manyindustries as a result of declining growth rates. Faced with insignificant growth,companies have no choice but to grasp for new weapons to increase their share,and strategic marketing can provide extra leverage in share battles.
Second, deregulation in many industries is mandating a move to strategic
marketing. For example, take the case of the airline, trucking, banking, andtelecommunications industries. In the past, with territories protected and prices
regulated, the need for strategic marketing was limited. With deregulation, it isan entirely different story. The prospect of Sears, Roebuck and Merrill Lynch as
direct competitors would have been laughable as recently as ten years ago. Thus,emphasis on strategic marketing is no longer a matter of choice if these companies are to perform well.
Third, many packaged-goods companies are acquiring companies in hitherto
nonmarketing-oriented industries and are attempting to gain market sharethrough strategic marketing. For example, apparel makers, with few exceptions,have traditionally depended on production excellence to gain competitive advantage. But when marketing-oriented consumer-products companies purchased
apparel companies, the picture changed. General Mills, through marketing strategy, turned Izod (the alligator shirt) into a highly successful business.
Chesebrough-Pond’s has done much the same with Health-Tex, making it theleading marketer of children’s apparel. On acquiring Columbia Pictures in 1982,
the Coca-Cola Company successfully tested the proposition that it could sellmovies like soft drinks. By using Coke’s marketing prowess and a host of innovative financing packages, Columbia emerged as a dominant force in the motion
picture business. It almost doubled its market share between 1982 and 1987 andincreased profits by 20 percent annually.9 Although in the last few years Izod,
Health-Tex, and Columbia Pictures have been sold, they fetched these marketing
powerhouses huge prices for their efforts in turning them around.
Fourth, shifts in the channel structure of many industries have posed new
problems. Traditional channels of distribution have become scrambled, and manufacturers find themselves using a mixture of wholesalers, retailers, chains, buying groups, and even captive outlets. In some cases, distributors andmanufacturers’ representatives are playing more important roles. In others, buying groups, chains, and cooperatives are becoming more significant. Because
these groups bring greatly increased sophistication to the buying process, especially as the computer gives them access to more and better information, buying
clout is being concentrated in fewer hands.

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31

Fifth, competition from overseas companies operating both in the UnitedStates and abroad is intensifying. More and more countries around the world aredeveloping the capacity to compete aggressively in world markets. Businesspeople in both developed and developing countries are aware of world market
trends and are confident that they can reach new markets. Eager to improve theireconomic conditions and their living standards, they are willing to learn, adapt,and innovate. Thirty years ago, most American companies were confident thatthey could beat foreign competitors with relative ease. After all, they reasoned,
we have the best technology, the best management skills, and the famous
American “can do’’ attitude. Today competition from Europe, Japan, and elsewhere is seemingly insurmountable. To cope with worldwide competition,
renewed emphasis on marketing strategy achieves significance.
Sixth, the fragmentation of markets—the result of higher per capita incomesand more sophisticated consumers—is another factor driving the increased
importance of strategic marketing. In the United States, for example, the numberof segments in the automobile market increased by one-third, from 18 to 24, during the period from 1988 to 1995 (i.e., two subcompact, two compact, two intermediate, four full size, two luxury, three truck, two van, and one station wagon
in 1978 to two minicompact, two subcompact, two compact, two midsized, twointermediate, two luxury, six truck, five van, and one station wagon in 1985).10
Many of these segments remain unserved until a company introduces a productoffering that is tailored to that niche. The competitive realities of fragmented markets require strategic-marketing capability to identify untapped market segments
and to develop and introduce products to meet their requirements.
Seventh, in the wake of easy availability of base technologies and shortening
product life cycles, getting to market quickly is a prerequisite for success in themarketplace. Early entrants not only can command premium prices, but they alsoachieve volume break points in purchasing, manufacturing, and marketing earlier
than followers and, thus, gain market share. For example, in the European market,
the first company to market car radios can typically charge 20 percent more for the
product than a competitor who enters the market a year later.11 In planning an
early entry into the marketplace, strategic marketing achieves significance.
Eighth, the days are gone when companies could win market share byachieving cost and quality advantages in existing, well-defined markets. As weenter the next century, companies will need to conceive and create new andlargely uncontested competitive market space. Corporate imagination and expeditionary policies are the keys that unlock new markets.12 Corporate imagination
involves going beyond served markets; that is, thinking about needs and functionalities instead of conventional customer-product grids; overturning traditional price/performance assumptions; and leading customers rather thanfollowing them.13 Creating new markets is a risky business; however, throughexpeditionary policies, companies can minimize the risk not by being fast followers but by the process of low-cost, fast-paced market incursions designed toreach the target market. To successfully develop corporate imagination andexpeditionary policies, companies need strategic marketing. Consider this lesson

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PART 1Introduction

in auto industry economics. Today it takes about 20 worker-hours to assemble a
Ford Taurus with a retail price of, say, $18,000. Since labor costs about $42 anhour, the direct-assembly expense is $840, about 5% of the sticker price. By comparison, the cost of marketing and distributing the car can reach 30%.14 The costs
include advertising, promotions (such as cash rebates and lease incentives), anddealer rent and mortgage payments plus inventory financing. Controlling marketing costs begins even before the vehicle leaves the drawing board or computer screen. By ensuring that a design meets the needs and desires of its
customers—size, features, performance, and so on—a manufacturer can sell a
new automobile for a higher price and avoid expensive rebates and other promotional gimmicks.
Finally, demographic shifts in American society have created a new customer
environment that makes strategic marketing an imperative.15 In years past, thetypical American family consisted of a working dad, a homemaker mom, and two
kids. But the 1990 census revealed that only 26 percent of the 93.3 million households then surveyed fit that description. Of those families reporting children
under the age of 18, 63 percent of the mothers worked full- or part-time outside
the home, up from 51 percent in 1985 and 42 percent in 1980. Smaller households
now predominate: more than 55 percent of all households comprise only one or
two persons. Even more startling, and frequently overlooked, is the fact that 9.7
million households are now headed by singles. This fastest-growing segment of
all—up some 60 percent over the previous decade—expanded mainly because of
an increase in the number of men living alone. Further, about 1 in 8 Americans is
65 years or older today. This group is expected to grow rapidly such that by 2030,
1 in 5 Americans will be elderly.16 And senior citizens are around for a lot longer
as life expectancy has risen. These statistics have strategic significance. The mass
market has splintered, and companies can’t sell their products the way they used
to. The largest number of households may fall into the two-wage-earner grouping, but that group includes everyone from manicurists to Wall Street brokers, agroup whose lifestyles and incomes are too diverse to qualify as a mass market.
We may see every market breaking into smaller and smaller units, with uniqueproducts being aimed at defined segments.

STRATEGIC MARKETING AND MARKETING MANAGEMENT
Strategic marketing focuses on choosing the right products for the right growthmarkets at the right time. It may be argued that these decisions are no different
from those emphasized in marketing management. However, the two disciplines
approach these decisions from different angles. For example, in marketing management, market segments are defined by grouping customers according to marketing mix variables. In the strategic marketing approach, market segments areformed to identify the group(s) that can provide the company with a sustainableeconomic advantage over the competition. To clarify the matter, Henderson labels
the latter grouping a strategic sector. Henderson notes:

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A strategic sector is one in which you can obtain a competitive advantage and exploit
it. . . . Strategic sectors are the key to strategy because each sector’s frame of reference
is competition. The largest competitor in an industry can be unprofitable in that theindividual strategic sectors are dominated by smaller competitors.17

A further difference between strategic marketing and marketing management
is that in marketing management the resources and objectives of the firm, however defined, are viewed as uncontrollable variables in developing a marketingmix. In strategic marketing, objectives are systematically defined at different levels after a thorough examination of necessary inputs. Resources are allocated tomaximize overall corporate performance, and the resulting strategies are formulated with a more inclusive view. As Abell and Hammond have stated:
A strategic market plan is not the same . . . as a marketing plan; it is a plan of all
aspects of an organization’s strategy in the market place. A marketing plan, in contrast, deals primarily with the delineation of target segments and the product, communication, channel, and pricing policies for reaching and servicing thosesegments—the so-called marketing mix.18

Marketing management deals with developing a marketing mix to serve designated markets. The development of a marketing mix should be preceded by adefinition of the market. Traditionally, however, market has been loosely defined.
In an environment of expansion, even marginal operations could be profitable;
therefore, there was no reason to be precise, especially when considering that thetask of defining a market is at best difficult. Besides, corporate culture emphasized short-term orientation, which by implication stressed a winning marketingmix rather than an accurate definition of the market.
To illustrate how problematic it can be to define a market, consider the laundry product Wisk. The market for Wisk can be defined in many different ways:
the laundry detergent market, the liquid laundry detergent market, or the prewash-treatment detergent market. In each market, the product would have a different market share and would be challenged by a different set of competitors.
Which definition of the market is most viable for long-term healthy performanceis a question that strategic marketing addresses.
A market can be viewed in many different ways, and a product can be used in manydifferent ways. Each time the product-market pairing is varied, the relative competitive
strength is varied, too. Many businesspeople do not recognize that a key element instrategy is choosing the competitor whom you wish to challenge, as well as choosing
the marketing segment and product characteristics with which you will compete.19

Exhibit 2-3 summarizes the differences between strategic marketing and marketing management. Strategic marketing differs from marketing management inmany respects: orientation, philosophy, approach, relationship with the environment and other parts of the organization, and the management style required. For
example, strategic marketing requires a manager to forgo short-term performancein the interest of long-term results. Strategic marketing deals with the business to
be in; marketing management stresses running a delineated business.

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PART 1Introduction

EXHIBIT 2-3
Major Differences between Strategic Marketing and Marketing Management*
Point of Difference

Strategic Marketing

Marketing Management

Time frameLong range; i.e., decisions
have long-term implications

Day-to-day; i.e., decisions
have relevance in a given
financial year

Orientation

Inductive and intuitive

Deductive and analytical

Decision process

Primarily bottom-up

Mainly top-down

Relationship withenvironment

Environment considered
ever-changing and dynamic

Environment considered
constant with occasional
disturbances

Opportunity sensitivity

Ongoing to seek newopportunities

Ad hoc search for a newopportunity

Organizational behavior

Achieve synergy between
different components of theorganization, both horizontally and verticallyPursue interests of thedecentralized unit

Nature of job

Requires high degree ofcreativity and originality

Requires maturity,
experience, and control
orientation

Leadership style

Requires proactive
perspective

Requires reactive
perspective

MissionDeals with what business toemphasize

Deals with running adelineated business*These differences are relative, not opposite ends of a continuum.

For a marketing manager, the question is: Given the array of environmental
forces affecting my business, the past and the projected performance of the industry or market, and my current position in it, which kind of investments am I justified in making in this business? In strategic marketing, on the other hand, thequestion is rather: What are my options for upsetting the equilibrium of the marketplace and reestablishing it in my favor? Marketing management takes market
projections and competitive position as a given and seeks to optimize withinthose constraints. Strategic marketing, by contrast, seeks to throw off those constraints wherever possible. Marketing management is deterministic; strategic
marketing is opportunistic. Marketing management is deductive and analytical;
strategic marketing is inductive and intuitive.

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35

THE PROCESS OF STRATEGIC MARKETING: AN EXAMPLE
The process of strategic marketing planning, charted in Exhibit 2-4, may be illustrated with an SBU (health-related remedies) of the New England ProductsCompany (a fictional name). Headquartered in Hartford, Connecticut, NEPC is aworldwide manufacturer and marketer of a variety of food and nonfood products, including coffee, orange juice, cake mixes, toothpaste, diapers, detergents,and health-related remedies. The company conducts its business in more than 100
countries, employs approximately 110,000 people, operates more than 147 manufacturing facilities, and maintains three major research centers. In 1998 (year ending June 30), the company’s worldwide sales amounted to $37.3 billion.
EXHIBIT 2-4
Process of Strategic Marketing36

Strategic Marketing

36

PART 1Introduction

Corporate
Strategy

In 1991, the company’s strategic plan established the following goals:• To strengthen significantly the company’s core businesses (i.e., toothpaste, diapers, and detergents).
• To view health care products as a critical engine of growth.
• To boost the share of profits from health-related products from 20 percent to 30
percent over the next decade.
• To divest those businesses not meeting the company’s criteria for profitability andgrowth, thus providing additional resources to achieve other objectives.
• To make an 18 percent return on total capital invested.
• To a great extent, to depend on retained earnings for financing growth.

This above strategy rested on the five factors, shown in Exhibit 2-4, that feed into
corporate strategy:• Value system—always to be strong and influential in marketing, achieving growththrough developing and acquiring new products for specific niches.
• Corporate publics—the willingness of NEPC stockholders to forgo short-term profits and dividends in the interest of long-term growth and profitability.
• Corporate resources—strong financial position, high brand recognition, marketing
powerhouse.
• Business unit performance—health-related remedies sales, for example, were higher
worldwide despite recessionary conditions.
• External environment—increased health consciousness among consumers.

Business Unit
MissionThe mission for one of NEPC’s 36 business units, health-related remedies,emerged from a simultaneous review of corporate strategy, competitive conditions, customers’ perspectives, past performance of the business unit, and marketing environment, as charted in Exhibit 2-4. The business unit mission for
health-related remedies was delineated as follows:• To consolidate operations by combining recent acquisitions and newly developed
products and by revamping old products.
• To accelerate business by proper positioning of products.
• To expand the product line to cover the entire human anatomy.

The mission for the business unit was translated into the following objectives andgoals:• To invest heavily to achieve $5.3 billion in sales by 2003, an increase of 110 percent over $2.8 billion in 1998.
• To achieve a leadership position in the United States.
• To introduce new products overseas as early as possible to preempt competition.

Marketing objectives for different products/markets emerged from these overallbusiness unit objectives. For example, the marketing objectives for a product tocombat indigestion were identified as follows:• To accelerate research to seek new uses for the product.
• To develop new improvements in the product.

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Marketing
Strategy37

Marketing objectives, customer and competitive perspectives, and product/market momentum (i.e., extrapolation of past performance to the future) form thebasis of marketing strategy. In the case of NEPC, the major emphasis of marketing strategy for health-related remedies was on positioning through advertisingand on new product development. Thus, the company decided to increase advertising support throughout the planning period and to broaden research anddevelopment efforts.
NEPC’s strategy was based on the following rationale. Consumers are
extremely loyal to health products that deliver, as shown by their willingness toresume buying Johnson & Johnson’s Tylenol after two poisoning episodes. But
while brand loyalty makes consumers harder to lure away, it also makes themeasier to keep, and good marketing can go a long way in this endeavor. The company was able to enlarge the market for its indigestion remedy, which experts
thought had hit maturity, through savvy marketing. NEPC used television advertising to sell it as a cure for overindulgence, which led to a 30 percent increase inbusiness during 1993–98.
As NEPC pushes further into health products, its vast research and technological resources will be a major asset. NEPC spends nearly $1 billion a year on
research, and product improvements have always been an important key to thecompany’s marketing prowess.
The overall strategy of the health-related remedies business unit was determined by industry maturity and the unit’s competitive position. The industry
was found to be growing, while the competitive position was deemed strong.
With insurers and the government trying to drive health care costs down,
consumers are buying more and more over-the-counter nostrums. Advertisers aremaking health claims for products from cereal to chewing gum. As the fitness
craze exemplifies, interest in health is higher than ever, and the aging of the population accentuates these trends: people are going to be older, but they are notgoing to want to feel older. Thus the health-related remedies industry has a significant potential for growth. NEPC is the largest over-the-counter remedies marketer. As shown in the list below, it has products for different ailments. The
company’s combined strength in marketing and research puts it in an enviable
position in the market.
• Skin—NEPC produces the leading facial moisturizer. NEPC also leads the teenage
acne treatment market. Work is now underway on a possible breakthrough antiaging product.
• Mouth—After being on the market for 28 years, NEPC’s mouthwash is the market
leader. Another NEPC product, a prescription plaque-fighting mouthwash, may
go over the counter, or it may become an important ingredient in other NEPC
oral hygiene products.
• Head—An NEPC weak spot, its aspirin, holds an insignificant share of the analgesic market. NEPC may decide to compete with an ibuprofen-caffeine combination painkiller.
• Chest—NEPC’s medicated chest rub is an original brand in a stable that now
includes cough syrup, cough drops, a nighttime cold remedy, and nasal spray.
Other line extensions and new products are coming, but at a fairly slow pace.

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PART 1Introduction• Abdomen—The market share for NEPC’s indigestion remedy is up 22 percent in
the last three years. Already being sold to prevent traveler’s diarrhea, it may bemarketed as an ulcer treatment. NEPC also dominates the over-the-counter bulk
laxative market. New clinical research shows that its laxative may reduce serum
cholesterol.
• Bones—NEPC orange juice has a 10 percent share of the market. Orange juicewith calcium is now being expanded nationwide and could be combined with a
low-calorie version.

Briefly, these inputs, along with the business unit’s goals, led to the following
business unit strategy: to attempt to improve position, to push for share.
Portfolio Analysis. The marketing strategy for each product/market wasreviewed using the portfolio technique (see Chapter 10). By positioning different
products/markets on a multifactor portfolio matrix (high/medium/low businessstrength and high/medium/low industry attractiveness), strategy for each product/market was examined and approved from the viewpoint of meeting business
unit missions and goals. Following the portfolio analysis, the approved marketing strategy became a part of the business unit’s strategic plan, which, whenapproved by top management, was ready to be implemented. As a part of implementation, an annual marketing plan was formulated and became the basis for
operations managers to pursue their objectives.
Implementation of the Strategic Plan. A few highlights of the activities of thehealth-related remedies business unit during 1998–2003 show how the strategicplan was implemented.
• Steps were taken to sell its laxative as an anticholesterol agent.
• The company won FDA permission to promote its indigestion remedy to doctors
as a preventive for traveler’s diarrhea.
• Company research has shown that its indigestion remedy helps treat ulcers.
Although some researchers have disputed this claim, the prospect of cracking themultibillion dollar ulcer treatment market is tantalizing.
• The company introduced its orange juice brand with calcium. The company
sought and won the approval of the American Medical Women’s Association forthe product and put the group’s seal on its containers.

STRATEGIC MARKETING IMPLEMENTATION
Strategic marketing has evolved by trial and error. In the 1980s, companies developed unique strategic-marketing procedures, processes, systems, and models.
Experience shows, however, that most companies’ marketing strategies are burdened with undue complexity. They are bogged down in principles that produce
similar responses to competition. Changes are needed to put speed and freshness
into marketing strategy.
Failings inStrategic Marketing

The following are the common problems associated with marketing strategy formulation and implementation.

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1. Too much emphasis on “where” to compete and not enough on “how” to compete. Experience shows that companies have devoted much more attention to
identifying markets in which to compete than to the means to compete in thesemarkets. Information on where to compete is easy to obtain but seldom brings
about sustainable competitive advantage. Further, “where’’ information is usuallyeasy for competitors to copy. “How’’ information, on the other hand, is tough to
get and tough to copy. It concerns the fundamental workings of the business andthe company. For example, McDonald’s motto, QSC & V, is a how-to-compete
strategy—it translates into quality food products; fast, friendly service; restaurant
cleanliness; and a menu that provides value. It is much more difficult to copy the“how’’ of McDonald’s strategy than the “where.’’20
In the next era of marketing strategy, companies will need to focus on how
to compete in entirely new ways. In this endeavor, creativity will play a crucialrole. For example, a large insurance company substantially improved its business by making improvements in underwriting, claim processing, and customer service, a “how’’ strategy that could not be replicated by competitors
forthwith.
2. Too little focus on uniqueness and adaptability in strategy. Most marketingstrategies lack uniqueness. For example, specialty stores increasingly look alikebecause they use the same layout and stock the same merchandise. In the 1980s,
when market information was scarce, companies pursued new and different
approaches. But today’s easy access to information often leads companies to follow identical strategies to the detriment of all.
Ideas for uniqueness and adaptability may flow from unknown sources.
Companies should, therefore, be sensitive and explore all possibilities. The point
may be illustrated with reference to Arm and Hammer’s advertising campaignthat encouraged people to place baking soda in their refrigerators to reduceodors. The idea was suggested in a letter from a consumer. The introduction ofthat unique application for the product in the early 1970s caused sales of Arm andHammer baking soda to double within two years.
3. Inadequate emphasis on “when’’ to compete. Because of the heavy emphasis onwhere and how to compete, many marketing strategies give inadequate attention
to “when’’ to compete. Any move in the marketplace should be adequately timed.
The optimum time is one that minimizes or eliminates competition and creates
the desired impact on the market; in other words, the optimum time makes it easier for the firm to achieve its objectives. Timing also has strategy implementation
significance. It serves as a guide for different managers in the firm to schedule
their activities to meet the timing requirement.
Decisions on timing should be guided by the following:
a.

b.

c.

Market knowledge. If you have adequate information, it is desirable to market
readily; otherwise you must wait until additional information has beengathered.
Competition. A firm may decide on an early entry to beat minor competition. If
you face major competition, you may delay entry if necessary; for example, toseek additional information.
Company readiness. For a variety of reasons, the company may not be ready tocompete. These reasons could be lack of financial resources, labor problems,inability to meet existing commitments, and others.

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PART 1Introduction

Addressing the
Problems ofStrategic Marketing

Having the ability to do all the right things, however, is no guarantee that planned
objectives will be realized. Any number of pitfalls may render the best strategies
inappropriate. To counter the pitfalls, the following concerns should be addressed:
1. Develop attainable goals and objectives.
2. Involve key operating personnel.
3. Avoid becoming so engrossed in current problems that strategic marketing isneglected and thus becomes discredited in the eyes of others.
4. Don’t keep marketing strategy separate from the rest of the management process.
5. Avoid formality in marketing strategy formulation that restrains flexibility andinhibits creativity.
6. Avoid creating a climate that is resistant to strategic marketing.
7. Don’t assume that marketing strategy development can be delegated to a planner.
8. Don’t overturn the strategy formulation mechanism with intuitive, conflicting
decisions.

PLAN OF THE BOOK
Today’s business and marketing managers are faced with a continuous stream ofdecisions, each with its own degree of risk, uncertainty, and payoff. These decisions may be categorized into two broad classes: operating and strategic. Withreference to marketing, operating decisions are the domain of marketing management. Strategic decisions constitute the field of strategic marketing.
Operating decisions are those dealing with current operations of the business. The typical objective of these decisions in a business firm is profit maximization. During times of business stagnation or recession, as experienced in theearly 1990s, efforts at profit maximization have typically encompassed a cost minimization perspective. Under these conditions, managers are pressured into
shorter and shorter time horizons. All too frequently, decisions are made regarding pricing, discounts, promotional expenditures, collection of marketing
research information, inventory levels, delivery schedules, and a host of otherareas with far too little regard for the long-term impact of the decision. As might
be expected, a decision that may be optimal for one time period may not be optimal in the long run.
The second category of decision making, strategic decisions, deals with thedetermination of strategy: the selection of the proper markets and the productsthat best suit the needs of those markets. Although strategic decisions may represent a very small fraction of the multitude of management decisions, they are
truly the most important as they provide the definition of the business and thegeneral relationship between the firm and its environment. Despite their importance, however, the need to make strategic decisions is not always as apparent as
the need (sometimes urgency) for successfully completing operating decisions.
Strategic decisions are characterized by the following distinctions:
1. They are likely to effect a significant departure from the established product market mix. (This departure might involve branching out technologically or innovating in other ways.)41

Strategic Marketing

CHAPTER 2 Strategic Marketing41

2. They are likely to hold provisions for undertaking programs with an unusuallyhigh degree of risk relative to previous experience (e.g., using untried resources
or entering uncertain markets and competitive situations where predictability ofsuccess is noticeably limited).
3. They are likely to include a wide range of available alternatives to cope with amajor competitive problem, the scope of these alternatives providing for significant differences in both the results and resources required.
4. They are likely to involve important timing options, both for starting development work and for deciding when to make the actual market commitment.
5. They are likely to call for major changes in the competitive “equilibrium,’’ creating a new operating and customer acceptance pattern.
6. They are likely to resolve the choice of either leading or following certain market
or competitive advances, based on a trade-off between the costs and risks of innovating and the timing vulnerability of letting others pioneer (in the expectation ofcatching up and moving ahead at a later date on the strength of a superior marketing force).

This book deals with strategic decisions in the area of marketing. Chapter 1
dealt with planning and strategy concepts, and this chapter examined various
aspects of strategic marketing. Chapters 3 through 6 deal with analysis of strategic information relative to company (e.g., corporate appraisal), competition, customer, and external environment. Chapter 7 focuses on the measurement ofstrategic capabilities, and Chapter 8 concentrates on strategic direction via goals
and objectives.
Chapters 9 and 10 are devoted to strategy formulation. Organization for strategy implementation and control are examined in Chapter 11. Chapter 12 discusses strategic techniques and models. The next five chapters, Chapters 13
through 17, review major market, product, price, distribution, and promotion
strategies. The final chapter, Chapter 18, focuses on global market strategy.

SUMMARY

This chapter introduced the concept of strategic marketing and differentiated itfrom marketing management. Strategic marketing focuses on marketing strategy,
which is achieved by identifying markets to serve, competition to be tackled, andthe timing of market entry/exit. Marketing management deals with developing amarketing mix to serve a designated market.
The complex process of marketing strategy formulation was described.
Marketing strategy, which is developed at the SBU level, essentially emerges fromthe interplay of three forces—customer, competition, and corporation—in a given
environment.
A variety of internal and external information is needed to formulate marketing strategy. Internal information flows both down from top management(e.g., corporate strategy) and up from operations management (e.g., past performance of products/markets). External information pertains to social, economic, political, and technological trends and product/market environment.
The effectiveness of marketing perspectives of the company is another input instrategy formulation. This information is analyzed to identify the SBU’s
strengths and weaknesses, which together with competition and customer,42

Strategic Marketing

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PART 1Introduction

define SBU objectives. SBU objectives lead to marketing objectives and strategy
formulation. The process of marketing strategy development was illustrated
with an example of a health-related product.
Finally, this chapter articulated the plan of this book. Of the two types of business decisions, operating and strategic, this book will concentrate on strategic
decision making with reference to marketing.

DISCUSSIONQUESTIONS

1. Define strategic marketing. Differentiate it from marketing management.
2. What are the distinguishing characteristics of strategic marketing?
3. What emerging trends support the continuation of strategic marketing as animportant area of business endeavor?
4. Differentiate between operating and strategic decisions. Suggest three examples of each type of decision from the viewpoint of a food processor.
5. How might the finance function have an impact on marketing strategy?
Explain.
6. Adapt to a small business the process of marketing strategy formulation as presented in Exhibit 2-4.
7. Specify the corporate inputs needed to formulate marketing strategy.

NOTES“Taking It on the Chin,” The Economist (18 April 1998): 60.
”When Marketing Failed at Texas Instruments,’’ Business Week (22 June 1981): 91. See
also Bro Uttal, “Texas Instruments Regroups,’’ Fortune (9 August 1982): 40.
3 Business Planning in the Eighties: The New Competitiveness of American Corporations (NewYork: Coopers & Lybrand, 1984).
4 For further discussion of the portfolio matrix, see Chapter 10.
5 See Robert W. Ruekert and Orville C. Walker, Jr., “Marketing’s Interaction with Other
Functional Units: A Conceptual Framework and Empirical Evidence,’’ Journal ofMarketing (January 1987): 1–19.
6 See Chapter 12.
7 David W. Cravens, “Examining the Impact of Market-Based Strategy Paradigms on
Marketing Strategy,” Journal of Strategic Marketing (September 1998): 197–208.
8 “Strategic Planning,” Business Week (26 August 1996): 46.
9 Laura Landro, “Parent and Partners Help Columbia Have Fun at the Movies,’’ The
Wall Street Journal (7 December 1984): 1.
10 Alex Taylor III, “Rough Road Ahead,” Fortune (17 March 1997): 115.
11 Don G. Reinertsen, “Whodunit? The Search for New Product Killers,’’ Electronic
Business (July 1983): 62–66.
12 Gary Hamel and C. K. Prahalad, “Corporate Imagination and Expeditionary
Marketing,’’ Harvard Business Review (July–August 1991): 81–92.
13 John Brady and Ian Davis, “Marketing’s Mid-Life Crisis,” The McKinsey Quarterly 2(1993): 17–28. Also see Adrian J. Slywotzky and Benson P. Shapiro, “Leveraging toBeat the Odds: The New Marketing Mind-Set,” Harvard Business Review (September–
October 1993): 97–107.
14 Fortune (4 April 1994): 61.
1
2

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Ken Dychtwald and Grey Gable, “American Diversity,’’ American Demographics (July
1991): 75–77.
16 ”The Economics of Aging,” Business Week (12 September 1994): 60.
17 Bruce D. Henderson, Henderson on Corporate Strategy (Cambridge, MA: Abt Books,
1981), 38.
18 Derek F. Abell and John S. Hammond, Strategic Market Planning (Englewood Cliffs, NJ:
Prentice-Hall, 1979), 9.
19 Henderson, Henderson on Corporate Strategy, 4.
20 Joel A. Bleeke, “Peak Strategies,’’ Across the Board (February 1988): 45–80.
15

3
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Corporate AppraisalO

ne important reason for formulating marketing strategy is to prepare thecompany to interact with the changing environment in which it operates.
Implicit here is the significance of predicting the shape the environment is likely
to take in the future. Then, with a perspective of the company’s present position,
the task ahead can be determined. Study of the environment is reserved for a later
chapter. This chapter is devoted to corporate appraisal.
An analogy to corporate appraisal is provided by a career counselor’s job.
Just as it is relatively easy to make a list of the jobs available to a young person, it
is simple to produce a superficial list of investment opportunities open to a company. With the career counselor, the real skill comes in taking stock of each applicant; examining the applicant’s qualifications, personality, and temperament;
defining the areas in which some sort of further development or training may berequired; and matching these characteristics and the applicant’s aspirations
against various options. Well-established techniques can be used to find out mostof the necessary information about an individual. Digging deep into the psycheof a company is more complex but no less important. Failure by the company inthe area of appraisal can be as stunting to future development in the corporate
sense as the misplacement of a young graduate in the personal sense.
How should the strategist approach the task of appraising corporate perspectives? What needs to be discovered? These and other similar questions are
explored in this chapter.

Know your enemy andknow yourself, and ina hundred battles you
will never be in peril.
SUN–T ZUMEANING OF CORPORATE APPRAISAL
Broadly, corporate appraisal refers to an examination of the entire organizationfrom different angles. It is a measurement of the readiness of the internal cultureof the corporation to interact with the external environment. Marketing strategists
are concerned with those aspects of the corporation that have a direct bearing on
corporate-wide strategy because that must be referred in defining the business
unit mission, the level at which marketing strategy is formulated. As shown in
Exhibit 3-1, corporate strategy is affected by such factors as value orientation to
top management, corporate publics, corporate resources, past performance of thebusiness units, and the external environment. Of these, the first four factors are
examined in this chapter.
Two important characteristics of strategic marketing are its concern withissues having far-reaching effects on the entire organization and change as an
essential ingredient in its conduct. These characteristics make the process of
45

45

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marketing strategy formulation a difficult job and demand creativity and adaptability on the part of the organization. Creativity, however, is not common among
all organizations. By the same token, adaptation to changing conditions is noteasy. As has been said:
Success in the past always becomes enshrined in the present by the over-valuation of
the policies and attitudes which accompanied that success. . . . With time these attitudes become embedded in a system of beliefs, traditions, taboos, habits, customs, andinhibitions which constitute the distinctive culture of that firm. Such cultures are as
distinctive as the cultural differences between nationalities or the personality differences between individuals. They do not adapt to change very easily.1

Human history is full of instances of communities and cultures being wipedout over time for the apparent reason of failing to change with the times. In thecontext of business, why is it that organizations such as Xerox, Wal-Mart, HewlettPackard, and Microsoft, comparative newcomers among large organizations, areconsidered blue-chip companies? Why should United States Rubber, American
Tobacco, and General Motors lag behind? Why are General Electric, Walt Disney,
Citicorp, Du Pont, and 3M continually ranked as “successful” companies? The
outstanding common denominator in the success of companies is the element ofchange. When time demands that the perspective of an organization change, andthe company makes an appropriate response, success is the outcome.

EXHIBIT 3-1
Scope of Corporate Appraisal

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47

Obviously, marketing strategists must take a close look at the perspectives ofthe organization before formulating future strategy. Strategies must bear a close
relationship to the internal culture of the corporation if they are to be successfully
implemented.

FACTORS IN APPRAISAL: CORPORATE PUBLICS
Business exists for people. Thus, the first consideration in the strategic process is
to recognize the individuals and groups who have an interest in the fate of thecorporation and the extent and nature of their expectations.
Meaning ofCorporate Public

The following groups generally constitute the interest-holders in business organizations:
1. Owners
2. Employees
3. Customers
4. Suppliers
5. Banking community and other lenders
6. Government
7. Community in which the company does business
8. Society at large

For the healthy growth of the organization, all eight groups must be served
adequately. Of all the stakeholders, in the past corporations paid little attention to
the communities in which they operated; today, however, the importance of service to community and to society is widely acknowledged. The community may
force a company to refrain from activities that are detrimental to the environment.
For example, the Boise Cascade Company was once denounced as harsh, stingy,socially insensitive, and considerably short of the highest ethical standards
because of its unplanned land development. Community interests ultimately prevailed, forcing the company to either give up its land development activities ormake proper arrangements for the disposal of waste and to introduce other environmental safeguards. Similarly, social concern may prevent a company frombecoming involved in certain types of business. A publishing company responsive to community standards may refuse to publish pornographic material.
Johnson & Johnson exemplified responsible corporate behavior when it
resolved the contingency created by the deaths of seven individuals who had consumed contaminated Tylenol capsules.2 Within a few days, the company instituted a total product recall at a cost of $50 million after taxes, despite the fact thatthe problem did not occur because of negligence on the part of the company.
Subsequently, the company took the initiative to develop more effective packaging to prevent tampering in the future. The company’s commitment to socially
responsible behavior was reaffirmed when it quit producing capsules entirely
after the tampering occurred again. Johnson & Johnson put the well-being of thecustomer ahead of profitability in resolving this tampering problem. In brief, the48

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requirements and expectations of today’s society must serve as basic ingredientsin the development of strategy:
Though profit and efficiency must remain central values within the culture, they must
be balanced by other values that help define the limits of activities designed to achieve
those objectives and by values describing other important ethical and socially responsible behaviors. Without the integration of concerns about ethics and social responsibility at the very beginning of the marketing planning process, as well as throughout
the process, the organizational culture may not provide the checks and balances
needed to develop ethical and socially responsible marketing programs.3

Corporate Response
to Different Publics

Historically, a business organization considered its sole purpose to be economic
gain, concerning itself with other spheres of society only when required by law or
self-interest or when motivated by philanthropy or charity. Charity was merely acelebration of a corporation’s good fortune that it desired to share with “outsiders”
or a display of pity for the unfortunate. Indirectly, of course, even this rather uninspired notion of charity gave the company a good name and thus served a public
relations function.4 In slack times, a company reduced its activities in all areas,
instituting both inside cost-cutting measures and the lowering of commitments toall publics other than stockholders. Such a perspective worked well until the
mid-1960s; however, with economic prosperity almost assured, different stakeholders have begun to demand a more equitable deal from corporations.
Concern over environmental pollution by corporations, for example, has
become a major issue in both the public and the private sector. Similarly, customers expect products to be wholesome; employees want opportunities foradvancement and self-improvement; and the community hopes that a corporation would assume some of its concerns, such as unemployment among minorities. Society now expects business corporations to help in resolving social
problems. In brief, the role of the corporation has shifted from that of an economic
institution solely responsible to its stockholders to that of a multifaceted force
owing its existence to different stakeholders to whom it must be accountable. As
one of the most progressive institutions in the society, the corporation is expected
to provide balanced prosperity in all fields. Two generations ago, the idea of abusiness being a party to a contract with society would have provoked an indignant snort from most businesspeople. Even 10 years ago, a business’s contract
with society was more likely material for a corporate president’s speech to thestockholders than a basis for policy. It is a measure of how much the attitudesof middle-of-the-road businesspeople have changed that the notion of a social
contract is now the basic assumption for their statements on the social responsibilities of a business. This new outlook extends the mission of the businessbeyond its primary obligation to owners.
In today’s environment, corporate strategy must be developed not simply toenhance financial performance, but also to maximize performance across theboard, delivering the highest gains to all stakeholders, or corporate publics. And
companies are responding to changing times. As former chairman Waldron of
Avon Products noted, “We have 40,000 employees and 1.3 million representatives.

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49. . . They have much deeper and more important stakes in our company than shareholders.”5
The “concept of stakeholders” is really an extension of the marketing concept,
the central doctrine in marketing.
Marketing concept and the stakeholder concept are strongly related with a common
root or core. Clearly, one commonality is that the stakeholder concept recognizes theconsumer as a public with concerns central to the organization’s purpose. Perhaps afurther element of this common core is a realization of the importance of cooperative
exchange with the consumer. In fact, all publics of an organization can be viewed in acooperative vs. adversarial perspective. Cooperative strategies with labor, marketing
channel members, etc., may result in eventual but not mutual symbiosis. For example,
if a manufacturer cooperates with wholesalers, then these wholesalers may be more
likely to cooperate with retailers. Similarly, retailers may then be more likely to treat
the customer well. Consequently, the customer will be more loyal to certain brands,
and this catalyzes the manufacturer to continue to be cooperative with channel members. This eventual, but not necessarily mutual, symbiosis may result in more long-run
stability and evolutionary potential within the business system.6

One company that systematically and continuously examines and serves theinterests of its stakeholders is Corning. It cooperates with labor, promotes diversity, and goes out of its way to improve the community. For example, the company’s partnership with the glass workers’ union promotes joint decision
making. Worker teams determine job schedules and even factory design. All U.S.
workers share a bonus based on point performance. All managers and salaried
workers attend seminars to build sensitivity and support for women and
African-American coworkers. A network of mentors helps minorities (i.e., African
Americans, Asians, Hispanics, and women) with career planning. Corning
acquires and rehabilitates commercial properties, then finds tenants (some minority-owned) at market rates to locate their business there. It works to attract new
business to the region and has invested in the local infrastructure by building a
Hilton hotel, a museum, and a city library.
More than the biggest employer in town, Corning plays benefactor, landlord, and social
engineer. The company is half-owner of a racetrack and sponsors a professional golf
tournament. Affordable housing, day care, new business development—it’s doing allthat, too. Corning is more directly involved in its community than most big U.S. corporations. . . . When a flood in 1972 put the town under 10 feet of water, the company
paid area teenagers to rehabilitate damaged homes and appliances, then spent millions
to build a new library and skating rink. But Corning’s recent efforts have been more
focused: They aim to turn a remote, insular town into a place that will appeal to thesmart professionals Corning wants to attract—a place that offers social options foryoung singles, support for new families, and cultural diversity for minorities.
It’s a strategy that often borders on corporate socialism. Corning bought the rundown bars—which “didn’t fit with our objective,’’ says one executive—as part of a
block-long redevelopment of Market Street, the town’s main commercial strip.
More important, Corning is working to create a region less dependent on its headquarters and 15 factories. . . . To help support the flagging local economy, Corningbought the Watkins Glen auto-racing track, which had slipped into bankruptcy. It

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rebuilt the facility, took in a managing partner, and last summer, saw the track host
200,000 visitors. Similarly, the company lobbied a supermarket chain to build an enormous new store. It persuaded United Parcel Service to locate a regional hub nearby.
In all, Corning expects its Corning Enterprises subsidiary, which spearheads community investments, to bring 200 new jobs to the Chemung River valley each year. It
also wants to boost the number of tourists by 2% annually and attract four new businesses to town. Corning Enterprises funds its activities largely with rental income
from real estate that it has purchased and rehabilitated.7

Corporate Publics:
Analysis of
Expectations

Although the expectations of different groups vary, in our society growth andimprovement are the common expectations of any institution. But this broad view
does not take into account the stakes of different groups within a business. For
planning purposes, a clearer definition of each group’s hopes is needed.
Exhibit 3-2 summarizes the factors against which the expectations of different
groups can be measured. The broad categories shown here should be broken
down into subcategories as far as possible. For example, in a community where
juvenile delinquency is rampant, youth programs become an important area ofcorporate concern. One must be careful, however, not to make unrealistic or false
assumptions about the expectations of different groups. Take owners, for example. Typically, 50 percent of earnings after taxes must be reinvested in the businessto sustain normal growth, but the payout desired by the owners may render it difficult to finance growth. Thus, a balance must be struck between the payment ofdividends and the plowing back of earnings. A vice president of finance for achemical company with yearly sales over $100 million said in a conversation withthe author:
While we do recognize the significance of retaining more money, we must consider thedesires of our stockholders. They happen to be people who actually live on dividend
payments. Thus, a part of long-term growth must be given up in order to maintaintheir short-term needs for regular dividend payments.

Apparently this company would not be correct in assuming that growth alone isthe objective of its stockholders. Thus, it behooves the marketing strategist to gain
clear insight into the demands of different corporate publics.
Who in the company should study stakeholders’ expectations? This task constitutes a project in itself and should be assigned either to someone inside thecompany (such as a strategic planner, an assistant to the president, a director of
public affairs, or a marketing researcher) or to a consultant hired for this purpose.
When this analysis is first undertaken, it will be fairly difficult to specify stakeholders, designate their areas of concern, and make their expectations explicit.
After the initial study is made, updating it from year to year should be fairly
routine.
The groups that constitute the stakeholders of a business organization areusually the same from one business to another. Mainly they are the owners,
employees, customers, suppliers, the banking community and other lenders, government, the immediate community, and society at large. The areas of concern ofeach group and their expectations, however, require surveying. As with any other51

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EXHIBIT 3-2
Corporate Publics and their Concerns
Publics

Areas of Concern

OwnersPayoutEquityStock priceNonmonetary desires

Customers

Business reliability
Product reliability
Product improvement
Product price
Product service
Continuity
Marketing efficiency

Employees of all ranks

Monetary reward
Reward of recognition
Reward of pride
Environment
Challenge
Continuity
Advancement

Suppliers

Price
Stability
Continuity
GrowthBanking community andother lenders

Sound risk
Interest payment
Repayment of principal

Government (federal,state, and local)

Taxes
Security and law enforcement
Management expertise
Democratic government
Capitalistic system
Implementation of programs

Immediate community

Economic growth and efficiency
Education
Employment and training

Society at large

Civil rights
Urban renewal and development
Pollution abatement
Conservation and recreation
Culture and arts
Medical care

51

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survey, this amounts to seeking information from an appropriate sample withineach group. A structured questionnaire is preferable for obtaining objective
answers. Before surveying the sample, however, it is desirable to conduct in-depth
interviews with a few members of each group. The information provided by theseinterviews is helpful in developing the questionnaire. While overall areas of concern may not vary from one period to another, expectations certainly do. For example, during a recession stockholders may desire a higher payout in dividends thanat other times. Besides, in a given period, the public may not articulate expectations in all of its areas of concern. During inflationary periods, for example, customers may emphasize stable prices only, while product improvement andmarketing efficiency may figure prominently in times of prosperity.
Corporate Publics
and Corporate
Strategy

The expectations of different publics provide the corporation with a focus forworking out its objectives and goals. However, a company may not be able to satisfy the expectations of all stakeholders for two reasons: limited resources andconflicting expectations among stakeholders. For example, customers may want
low prices and simultaneously ask for product improvements. Likewise, to meetexactly the expectations of the community, the company may be obliged to reduce
dividends. Thus, a balance must be struck between the expectations of different
stakeholders and the company’s ability to honor them.
The corporate response to stakeholders’ expectations emerges in the form of
its objectives and goals, which in turn determine corporate strategy. While objectives and goals are discussed in detail in Chapter 8, a sample of corporate objectives with reference to customers is given here.
Assume the following customer expectations for a food-processing company:
1. The company should provide wholesome products.
2. The company should clearly state the ingredients of different products in words
that are easily comprehensible to an ordinary consumer.
3. The company should make all efforts to keep prices down.

The company, based on these expectations, may set the following goals:
Wholesome Products
1. Create a new position—vice president, product quality. No new products will be
introduced into the market until they are approved for wholesomeness by thisvice president. The vice president’s decision will be upheld no matter how brighta picture of consumer acceptance of a product is painted by marketing research
and marketing planning.
2. Create a panel of nutrient testers to analyze and judge different products for theirwholesomeness.
3. Communicate with consumers about the wholesomeness of the company’s products, suggesting that they deal directly with the vice president of product quality
should there be any questions. (Incidentally, a position similar to vice president of
product quality was created at Gillette a few years ago. This executive’s decisions
overruled the market introduction of products despite numerous other reasonsfor early introduction.)

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Information on Ingredients
1. Create a new position—director, consumer information. The person in this position will decide what information about product ingredients, nutritive value, etc.,
should be included on each package.
2. Seek feedback every other year from a sample of consumers concerning the effectiveness and clarity of the information provided.
3. Encourage customers, through various forms of promotions, to communicate
with the director of consumer information on a toll-free phone line to clarify
information that may be unclear.
4. Revise information contents based on numbers 2 and 3.

Keeping Prices Low
1. Communicate with customers on what leads the company to raise different prices(e.g., cost of labor is up, cost of ingredients is up, etc.).
2. Design various ways to reduce price pressure on consumers. For example,
develop family packs.
3. Let customers know how much they can save by buying family packs. Assure
them that the quality of the product will remain intact for a specified period.
4. Work on new ways to reduce costs. For example, a substitute may be found for a
product ingredient whose cost has gone up tremendously.

By using this illustration, the expectations of each group of stakeholders canbe translated into specific goals. Some firms, Adolph Coors Company, for example, define their commitment to stakeholders more broadly (see Exhibit 3-3).
However, this company is not alone in articulating its concern for stakeholders. A
whole corporate culture has sprung up that argues for the essential commonalityof labor-management community-shareholder interests.

FACTORS IN APPRAISAL: VALUE ORIENTATION OF TOP MANAGEMENT
The ideologies and philosophies of top management as a team and of the CEO as
the leader of the team have a profound effect on managerial policy and the strategic development process. According to Steiner:[The CEO’s] aspirations about his personal life, the life of his company as an institution, and the lives of those involved in his business are major determinants of choiceof strategy. His mores, habits, and ways of doing things determine how he behavesand decides. His sense of obligation to his company will decide his devotion andchoice of subject matter to think about.8

Rene McPherson, former CEO of Dana Corporation, incessantly emphasizedcost reduction and productivity improvement: the company doubled its productivity in seven years. IBM chairmen have always preached the importance of calling on customers—to the point of stressing the proper dress for a call. Over time,a certain way of dressing became an accepted norm of behavior for the entire corporation. Texas Instruments’ ex-chairman Patrick Haggerty made it a point todrop in at a development laboratory on his way home each night when he was in
Dallas to emphasize his view of the importance of new products for the company.

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EXHIBIT 3-3
Coors Commitment to Its Stakeholders
Our corporate philosophy can be summed up by the statement, “Quality in all we are
and all we do.” This statement reflects our total commitment to quality relationships
with customers, suppliers, community, stockholders and each other. Quality relationships
are honorable, just, truthful, genuine, unselfish, and reputable.
We are committed first to our customers for whom we must provide products andservices of recognizably superior quality. Our customers are essential to our existence.
Every effort must be made to provide them with the highest quality products and services at fair and competitive prices.
We are committed to build quality relationships with suppliers because we require
the highest quality goods and services. Contracts and prices should be mutually beneficial for the Company and the supplier and be honorably adhered to by both.
We are committed to improve the quality of life within our community. Our policy is
to comply strictly with all local, state and federal laws, with our Corporate Code of
Conduct and to promote the responsible use of our products. We strive to conserve our
natural resources and minimize our impact on the environment. We pay our fair tax
share and contribute resources to enhance community life. We boldly and visibly support
the free enterprise system and individual freedom within a framework which also promotes personal responsibility and caring for others.
We are committed to the long-term financial success of our stockholders throughconsistent dividends and appreciation in the value of the capital they have put at risk.
Reinvestment in facilities, research and development, marketing and new business
opportunities which provide long-term earnings growth take precedence over short-term
financial optimization.
These values can only be fulfilled by quality people dedicated to quality relationships within our Company. We are committed to provide fair compensation and a quality
work environment that is safe and friendly. We value personal dignity. We recognize
individual accomplishment and the success of the team. Quality relationships are built
upon mutual respect, compassion and open communication among all employees. We
foster personal and professional growth and development without bias or prejudice andencourage wellness in body, mind and spirit for all employees.
Source: Adolph Coors Company.

Such single-minded focus on a value becomes an integral part of a company’s culture. As employees steeped in the corporate culture move up the ladder, they
become role models for newcomers, and the process continues.9
How companies in essentially the same business move in different strategic
directions because of different top management values can be illustrated with an
example from American Can Company and Continental Group. Throughout the
1970s, both Robert S. Hatfield, then Continental’s chairman, and William F. May,
his counterpart at American Can, made deep changes in their companies’ product portfolios. Both closed numerous, aged can-making plants. Both divested tangential businesses they deemed to have lackluster growth prospects. And bothsought either to hire or promote executives who would steer their companies in
profitable directions.

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But similar as their overall strategies might seem, their concepts of their companies diverged markedly. May envisioned American Can as a corporate thinktank, serving as both a trend spotter and a trendsetter. He put his trust in theadvice of financial experts who, although lean on operating experience, wereknowledgeable about business theory. They took American Can into such diverse
fields as aluminum recycling, record distribution, and mail-order consumer products. By contrast, Hatfield sought executives with proven records in spotting new
potential in old areas. The company acquired Richmond Corporation, an insurance holding company, and Florida Gas Company.10
Importance ofValue Orientationin the Corporate
Environment

It would be wrong to assume that every firm wants to grow. There are companies
that probably could grow faster than their current rates indicate. But when top
management is averse to expansion, sluggishness prevails throughout the organization, inhibiting growth. A large number of companies start small, perhaps
with a family managing the organization. Some entrepreneurs at the helm of suchcompanies are quite satisfied with what they are able to achieve. They would
rather not grow than give up complete control of the organization. Obviously, if
managerial values promote stability rather than growth, strategy will form
accordingly. For Ben & Jerry’s Homemade Inc., social agenda is more important
than business expansion. When a top supplier from Tokyo called to offer distribution in Japan, a lucrative ice-cream market, the company said no because theJapanese company had no reputation for backing social causes.11
Of course, if the owners find that their expectations are in conflict with thevalue system of top management, they may seek to replace the company’s management with a more philosophically compatible team. As an example, a flamboyant CEO who emphasizes growth and introduces changes in the organization
to the extent of creating suspicion among owners, board members, and colleagues
may lead to the CEO’s exit from the organization. An unconventionally highdebt-to-equity ratio can be sufficient cause for a CEO to be dismissed. Conflictover the company’s social agenda cost Ben & Jerry’s the services of a CEO, Robert
Holland Jr. He resigned after less than two years on the job because he ran into
opposition from the cofounders regarding no-fat sorbet because that meant
buying less hormone-free milk from those virtuous dairy farmers. And when
Holland tried to distribute products in France, a dispute arose when cofounder
Ben issued a statement condemning France’s nuclear-testing program.12
In brief, the value systems of the individual members of top management
serve as important inputs in strategy development. If people at the top hold conflicting values, the chosen strategy will lack the willing cooperation and commitment of all executives. Generally, differing values are reflected in conflicts overpolicies, objectives, strategies, and structure.
This point may be illustrated with reference to Johnson & Johnson, a solidly
profitable company. Its core businesses are entering market maturity and offer limited long-term growth potential. In the mid-1980s, therefore, the company
embarked on a program to manufacture sophisticated technology products. But thedevelopment and marketing of high-tech products require a markedly different

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culture than that needed for Johnson & Johnson’s traditional products. High-tech
products require greater cooperation among corporate units, which is sometimes
hard to obtain. Traditionally, Johnson & Johnson’s various businesses have been
run as completely decentralized units with total autonomy. To successfully achieve
the shift to technology products, the CEO of the company, James E. Burke, is tinkering in subtle but important ways with a management style and corporate culture that have long been central to the company’s success.13 Similar efforts are atwork at Procter & Gamble: “Pressed by competitors and aided by new technology,
P&G is, in fact, remodeling its corporate culture—a process bringing pain to some,relief to others and wonderment to most.”14
Top Management
Values andCorporate Culture

Over time, top management values come to characterize the culture of the entire
organization. Corporate culture in turn affects the entire perspective of the organization. It influences its product and service quality, advertising content, pricing
policies, treatment of employees, and relationships with customers, suppliers,
and the community.
Corporate culture gives employees a sense of direction, a sense of how tobehave and what they ought to be doing. Employees who fail to live up to the cultural norms of the organization find the going tough. This point may be illustrated with reference to PepsiCo and J.C. Penney Company. At PepsiCo, beating
the competition is the surest path to success. In its soft drink operation, Pepsi
takes on Coke directly, asking consumers to compare the taste of the two colas.
This kind of direct confrontation is reflected inside the company as well.
Managers are pitted against each other to grab more market share, to work
harder, and to wring more profits out of their businesses. Because winning is the
key value at PepsiCo, losing has its penalties. Consistent runners-up find theirjobs gone. Employees know they must win merely to stay in place and must devastate the competition to get ahead.15
But the aggressive manager who succeeds at Pepsi would be sorely out ofplace at J.C. Penney Company, where a quick victory is far less important thanbuilding long-term loyalty.
Indeed, a Penney store manager once was severely rebuked by the company’s president for making too much profit. That was considered unfair to customers, whose
trust Penney seeks to win. The business style set by the company’s founder—which
one competitor describes as avoiding “taking unfair advantage of anyone the company did business with”—still prevails today. Customers know they can return merchandise with no questions asked; suppliers know that Penney will not haggle overterms; and employees are comfortable in their jobs, knowing that Penney will avoid
layoffs at all costs and will find easier jobs for those who cannot handle moredemanding ones. Not surprisingly, Penney’s average executive tenure is 33 years
while Pepsi’s is 10.16

These vastly different methods of doing business are just two examples ofcorporate culture. People who work at PepsiCo and at Penney sense that corporate values constitute the yardstick by which they will be measured. Just as tribal
cultures have totems and taboos that dictate how each member should act toward

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fellow members and outsiders, a corporation’s culture influences employees’
actions toward customers, competitors, suppliers, and one another. Sometimes
the rules are written, but more often they are tacit. Most often they are laid down
by a strong founder and hardened by success into custom.
One authority describes four categories of corporate culture—academies,clubs, baseball teams, and fortresses.17 Each category attracts certain personalities. The following are some of the traits among managers who gravitate to a particular corporate culture.
Academies— Have parents who value self-reliance but put less emphasis on honesty and consideration.
— Tend to be less religious.
— Graduate from business school with high grades.
— Have more problems with subordinates in their first ten years of work.

Clubs— Have parents who emphasize honesty and consideration.
— Have a lower regard for hard work and self-reliance.
— Tend to be more religious.
— Care more about health, family, and security and less about future income andautonomy.
— Are less likely to have substantial equity in their companies.
Baseball Teams— Describe their fathers as unpredictable.
— Generally have more problems planning their careers in the first ten years after
business school and work for more companies during that period than classmatesdo.
— Include personal growth and future income among their priorities.
— Value security less than others.
Fortresses— Have parents who value curiosity.
— Were helped strongly by mentors in the first year out of school.
— Are less concerned than others with feelings of belonging, professional growth,and future income.
— Experience problems in career planning, on-the-job decisions, and job implementation.

An example of an academy is IBM, where managers spend at least 40 hours
each year in training, being carefully groomed to become experts in a particularfunction. United Parcel Service represents a club culture, which emphasizes
grooming managers as generalists, with initiation beginning at the entry level.
Generally speaking, accounting firms, law firms, and consulting, advertising, andsoftware development companies exhibit baseball team cultures. Entrepreneurial
in style, they seek out talent of all ages and experience and value inventiveness.
Fortress companies are concerned with survival and are usually best represented

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by companies in a perpetual boom-and-bust cycle (e.g., retailers and natural
resource companies).
Many companies cannot be neatly categorized in any one way. Many
exhibit a blend of corporate cultures. For example, within General Electric, theNBC unit has baseball team qualities, whereas the aerospace division operates
like a club, the electronics division like an academy, and the home applianceunit like a fortress. Companies may move from one category to another as theymature or as forced by the environment. For example, Apple started out as a
baseball team but now appears to be emerging as an academy. Banks have traditionally exhibited a club culture, but with deregulation, they are evolving into
baseball teams.
In the current environment, the changes that businesses are being forced tomake merely to stay competitive—improving quality, increasing speed, becoming
customer oriented—are so fundamental that they must take root in a company’s
very essence; that is, its culture. Cultural change, while difficult and timeconsuming to achieve, is nevertheless feasible if approached properly. The CEOmust direct change to make sure that it happens coherently. He or she must live
the new culture, become the walking embodiment of it, and spot and celebrate
subordinates who exemplify the values that are to be inculcated. The following
are keys to cultural change:— Understand your old culture first. You can’t chart a course until you know
where you are.
— Encourage those employees who are bucking the old culture and have ideas for abetter one.
— Find the best subculture in your organization, and hold it up as an example fromwhich others can learn.
— Don’t attack culture head on. Help employees find their own new ways toaccomplish their tasks, and a better culture will follow.
— Don’t count on a vision to work miracles. At best, a vision acts as a guiding principle for change.
— Figure on five to ten years for significant, organization-wide improvement.
— Live the culture you want. As always, actions speak louder than words.18

Trying to change an institution’s culture is certain to be frustrating. Most
people resist change, and when the change goes to the basic character of the place
where they earn a living, many people become upset. A company trying to
improve its culture is like a person trying to improve his or her character. The
process is long, difficult, often agonizing. The only reason that people put themselves through such difficulty is that it is correspondingly satisfying and valuable.
As AT&T’s CEO Robert Allen comments:
It’s not easy to change a culture that was very control oriented and top down. We’retrying to create an atmosphere of turning the organization chart upside down,
putting the customers on top. The people close to the customer should be doing the
key decision-making.19

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Measurement ofValues59

In emphasizing the significance of the value system in strategic planning, several
questions become pertinent. Should the corporation attempt to formally establish
values for important members of management? If so, who should do it? Whatmeasures or techniques should be used? If the values of senior executives are in
conflict, what should be done? Can values be changed?
It is desirable that the values of top management should be measured. If nothing else, such measurement will familiarize the CEO with the orientation of top
executives and will help the CEO to better appreciate their viewpoints. Opinions
differ, however, on who should do the measuring. Although a good case can bemade for giving the assignment to a staff person, a strategic planner or a humanresources planner, for example, hiring an outside consultant is probably the mosteffective way to gain an objective perspective on management values. If a consultant’s findings appear to create conflict in the organization, they can be
scrapped. With help from the consultant, the human resources planner in thecompany, working closely with the strategic planner, can design a system for themeasurement of values once the initial effort is made.
Values can be measured in various ways. A popular technique is the selfevaluating scale developed by Allport, Vernon, and Lindzey.20 This scale divides
values into six classes: religious, political, theoretical, economic, aesthetic, andsocial. A manual is available that lists the average scores of different groups.
Executives can complete the test in about 30 minutes and determine the structureof their values individually. Difficulties with using this scale lie in relating theexecutives’ values to their jobs and in determining the impact of these values on
corporate strategy.
A more specific way is to pinpoint those aspects of human values likely toaffect strategy development and to measure one’s score in relation to these values
on a simple five- or seven-point scale. For example, we can measure an executive’s orientation toward leadership image, performance standards and evaluation, decision-making techniques, use of authority, attitude about change, andnature of involvement. Exhibit 3-4 shows a sample scale for measuring thesevalues.
As a matter of fact, a formal value orientation profile of each executive may
not be entirely necessary. By raising questions such as the following about each
top executive, one can gather insight into value orientations. Does the executive:
•
•
•
•
•

Seem efficiency-minded?
Like repetition?
Like to be first in a new field instead of second?
Revel in detail work?
Seem willing to pay the price of keeping in personal touch with the customer,etc.?

Can the value system of an individual be changed? Traditionally, it has been
held that a person’s behavior is determined mainly by the inner self reacting withina given environment. In line with this thinking, major shifts in values should be difficult to achieve. In recent years, however, a new school of behaviorists has emerged

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EXHIBIT 3-4
Measuring Value Orientation

A. Leadership Image1
2

3

Considered unfair and
not well liked

3

Permissive; tolerates
mediocracy

3

3

4

5

4

5

Implies authority rather thanovertly using it

3

Resists change

F. Nature of Involvement12

5

Based on scientific analylsis

Exhibits raw authority;
highly authoritative

E. Attitude About Change
124Highly demanding and critical;
replaces mediocracy

Based on intuition

D. Use of Authority
1
2

5

Shows concern for others, is sincere
fair, and ethical; evokes respect

B. Performance
1
2

C. Decision–Making Techniques
1
2

4

4

5

Seeks change and pushes others

3

Mainly interested in operational problems;interested in short-term results

4

5

Gives much to strategy

that assigns a more significant role to the environment. These new behaviorists
challenge the concept of “self” as the underlying force in determining behavior.21 If
their “environmental” thesis is accepted, it should be possible to bring about achange in individual values so that senior executives can become more unified.

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However, the science of human behavior has yet to discover the tools that can beused to change values. Thus, it would be appropriate to say that minor changes inpersonal values can be produced through manipulation of the environment; butwhere the values of an individual executive differ significantly from those of a colleague, an attempt to alter an individual’s values would be difficult.
Several years ago, differing values caused a key executive at Procter &Gamble, John W. Hanley, to leave the company for the CEO position at Monsanto.
Other members of the Procter & Gamble management team found him too
aggressive, too eager to experiment and change practices, and too quick to challenge his superior. Because he could not be brought around to the conservative
style of the company’s other executives, he was passed over for the presidency
and eventually left the company.22
Value Orientation
and Corporate
Strategy

The influence of the value orientation of top management on the perspectives ofthe business has already been emphasized. This section examines how a particular type of value orientation may lead to certain objectives and strategy perspectives. Two examples of this influence are presented below. In the first example, thepresident is rated high on social and aesthetic values, which seems to indicate a

Example A
ValuesThe president of a small manufacturer of office duplicating equipment ranked relatively
high on social values, giving particular attention to the security, welfare, and happinessof the employees. Second in order of importance to the president were aesthetic values.
Objectives and Strategies
1. Slow-to-moderate company growth
2. Emphasis on a single product3. An independent-agent form of sales organization
4. Very high-quality products with aesthetic appeal
5. Refusal to compete on a price basis
Example B
Values
The top-management team members of a high-fidelity loudspeaker systems manufacturer placed greater emphasis on theoretical and social values than on other values.
Objectives and Strategies
1. Scientific truth and integrity in advertising
2. Lower margins to dealers than competitors were paying
3. Maintenance of “truth and honesty” in relationships with suppliers, dealers, andemployees

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greater emphasis on the quality of a single product than on growth per se. In thesecond example, again, the theoretical and social orientation of top management
appears to stress truth and honesty rather than strictly growth. If the strategicplans of these two companies were to emphasize growth as a major goal, theywould undoubtedly fail. Planned perspectives may not be implemented if they
are constrained by top management’s value system.
A corporation’s culture can be its major strength when it is consistent with its
strategies, as demonstrated by the following examples:• At IBM, marketing drives a service philosophy that is almost unparalleled. The
company keeps a hot line open 24 hours a day, seven days a week, to service IBM
products.
• At International Telephone and Telegraph Corporation, financial discipline
demands total dedication. To beat out the competition in a merger, an executive
once called former chairman Harold S. Geneen at 3 a.m. to get his approval.
• At Microsoft, an emphasis on innovation creates freedom with responsibility.
Employees can set their own hours and working style, but they are expected to
articulate and support their activities with evidence of progress.
• At Delta Air Lines Inc., a focus on customer service produces a high degree ofteamwork. Employees switch jobs to keep planes flying and baggage moving.
• At Toyota standards in efficiency, productivity, and quality are the most important pursuits. No wonder the company is the benchmark in manufacturing andproduct development.
• At GE every business unit should conduct continuous campaigns to become thelowest-cost producer in its area. One approach to reducing costs and improving
productivity is work-outs, which are multi-day retreats. After the boss and outside consultants lay out the unit’s achievements, problems, and business environment, the participants brainstorm to come up with recommendations for
improving operations. They receive on-the-spot responses and pledges that whatis agreed upon will be implemented quickly.

In summary, an organization in the process of strategy formulation must study
the values of its executives. While exact measurement of values may not be possible, some awareness of the values held by top management is helpful
to planners. Care should be taken not to threaten or alienate executives bychallenging their beliefs, traits, or outlooks. In the strategy formulation, the value
package of the management team should be duly considered even if
it means compromising on growth and profitability. Where no such compromise isfeasible, it is better to transfer or change the assignment of a dissenting executive.
The experience of Interpace Corporation’s CEO is relevant here. After movingfrom International Telephone and Telegraph Corporation (ITT) in the early 1980s,
he drew on his ITT background to manage Interpace, a miniconglomerate withinterests in such diverse products as teacups and concrete pipes. He used a formula that had worked well at ITT, which consisted of viewing assets primarily as
financial pawns to be shifted around at the CEO’s will, of compelling managers
to abide by financial dicta, and of focusing on financial results. The approach
seemed reasonable, but its implementation at Interpace was fraught with problems. ITT’s management style did not fit the Interpace culture, despite the fact

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that the CEO replaced 35 members of a 51-person team.23 Culture that prevents acompany from meeting competitive threats or from adapting to changing economic or social environments can lead to stagnation and the company’s ultimate
demise unless the company makes a conscious effort to change.

FACTORS IN APPRAISAL: CORPORATE RESOURCES
The resources of a firm are its distinctive capabilities and strengths. Resources are
relative in nature and must always be measured with reference to the competition.
Resources can be categorized as financial strength, human resources, raw material reserve, engineering and production, overall management, and marketingstrength. The marketing strategist needs to consider not only marketing resources
but also resources of the company across the board. For example, price setting isa part of marketing strategy, yet it must be considered in the context of the financial strength of the company if the firm is to grow as rapidly as it should. It is
obvious that profit margins on sales, combined with dividend policy, determine
the amount of funds that a firm can generate internally. It is less well understood,
but equally true, that if a firm uses more debt than its competitors or pays lower
dividends, it can generate more funds for growth by decreasing profit margins.
Thus, it is important in strategy development that all of the firm’s resources are
fully utilized in a truly integrated way. The firm that does not use its resources
fully is a target for the firm that will—even if the latter has fewer resources. Fulland skillful utilization of resources can give a firm a distinct competitive edge.
Resources andMarketing Strategy

Consider the following resources of a company:
1. Has ample cash on hand (financial strength).
2. Average age of key management personnel is 42 years (human resources).
3. Has a superior raw material ingredient in reserve (raw material reserve).
4. Manufactures parts and components that go into the final product using the company’s own facilities (plant and equipment).
5. The products of the company, if properly installed and serviced regularly, neverstop while being used (technical competence).
6. Has knowledge of, a close relationship with, and expertise in doing business withgrocery chains (marketing strength).

How do these resources affect marketing strategy? The cash-rich company,
unlike the cash-tight company, is in a position to provide liberal credit accommodation to customers. General Electric, for example, established the General Electric
Credit Corporation (now called GE Capital Corporation) to help its dealers andultimate customers to obtain credit. In the case of a manufacturer of durable goods
whose products are usually bought on credit, the availability of easy credit canitself be the difference between success and failure in the marketplace.
If a company has a raw material reserve, it does not need to depend on outside suppliers when there are shortages. In the mid-1980s, there was a shortageof high-grade paper. A magazine publisher with its own forests and paper

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manufacturing facilities did not need to depend on paper companies to acquire
paper. Thus, even when a shortage forced its competitors to reduce the sizes of
their magazines, the company not dependent on outsiders was able to provide
the same pre-shortage product to its customers.
In the initial stages of the development of color television, RCA was the only
company that manufactured color picture tubes. In addition to using these tubes
in its own television sets, RCA also sold them to other manufacturers/competitors such as GE. When the market for color television began to grow, RCA was ina strong position to obtain a larger share of the growth partly because of its easy
access to picture tubes. GE, on the other hand, was weaker in this respect.
IBM’s technical capabilities, among other things, helped it to be an innovatorin developing data processing equipment and in introducing it to the market.
IBM’s excellent after-sale service facilities in themselves promoted the company’s
products. After-sale servicing put a promotional tool in the hands of salespeople
to push the company’s products.
Procter & Gamble is noted for its superior strength in dealing with grocerychannels. The fact that this strength has served Procter & Gamble well hardly
needs to be mentioned. More than anything else, marketing strength has helped
Procter & Gamble to compete successfully with established companies in the
introduction of new products. In brief, the resources of a company help it toestablish and maintain itself in the marketplace. It is, of course, necessary forresources to be appraised objectively. It is the marketing power of big retailers
like Wal-Mart that forces magazine publishers to share advance copies of forthcoming issues with them. They then decide if a particular issue will be sold in
their stores. For example, Wal-Mart stores banned the April 1997 issue of Vibe, amagazine that focuses on rap music and urban culture, after viewing an early
print of its cover and deeming it too risqué. Similarly, Winn-Dixie supermarkets(a 1,186-store chain) refused to carry the March 1997 issue of Cosmopolitan (thenation’s best-selling monthly magazine in terms of newsstand sales) because
they judged it contained material that would be objectionable to many of theircustomers.24
Measurement of
Resources

A firm is a conglomerate of different entities, each having a number of variables
that affects performance. How far should a strategist probe into these variables
to designate the resources of the firm? Exhibit 3-5 is a list of possible strategic
factors. Not all of these factors are important for every business; attention
should be focused on those that could play a critical role in the success or failure of the particular firm. Therefore, the first step in designating resources is tohave executives in different areas of the business go through the list and identify those variables that they deem strategic for success. Then each strategic
factor may be evaluated either qualitatively or quantitatively. One way of conducting the evaluation is to frame relevant questions around each strategic
factor, which may be rated on either a dichotomous or a continuous scale. As an
example, the paragraphs that follow discuss questions relevant to a men’s
sportswear manufacturer.

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EXHIBIT 3-5
Strategic Factors in BusinessA.

General Managerial
1.
2.
3.
4.
5.
6.
7.

8.

9.
10.
11.
12.
13.
B.

Financial
1.

2.
3.
4.
5.
6.
7.

C.

Ability to attract and maintain high-quality top management
Ability to develop future managers for overseas operations
Ability to develop future managers for domestic operations
Ability to develop a better organizational structure
Ability to develop a better strategic planning program
Ability to achieve better overall control of company operations
Ability to use more new quantitative tools and techniques in decision making at
a. Top management levels
b. Lower management levels
Ability to assure better judgment, creativity, and imagination in decision
making at
a. Top management levels
b. Lower management levels
Ability to use computers for problem solving and planning
Ability to use computers for information handling and financial control
Ability to divest nonprofitable enterprises
Ability to perceive new needs and opportunities for products
Ability to motivate sufficient managerial drive for profits

Ability to raise long-term capital at low costa. Debt
b. Equity
Ability to raise short-term capital
Ability to maximize value of stockholder investment
Ability to provide a competitive return to stockholders
Willingness to take risks with commensurate returns in what appear to be excellent new business opportunities in order to achieve growth objectives
Ability to apply return on investment criteria to research and development
investments
Ability to finance diversification by means ofa. Acquisitions
b. In-house research and development

Marketing
1.
2.
3.
4.
5.
6.
7.
8.
9.

Ability to accumulate better knowledge about markets
Ability to establish a wide customer base
Ability to establish a selective consumer base
Ability to establish an efficient product distribution system
Ability to get good business contracts (government and others)
Ability to assure imaginative advertising and sales promotion campaigns
Ability to use pricing more effectively (including discounts, customer credit,
product service, guarantees, delivery, etc.)
Ability to develop better relationships between marketing and new productengineering and production
Ability to produce vigor in sales organization

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EXHIBIT 3-5
Strategic Factors in Business (continued)
D. Engineering and Production
1. Ability to develop effective machinery and equipment replacement policies
2. Ability to provide more efficient plant layout
3. Ability to develop sufficient capacity for expansion
4. Ability to develop better materials and inventory control
5. Ability to improve product quality control
6. Ability to improve in-house product engineering
7. Ability to improve in-house basic product research capabilities
8. Ability to develop more effective profit improvement (cost reduction) programs
9. Ability to develop better ability to mass produce at low per-unit cost
10. Ability to relocate present production facilities
11. Ability to automate production facilities
12. Ability to inspire better management of and better results from research anddevelopment expenditures
13. Ability to establish foreign production facilities
14. Ability to develop more flexibility in using facilities for different products
15. Ability to be in the forefront of technology and be extremely scientifically creativeE.

Products
1. Ability to improve present products
2. Ability to develop more efficient and effective product line selection
3. Ability to develop new products to replace old ones
4. Ability to develop new products in new markets
5. Ability to develop sales for present products in new markets
6. Ability to diversify products by acquisition
7. Ability to attract more subcontracting
8. Ability to get bigger share of product market

F.

Personnel
1. Ability to attract scientists and highly qualified technical employees
2. Ability to establish better relationships with employees
3. Ability to get along with labor unions
4. Ability to better utilize the skills of employees
5. Ability to motivate more employees to remain abreast of developments in theirfields6. Ability to level peaks and valleys of employment requirements
7. Ability to stimulate creativity in employees
8. Ability to optimize employee turnover (not too much and not too little)

G. Materials
1. Ability to get geographically closer to raw material sources
2. Ability to assure continuity of raw material supplies
3. Ability to find new sources of raw materials
4. Ability to own and control sources of raw materials
5. Ability to bring in house presently purchased materials and components
6. Ability to reduce raw material costs

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Top Management. Which executives form the top management? Which manager can be held responsible for the firm’s performance during the past few
years? Is each manager capable of undertaking future challenges as successfully
as past challenges were undertaken? Is something needed to boost the morale of
top management? What are the distinguishing characteristics of each top executive? Are there any conflicts, such as personality conflicts, among them? If so,
between whom and for what reasons? What has been done and is being done fororganizational development? What are the reasons for the company’s performance during the past few years? Are the old ways of managing obsolete? What
more can be done to enhance the company’s capabilities?
Marketing. What are the company’s major products/services? What are thebasic facts about each product (e.g., market share, profitability, position in thelife cycle, major competitors and their strengths and weaknesses, etc.)? In which
field can the firm be considered a leader? Why? What can be said about thefirm’s pricing policies (i.e., compared with value and with the prices of competitors)? What is the nature of new product development efforts, the coordination between research and development and manufacturing? How does themarket look in the future for the planning period? What steps are being taken
or proposed to meet future challenges? What can be said about the company’s
channel arrangements, physical distribution, and promotional efforts? What isthe behavior of marketing costs? What new products are expected to belaunched, when, and with what expectations? What has been done about consumer satisfaction?
Production. Are people capable of working on new machines, new processes,
new designs, etc., which may be developed in the future? What new plant, equipment, and facilities are needed? What are the basic facts about each product (e.g.,cost structure, quality control, work stoppages)? What is the nature of labor relations? Are any problems anticipated? What steps have been proposed or taken to
avert strikes, work stoppages, and so forth? Does production perform its part
effectively in the manufacturing of new products? How flexible are operations?
Can they be made suitable for future competition and new products well on theway to being produced and marketed commercially? What steps have been proposed or taken to control pollution? What are the important raw materials being
used or likely to be used? What are the important sources for each raw material?
How reliable are these sources?
Finance. What is the financial standing of the company as a whole and of itsdifferent products/divisions in terms of earnings, sales, tangible net worth, working capital, earnings per share, liquidity, inventory, cash flow position, and capital structure? What is the cost of capital? Can money be used more productively?
What is the reputation of the company in the financial community? How does thecompany’s performance compare with that of competitors and other similarly
sized corporations? What steps have been proposed or taken to line up new
sources of capital, to increase return on investment through more productive useof resources, and to lower break-even points? Has the company managed tax

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matters aggressively? What contingency steps are proposed to avert threats ofcapital shortage or a takeover?
Research and Development. What is the research and development reputation of the company? What percentage of sales and profits in the past can bedirectly attributed to research and development efforts? Are there any conflicts or
personality clashes in the department? If so, what has been proposed and what isbeing done? What is the status of current major projects? When are they expected
to be completed? In what way will they help the company’s performance? Whatkind of relationships does research and development have with marketing andmanufacturing? What steps have been proposed and are being taken to cut overhead and improve quality? Are all scientists/researchers adequately used? If not,why not? Can we expect any breakthroughs from research and development? Are
there any resentments? If so, what are they and for what reason do they exist?
Miscellaneous. What has been proposed or done to serve minorities, the community, the cause of education, and other such concerns? What is the nature of
productivity gains for the company as a whole and for each part of the company?
How does the company stand in comparison to industry trends and national
goals? How well does the company compete in the world market? Which countries/companies constitute tough competitors? What are their strengths andweaknesses? What is the nature and scope of the company’s public relations function? Is it adequate? How does it compare with that of competitors and othercompanies of similar size and character? Which government agencies—federal,state, or local—does the company deal with most often? Are the company’s relationships with various levels of government satisfactory? Who are the company’s
stockholders? Do a few individuals/institutions hold majority stock? What are
their corporate expectations? Do they prefer capital gains or dividend income?
Ratings on these questions may be added up to compute the total resource
score in each area. It must be understood that not all questions can be evaluatedusing the same scale. In many cases, quantitative measurement may be difficultand subjective evaluation must be accepted. Further, measurement of resources
should be done for current effectiveness and for future perspectives.
Strategic factors for success lie in different functional areas, the distribution
network, for example, and they vary by industry. As shown in Exhibit 3-6, thesuccess factors for different industries fall at different points along a continuumof functional activities that begins with raw materials sourcing and ends with servicing. In the uranium industry, raw materials sourcing is the key to successbecause low-quality ore requires much more complicated and costly processing.
Inasmuch as the price of uranium does not vary among producers, the choice ofthe source of uranium supply is the crucial determinant of profitability. In contrast, the critical factor in the soda industry is production technology. Because themercury process is more than twice as efficient as the semipermeable membrane
method of obtaining soda of similar quality, a company using the latter process is
at a disadvantage no matter what else it might do to reduce extra cost. In otherwords, the use of mercury technology is a strategic resource for a soda company

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EXHIBIT 3-6
Success Factors for Different Industries
Specimen Industries
Key Factor or Function

To Increase Profit

To Gain Share

Raw materials sourcing

Uranium

Petroleum

Product facilities(economies of scale)

Shipbuilding, steelmaking

Shipbuilding, steelmaking

DesignAircraft

Aircraft, hi-fi

Production technology

Soda, semiconductors

Semiconductors

Product range/variety

Department stores

Components

Application engineering/engineers

Minicomputers

Large-scale integration(LSI), microprocessors

Sales force(quality × quantity)

Electronic code recorders(ECR)

Automobiles

Distribution network

Beer

Films, home appliancesServicing

Elevators

Commercial vehicles(e.g., taxis)

Source: Kenichi Ohmae, The Mind of the Strategist (New York: McGraw-Hill Book Co., 1982): 47.

if its competitors have chosen not to go to the expense and difficulty of changing
over from the semipermeable membrane method.25

PAST PERFORMANCE OF BUSINESS UNITS
The past performance of business units serves as an important input in formulating corporate-wide strategy. It helps in the assessment of the current situation andpossible developments in the future. For example, if the profitability of an SBU
has been declining over the past five years, an appraisal of current performanceas satisfactory cannot be justified, assuming the trend continues. In addition, any
projected rise in profitability must be thoroughly justified in the light of thistrend. The perspectives of different SBUs over time, vis-à-vis other factors (topmanagement values, concerns of stakeholders, corporate resources, and thesocioeconomic-political-technological environment), show which have the potential for profitable growth.
SBU performance is based on such measures as financial strength (sales—
dollar or volume—operating profit before taxes, cash flow, depreciation, sales per
employee, profits per employee, investment per employee, return on investment/sales/assets, and asset turnover); human resources (use of employee skills,
productivity, turnover, and ethnic and racial composition); facilities (rated capacity, capacity utilization, and modernization); inventories (raw materials, finished

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products, and obsolete inventory); marketing (research and development expenditures, new product introductions, number of salespersons, sales per salesperson,
independent distributors, exclusive distributors, and promotion expenditures);international business (growth rate and geographic coverage); and managerial
performance (leadership capabilities, planning, development of personnel, anddelegation).
Usually the volume of data that the above information would generate ismuch greater than required. It is desirable, therefore, for management to specify
what measures it considers important in appraising the performance of SBUs.
From the viewpoint of corporate management, the following three measures are
frequently the principal measures of performance:
1. Effectiveness measures the success of a business’s products and programs in
relation to those of its competitors in the market. Effectiveness commonly is measured by such items as sales growth in comparison with that of competitors or bychanges in market share.
2. Efficiency is the outcome of a business’s programs in relation to the resources
employed in implementing them. Common measures of efficiency are profitability as a percentage of sales and return on investment.
3. Adaptability is the business’s success in responding over time to changing conditions and opportunities in the environment. Adaptability can be measured in avariety of ways, but common measures are the number of successful new productintroductions in relation to those of competitors and the percentage of sales
accounted for by products introduced within some recent time period.26

To ensure consistency in information received from different SBUs, it isworthwhile to develop a pro forma sheet listing the categories of information that
corporate management desires. The general profile produced from the evaluationof information obtained through pro forma sheets provides a quick picture of
how well things are going.

SUMMARY

Corporate appraisal constitutes an important ingredient in the strategy development process because it lays the foundation for the company to interact with the
future environment. Corporate publics, value orientation of top management,
and corporate resources are the three principal factors in appraisal discussed inthis chapter. Appraisal of the past performance of business units, which also
affects formulation of corporate strategy for the future, is covered briefly.
Corporate publics are all those groups having a stake in the organization; thatis, owners, employees, customers, suppliers, the banking community and other
lenders, government, the community in which the company does business, andsociety at large. Expectations of all stakeholders should be considered in formulating corporate strategy. Corporate strategy is also deeply influenced by thevalue orientation of the corporation’s top management. Thus, the values of top
management should be studied and duly assessed in setting objectives. Finally,
the company’s resources in different areas should be carefully evaluated. They
serve as major criteria for the formulation of future perspectives.

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DISCUSSIONQUESTIONS

NOTES

71

1. How often should a company undertake corporate appraisal? What are
the arguments for and against yearly corporate appraisal?
2. Discuss the pros and cons of having a consultant conduct the appraisal.
3. Identify five companies that in your opinion have failed to change with timeand have either pulled out of the marketplace or continue in it as laggards.
4. Identify five companies that in your opinion have kept pace with time as evidenced by their performance.
5. What expectations does a community have of (a) a bank, (b) a medical group,and (c) a manufacturer of cyclical goods?
6. What top management values are most likely to lead to a growth orientation?
7. Is growth orientation necessarily good? Discuss.
8. In your opinion, what marketing resources are the most critical for success inthe cosmetics industry?

Perspectives on Corporate Strategy (Boston: Boston Consulting Group, 1968): 93.
Donald P. Robin and R. Eric Reidenback, “Social Responsibility Ethics and Marketing
Strategy: Closing the Gap between Concept and Application,’’ Journal of Marketing(January 1987): 55.
3 Robin and Reidenbach, “Social Responsibility,’’ 52.
4 “Are Good Causes Good Marketing,” Business Week (21 March 1994): 64.
5 “The Battle for Corporate Control,’’ Business Week (18 May 1987): 102.
6 Robert F. Lusch and Gene R. Laczniak, “The Evolving Marketing Concept, Competitive
Intensity and Organizational Performance,’’ Journal of the Academy of Marketing
Science (Fall 1987): 10.
7 “Corning’s Class Act,’’ Business Week (13 May 1991): 76.
8 George A. Steiner, Top Management Planning (New York: Macmillan Co., 1969), 241.
9 Thomas J. Peters, “Putting Excellence into Management,’’ McKinsey Quarterly (Autumn1980): 37.
10 “Where Different Styles Have Led Two Canmakers,’’ Business Week (27 July 1981):
81–82. See also Bernard Wysocki, Jr., “The Chief’s Personality Can Have a Big Impact
for Better or Worse,’’ The Wall Street Journal (11 September 1984): 1.
11 Alex Taylor III, “Yo Ben! Yo Jerry! It’s Just Ice Cream!” Fortune, (28 April 1997): 374.
12 “Is It Rainforest Crunch Time?” Business Week, (15 July 1996): 70.
13 “Changing a Corporate Culture,’’ Business Week (14 May 1984): 130.
14 Brian Dumaine, “P&G Rewrites the Marketing Rules,’’ Fortune (6 November 1989): 34.
15 Mayron Magnet, “Let’s Go for Growth,” Fortune (7 March 1994): 70.
16 “Corporate Culture,’’ 34. See also Bro Uttal, “The Corporate Culture Vultures,’’ Fortune(17 October 1983): 66–73; Trish Hall, “Demanding Pepsi Company Is Attempting to
Make Work Nicer for Managers,’’ The Wall Street Journal (23 October 1984): 31.
17 Carol Hymowitz, “Which Corporate Culture Fits You?’’ The Wall Street Journal (17 July1989): B1.
18 Brian Dumaine, “Creating a New Company Culture,’’ Fortune (15 January 1990): 128.
19 David Kirkpatrick, “Could AT&T Rule the World,” Fortune (17 May 1993): 57.
20 Gordon W. Allport, Philip E. Vernon, and Gardner Lindzey, Study of Values and theManual of Study of Values (Boston: Houghton Mifflin Co., 1960).
21 B. F. Skinner, Beyond Freedom and Dignity (New York: Alfred A. Knopf, 1971).
1
2

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Aimee L. Horner, “Jack Hanley Got There by Selling Harder,’’ Fortune (November1976): 162.
23 “How a Winning Formula Can Fail,’’ Business Week (25 May 1981): 119–20.
24 G. Bruce Knecht, “Big Retail Chains Get Special Advance Looks at Magazine
Contents,” The Wall Street Journal (12 October 1997): A1.
25 Kenichi Ohmae, The Mind of the Strategist (New York: McGraw-Hill Book Co., 1982):
46–47.
26 Orville C. Walker, Jr. and Robert W. Ruekert, “Marketing’s Role in the Implementationof Business Strategies: A Critical Review and Conceptual Framework,” Journal ofMarketing (July 1987): 19.
22

4
CHAPTER FOUR

Understanding
Competition
The most complete andhappy victory is this: tocompel one’s enemy togive up his purpose,
while suffering no harm
oneself.
BELISARIUS

I

n a free market economy, each company tries to outperform its competitors. A
competitor is a rival. A company must know, therefore, how it stands up
against each competitor with regard to “arms and ammunition”—skill in maneuvering opportunities, preparedness in reacting to threats, and so on. To obtainadequate knowledge about the competition, a company needs an excellent intelligence network.
Typically, whenever one talks about competition, emphasis is placed on price,
quality of product, delivery time, and other marketing variables. For the purposes ofstrategy development, however, one needs to go far beyond these marketing tactics.
Simply knowing that a competitor has been lowering prices, for example, is not sufficient. Over and above that, one must know how much flexibility the competitor has infurther reducing the price. Implicit here is the need for information about the competitor’s cost structure.
This chapter begins by examining the meaning of competition. The theory ofcompetition is reviewed, and a scheme for classifying competitors is advanced.
Various sources of competitive intelligence are mentioned, and models for understanding competitive behavior are discussed. Finally, the impact of competition in
formulating marketing strategy is analyzed.
MEANING OF COMPETITION

The term competition defies definition because the view of competition held by different groups (e.g., lawyers, economists, government officials, and businesspeople) varies. Most firms define competition in crude, simplistic, and unrealistic
terms. Some firms fail to identify the true sources of competition; others underestimate the capabilities and reactions of their competitors. When the business climate is stable, a shallow outlook toward the competition might work, but in thecurrent environment, business strategies must be competitively oriented.
73

73

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Natural andStrategic
Competition

A useful way to define competition is to differentiate between natural and strategic competition. Natural competition refers to the survival of the fittest in a given
environment. It is an evolutionary process that weeds out the weaker of two
rivals. Applied to the business world, it means that no two firms doing businessacross the board the same way in the same market can coexist forever. To survive,
each firm must have something uniquely superior to the other.
Natural competition is an extension of the biological phenomenon of
Darwinian natural selection. Characteristically, this type of competition—evolution by adaptation—occurs by trial and error; is wildly opportunistic day to day;pursues growth for its own sake; and is very conservative, because growth fromsuccessful trials must prevail over death (i.e., bankruptcy) by random mistake.
Strategic competition is the studied deployment of resources based on a highdegree of insight into the systematic cause and effect in the business ecologicalsystem. It tries to leave nothing to chance. Strategic competition is a new phenomenon in the business world that may well have the same impact upon business productivity that the industrial revolution had upon individual productivity.
Strategic competition requires (a) an adequate amount of information about thesituation, (b) development of a framework to understand the dynamic interactive
system, (c) postponement of current consumption to provide investment capital,(d) commitment to invest major resources to an irreversible outcome, and (e) an
ability to predict the output consequences even with incomplete knowledge of
inputs. The following are the basic elements of strategic competition:• The ability to understand competitive interaction as a complete dynamic systemthat includes the interaction of competitors, customers, money, people, andresources.
• The ability to use this understanding to predict the consequences of a given intervention in the system and how that intervention will result in new patterns ofequilibrium.
• The availability of uncommitted resources that can be dedicated to different usesand purposes in the present even though the dedication is permanent and thebenefits will be deferred.
• The ability to predict risk and return with sufficient accuracy and confidence tojustify the commitment of such resources.
• The willingness to deliberately act to make the commitment.

Japan’s emergence as a major industrial power over a short span of time illustrates the practical application of strategic competition.
The differences between Japan and the U.S. deserve some comparative analysis. There
are lessons to be learned. These two leading industrial powers came from different
directions, developed different methods, and followed different strategies.
Japan is a small group of islands whose total land area is smaller than a number ofour 50 states. The U.S., by comparison, is a vast land.
Japan is mountainous with very little arable land. The U.S. is the world’s largest
and most fertile agricultural area in a single country.
Japan has virtually no energy or natural resources. The U.S. is richly endowed withenergy, minerals, and other vital resources.

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Japan has one of the oldest, most homogenous, most stable cultures. For 2,000 years
or more, there was virtually no immigration, no dilution of culture, or any foreigninvasion. The U.S. has been a melting pot of immigrants from many cultures andmany languages over one-tenth the time span. For most of its history, the U.S. has been
an agrarian society and a frontier society.
The Japanese developed a high order of skill in living together in cooperation overmany centuries. Americans developed a frontier mentality of self-reliance and individuality.
The evolution of the U.S. into a vast industrial society was a classic example of natural competition in a rich environment with no constraints or artificial barriers.
This option was not open to Japan. It had been in self-imposed isolation from therest of the world for several hundred years until Commodore Perry sailed into Tokyo
harbor and forced the signing of a navigation and trade treaty. Japan had been
unaware of the industrial revolution already well underway in the West. It decided tocompete in that world. But it had no resources.
To rise above a medieval economy, Japan had to obtain foreign materials. To
obtain foreign materials, it had to buy them. To buy abroad required foreign exchange.
To obtain foreign exchange, exports were required. Exports became Japan’s lifeline.
But effective exports meant the maximum value added, first with minimum material
and then with minimum direct labor. Eventually this led Japan from labor intensive tocapital intensive and then to technology intensive businesses. Japan was forced todevelop strategic business competition as part of national policy.1

THEORY OF COMPETITION
Competition is basic to the free enterprise system. It is involved in all observablephenomena of the market—the prices at which products are exchanged, the kinds
and qualities of products produced, the quantities exchanged, the methods of distribution employed, and the emphasis placed on promotion. Over many decades,
economists have contributed to the theory of competition. A well-recognizedbody of theoretical knowledge about competition has emerged and can begrouped broadly into two categories: (a) economic theory and (b) industrial organization perspective. These and certain other hypotheses on competition from theviewpoint of businesspeople will now be introduced.
Economic Theoryof Competition

Economists have worked with many different models of competition. Still central
to much of their work is the model of perfect competition, which is based on thepremise that, when a large number of buyers and sellers in the market are dealing in homogeneous products, there is complete freedom to enter or exit the market and everyone has complete and accurate knowledge about everyone else.

Industrial
Organization
Perspective

The essence of the industrial organization (IO) perspective is that a firm’s positionin the marketplace depends critically on the characteristics of the industry environment in which it competes. The industry environment comprises structure, conduct, and performance. Structure refers to the economic and technical perspectivesof the industry in the context in which firms compete. It includes (a) concentrationin the industry (i.e., the number and size distribution of firms), (b) barriers to entry

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in the industry, and (c) product differentiation among the offerings of different
firms that make up the industry. Conduct, which is essentially strategy, refers tofirms’ behavior in such matters as pricing, advertising, and distribution.
Performance includes social performance, measured in terms of allocative efficiency (profitability), technical efficiency (cost minimization), and innovativeness.
Following the IO thesis, the structure of each industry vis-à-vis concentration,
product differentiation, and entry barriers varies. Structure plays an importantrole in the competitive behavior of different firms in the market.
Businesspeople must be continually aware of the structure of the markets they arepresently in or of those they seek to enter. Their appraisal of their present and futurecompetitive posture will be influenced substantially by the size and concentration ofexisting firms as well as by the extent of product differentiation and the presence orabsence of significant barriers to entry.
If a manager has already introduced the firm’s products into a market, the existence of certain structural features may provide the manager with a degree of insulation from the intrusion of firms not presently in that market. The absence, or relative
unimportance, of one or more entry barriers, for example, supplies the manager withinsights into the direction from which potential competition might come. Conversely,
the presence or absence of entry barriers indicates the relative degree of effort required
and the success that might be enjoyed if the manager attempted to enter a specificmarket. In short, a fundamental purpose of marketing strategy involves the buildingof entry barriers to protect present markets and the overcoming of existing entry barriers around markets that have an attractive potential.2

Business
Viewpoint

From the businessperson’s perspective, competition refers to rivalry among firms
operating in a market to fill the same customer need. The businessperson’s majorinterest is to keep the market to himself or herself by adopting appropriate strategies. How and why competition occurs, its intensity, and what escape routes arefeasible have not been conceptualized.3 In other words, there does not exist a theory of competition from the business viewpoint.
In recent years, however, Henderson has developed the theory of strategiccompetition discussed above. Some of the hypotheses on which his theory rests
derive from military warfare:• Competitors who persist and survive have a unique advantage over all others. Ifthey did not have this advantage, then others would crowd them out of the market.
• If competitors are different and coexist, then each must have a distinct advantage
over the other. Such an advantage can only exist if differences in a competitor’s
characteristics match differences in the environment that give those characteristics their relative value.
• Any change in the environment changes the factor weighting of environmental
characteristics and, therefore, shifts the boundaries of competitive equilibriumand “competitive segments.’’ Competitors who adapt best or fastest gain anadvantage from change in the environment.4

Henderson presents an interesting new way of looking at the marketplace: asa battleground where opposing forces (competitors) devise ways (strategies) to77

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outperform each other. Some of his hypotheses can be readily observed, tested,and validated and could lead to a general theory of business competition.
However, many of his interlocking hypotheses must still be revised and tested.

CLASSIFYING COMPETITORS
A business may face competition from various sources either within or outside its
industry. Competition may come from essentially similar products or from substitutes. The competitor may be a small firm or a large multinational corporation.
To gain an adequate perspective on the competition, a firm needs to identify all
current and potential sources of competition.
Competition is triggered when different industries try to serve the same customer needs and demands. For example, a customer’s entertainment needs may
be filled by television, sports, publishing, or travel. New industries may also enter
the arena to satisfy entertainment needs. In the early 1980s, for example, the computer industry entered the entertainment field with video games.
Different industries position themselves to serve different customer
demands—existing, latent, and incipient. Existing demand occurs when a product is bought to satisfy a recognized need. An example is Swatch Watch to determine time. Latent demand refers to a situation where a particular need has beenrecognized, but no products have yet been offered to satisfy the need. Sonytapped the latent demand through Walkman for the attraction of “music on themove.” Incipient demand occurs when certain trends lead to the emergence of aneed of which the customer is not yet aware. A product that makes it feasible toread books while sleeping would illustrate the incipient demand.
A competitor may be an existing firm or a new entrant. The new entrant may
enter the market with a product developed through research and development or
through acquisition. For example, Texas Instruments entered the educational toy
business through research and development that led to the manufacture of their
Speak and Spell product. Philip Morris entered the beer market by acquiring
Miller Brewing Company.
Often an industry competes by producing different product lines. General
Foods Corporation, for example, offers ground, regular instant, freeze-dried,
decaffeinated, and “international” coffee to the coffee market. Product lines canbe grouped into three categories: a me-too product, an improved product, or abreakthrough product. A me-too product is similar to current offerings. One ofmany brands currently available in the market, it offers no special advantage overcompeting products. An improved product is one that, while not unique, is generally superior to many existing brands. A breakthrough product is an innovation and is usually technical in nature. The digital watch and the color television
set were once breakthrough products.
In the watch business, companies have traditionally competed by offering
me-too products. Occasionally, a competitor comes out with an improved product, as Seiko did in the 1970s by introducing quartz watches. Quartz watches
were a little fancier and supposedly more accurate than other watches. Texas

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Instruments, however, entered the watch business via a breakthrough product,
the digital watch.
Finally, the scope of a competing firm’s activities may be limited or extensive. For example, General Mills may not worry if a regional chain of Italianeateries is established to compete against its Olive Garden chain of Italianrestaurants. However, if McDonald’s were to start offering Italian food,
General Mills would be concerned at the entry of such a strong and seasoned
competitor.
Exhibit 4-1 illustrates various sources of competition available to fulfill theliquid requirements of the human body. Let us analyze the competition here for acompany that maintains an interest in this field. Currently, the thrust of the market is to satisfy existing demand. An example of a product to satisfy latentdemand would be a liquid that promises weight loss; a liquid to prevent aging
would be an example of a product to satisfy incipient demand.
The industries that currently offer products to quench customer thirst are
the liquor, beer, wine, soft drink, milk, coffee, tea, drinking water, and fruit juiceindustries. A relatively new entrant is mineral and sparkling water. Looking justat the soft drink industry, assuming that this is the field that most interests ourcompany, we see that the majority of competitors offer me-too products (e.g.,
regular cola, diet cola, lemonade, and other fruit-based drinks). However, caffeine-free cola has been introduced by two major competitors, Coca-Cola
Company and PepsiCo. There has been a breakthrough in the form of low-calorie, caffeine-free drinks. A beverage containing a day’s nutritional requirements
is feasible in the future.
The companies that currently compete in the regular cola market are CocaCola, PepsiCo, Seven-Up, Dr. Pepper, and a few others. Among these, however,the first two have a major share of the cola market. Among new industry entrants,
General Foods Corporation and Nestle Company are likely candidates (anassumption). The two principal competitors, Coca-Cola Company and PepsiCo,
are large multinational, multibusiness firms. This is the competitive arena where
our company will have to fight if it enters the soft drink business.

INTENSITY, OR DEGREE, OF COMPETITION
The degree of competition in a market depends on the moves and countermovesof various firms active in the market. It usually starts with one firm trying toachieve a favorable position by pursuing appropriate strategies. Because what isgood for one firm may be harmful to rival firms, rival firms respond with counter
strategies to protect their interests.
Intense competitive activity may or may not be injurious to the industry as awhole. For example, while a price war may result in lower profits for all membersof an industry, an advertising battle may increase demand and actually be mutually beneficial. Exhibit 4-2 lists the factors that affect the intensity of competitionin the marketplace. In a given situation, a combination of factors determines thedegree of competition.

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EXHIBIT 4-1
Source of Competition
Customer Need: Liquid for the Body
Existing need
Latent need
Incipient needThirstLiquid to reduce weight
Liquid to prevent aging

Industry Competition (How Can I Quench My Thirst?)
Existing industries

New industry

Hard liquor
Beer
Wine
Soft drink
Milk
CoffeeTea
Water
Mineral water

Product Line Competition (What Form of Product Do I Want?)
Me-too products

Improved productBreakthrough product

Regular cola
Diet cola
Lemonade
Fruit-based drink
Caffeine-free cola
Diet and caffeine-free cola providing full nutrition

Organizational Competition (What Brand Do I Want?)
Type of Firm
Existing firms

New entrants

Scope of Business
Geographic
Product/market

Opportunity
Potential

Coca-Cola
PepsiCo
Seven-Up
Dr. Pepper
General Foods
NestleRegional, national, multinational
Single versus multiproduct industry

A promising market is likely to attract firms seeking to capitalize on an available
opportunity. As the number of firms interested in sharing the pie increases, thedegree of rivalry increases. Take, for example, the home computer market. In theearly 1980s, everyone from mighty IBM to such unknowns in the field as Timex
Watch Company wanted a piece of the personal computer pie. As firms started

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EXHIBIT 4-2
Factors Contributing to Competitive Rivalry
Opportunity potential
Ease of entry
Nature of product
Exit barriers
Homogeneity of market
Industry structure or competitive position of firms
Commitment to the industry
Feasibility of technological innovations
Scale economies
Economic climate
Diversity of firms

jockeying for position, the intensity of competition increased manifold. A numberof firms, for example, Texas Instruments and Atari, were forced to quit the market. At the same time, new competitors such as Dell and Compaq entered themarket, undermining even IBM.
Ease of Entry

When entry into an industry is relatively easy, many firms, including some marginal ones, are attracted to it. The long-standing, committed members of theindustry, however, do not want “outsiders’’ to break into their territory. Therefore,
existing firms discourage potential entrants by adopting strategies that enhancecompetition.

Nature of Product

When the products offered by different competitors are perceived by customers
to be more or less similar, firms are forced into price and, to a lesser degree, service competition. In such situations, competition can be really severe.

Exit Barriers

For a variety of reasons, it may be difficult for a firm to get out of a particularbusiness. Possible reasons include the relationship of the business to other businesses of the firm, high investment in assets for which there may not be an advantageous alternative use, high cost of discharging commitments (e.g., fixed labor
contracts and future purchasing agreements), top management’s emotional
attachment to the business, and government regulations prohibiting exit (e.g., thelegal requirement that a utility must serve all customers).

Homogeniety of
the Market

When the entire market represents one large homogeneous unit, the intensity ofcompetition is much greater than when the market is segmented. Even if the
product sold is a commodity, segmentation of the market is possible. It is possible, for example, to identify frequent buyers of the commodity as one segment;
and occasional buyers as another. But if a market is not suited to segmentation,
firms must compete to serve it homogeneously, thus intensifying competition.

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Industry Structure

When the number of firms active in a market is large, there is a good chance that
one of the firms may aggressively seek an advantageous position. Such aggression leads to intense competitive activity as firms retaliate. On the other hand, if
only a few firms constitute an industry, there is usually little doubt about industry leadership. In situations where there is a clear industry leader, care is often
taken not to irritate the leader since a resulting fight could be very costly.

Commitment to
the Industry

When a firm has wholeheartedly committed itself to a business, it will do everything to hang on, even becoming a maverick that fearlessly makes moves withoutworrying about the impact on either the industry or its own resources. Polaroid
Corporation, for example, with its strong commitment to instant photography,
must maintain its position in the field at any cost. Another example is Gillette’s
commitment to the shaving business. Such an attachment to an industry enhancescompetitive activity.

Feasibility ofTechnologicalInnovations

In industries where technological innovations are frequent, each firm likes to do
its best to cash in while the technology lasts, thus triggering greater competitive
activity.

Scale Economies

Where economies realizable through large-scale operations are substantial, a firm
will do all it can to achieve scale economies. Attempts to capture scale economies
may lead a firm to aggressively compete for market share, escalating pressures onother firms. A similar situation occurs when a business’s fixed costs are high andthe firm must spread them over a large volume. If capacity can only be added inlarge increments, the resulting excess capacity will also intensify competition.
Consider the airlines industry. Northwest Airlines commands 73% of the traffic at Detroit Metropolitan Wayne County Airport, and it wants to keep it thatway by discouraging competitors. For example, a few years back, an upstart
Spirit Airlines entered the Detroit-Philadelphia market with one-way fare of $49,
while Northwest’s average one-way fare was more than $170. Northwest soon
slashed its fares to Philadelphia to $49 on virtually all seats at all times, and added
30% more seats. A few months later, Spirit abandoned the route and Northwest
raised its fare to more than $220.5

Economic Climate

During depressed economic conditions and otherwise slow growth, competition
is much more volatile as each firm tries to make the best of a bad situation.

Diversity of Firms

Firms active in a field over a long period come to acquire a kind of industry standard of behavior. But new participants invading an industry do not necessarily
like to play the old game. Forsaking industry patterns, newcomers may have different strategic perspectives and may be willing to go to any lengths to achieve
their goals. The Miller Brewing Company’s unconventional marketing practices
are a case in point. Miller, nurtured and guided by its parent, Philip Morris, segmented the market by introducing a light beer to an industry that had hitherto

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considered beer a commodity-type product. When different cultures meet in themarketplace, competition can be fierce.

COMPETITIVE INTELLIGENCE
Competitive intelligence is the publicly available information on competitors, current and potential, that serves as an important input in formulating marketing strategy. No general would order an army to march without first fully knowing theenemy’s position and intentions. Likewise, before deciding which competitive
moves to make, a firm must be aware of the perspectives of its competitors.
Competitive intelligence includes information beyond industry statistics and trade
gossip. It involves close observation of competitors to learn what they do best andwhy and where they are weak. No self-respecting business admits to not doing anadequate job of scanning the competitive environment, but what sets the outstanding companies apart from the merely self-respecting ones is that they watch theircompetition in such depth and with such dedication that, as a marketing executive
once remarked to the author, “The information on competitive moves reaches them
before even the management of the competing company learns about it.’’Three types of competitive intelligence may be distinguished: defensive, passive, and offensive intelligence. Defensive intelligence, as the name suggests, isgathered to avoid being caught off-balance. A deliberate attempt is made to gather
information on the competition in a structured fashion and to keep track of moves
that are relevant to the firm’s business. Passive intelligence is ad hoc information
gathered for a specific decision. A company may, for example, seek information on
a competitor’s sales compensation plan when devising its own compensation
plan. Finally, offensive intelligence is undertaken to identify new opportunities.
From a strategic perspective, offensive intelligence is the most relevant.
Strategic Usefulness
of Competitive
Intelligence

Such information as how competitors make, test, distribute, price, and promote
their products can go a long way in developing a viable marketing strategy. The
Ford Motor Company, for example, has an ongoing program for tearing down
competitors’ products to learn about their cost structure. Exhibit 4-3 summarizes
the process followed at Ford. This competitive knowledge has helped Ford in its
strategic moves in Europe. For example, from regularly tearing down the Leyland
Mini (a small truck), the company concluded that (a) Leyland was not making
money on the Mini at its current price and (b) Ford should not enter the small
truck market at current price levels. Based on these conclusions, Ford was able toarrive at a firm strategic decision not to assemble a “Mini.’’The following example compares two companies that decided to enter the
automatic dishwasher market at about the same time. One of the companies
ignored the competition, floundered, and eventually abandoned the field; theother did a superior job of learning from the competition and came out on top.
When the CEO of the first company, a British company, learned from his marketing department about the market growth potential for dishwashers and about current competitors’ shares, he lost no time setting out to develop a suitable machine.

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EXHIBIT 4-3
Ford Motor Company’s Competitive Product Tear-Down Process
1. Purchase the product. The high cost of product teardown, particularly for a carmaker,
gives some indication of the value successful competitors place on the knowledge
they gain.
2. Tear the product down—literally. First, every removable component is unscrewed or
unbolted; the rivets are undone; finally, individual spot welds are broken.
3. Reverse-engineer the product. While the competitor's car is being dismantled,detailed drawings of parts are made and parts lists are assembled, together withanalyses of the production processes that were evidently involved.
4. Build up costs. Parts are costed out in terms of make-or-buy, the variety of parts used
in a single product, and the extent of common assemblies across model ranges.
Among the important facts to be established in a product teardown, obviously, are thenumber and variety of components and the number of assembly operations. The costsof the processes are then built up from both direct labor requirements and overheads(often vital to an understanding of competitor cost structures).
5. Establish economies of scale. Once individual cost elements are known, they can be
put together with the volume of cars produced by the competitor and the total number of people employed to develop some fairly reliable guides to the competitor's
economies of scale. Having done this, Ford can calculate model-run lengths and volumes needed to achieve, first, break even and then profit.
Source: Robin Leaf, “How to Pick Up Tips from Your Competitors,” Director (February 1978): 60.

Finding little useful information available on dishwasher design, the directorof research and development decided to begin by investigating the basic mechanics of the dishwashing process. Accordingly, she set up a series of pilot projects toevaluate the cleaning performance of different jet configurations, the merits ofalternative washing-arm designs, and the varying results obtained with different
types and quantities of detergent on different washing loads. At the end of a year
she had amassed a great deal of useful knowledge. She also had a pilot machinerunning that cleaned dishes well and a design concept for a production version.
But considerable development work was still needed before the prototype could
be declared a satisfactory basis for manufacture.
To complicate matters, management had neglected to establish effective linkages among the company’s three main functions—marketing, technology, andproduction. So it was not until the technologists had produced the prototype anddesign concepts that marketing and production began asking for revisions andsuggesting new ideas, further delaying the development of a marketable product.
So much for the first company, with its fairly typical traditional response tomarket opportunities. The second company, which happened to be Japanese,started with the same marketing intelligence but responded in a very different
fashion.
First, it bought three units of every available competitive dishwasher. Next,
management formed four special teams: (a) a product test group of marketingand technical staff, (b) a design team of technologists and production people, (c)84Understanding Competition

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a distribution team of marketing and production staff, and (d) a field team ofproduction staff.
The product test group was given one of each competitive model and asked
to evaluate performance: dishwashing effectiveness, ease of use, and reliability(frequency and cause of breakdown). The remaining two units of each competitive model were given to the design team, who stripped down one of each pair todetermine the number and variety of parts, the cost of each part, and the ease of
assembly. The remaining units were stripped down to “life-test’’ each component,
to identify design improvements and potential sources of supply, and to develop
a comprehensive picture of each competitor’s technology. Meanwhile, the distribution team was evaluating each competitor’s sales and distribution system(numbers of outlets, product availability, and service offered), and the field team
was investigating competitors’ factories and evaluating their production facilities
in terms of cost of labor, cost of supplies, and plant productivity.
All this investigating took a little less than a year. At the end of that time, theJapanese still knew a lot less about the physics and chemistry of dishwashing
than their British rivals, but the knowledge developed by their business teams
had put them far ahead. In two more months they had designed a product that
outperformed the best of the competition, yet would cost 30 percent less to build,based on a preproduction prototype and production process design. They also
had a marketing plan for introducing the new dishwasher to the Japanese domestic market before taking it overseas. This plan positioned the product relative tothe competition and defined distribution system requirements in terms of stocking and service levels needed to meet the expected production rate. Finally, theJapanese had prepared detailed plans for building a new factory, establishingsupply contracts, and training the labor force.
The denouement of this story is what one might expect: The competitive
Japanese manufacturer brought its new product to market two years ahead of themore traditionally minded British manufacturer and achieved its planned market
share 10 weeks later. The traditional company steadily lost money and eventually
dropped out of the market.
As the above anecdote shows, competitive analysis has three major objectives:
1. It allows you to understand your position of comparative advantage and yourcompetitors’ positions of comparative advantage.
2. It allows you to understand your competitors’ strategies—past, present, and as
they are likely to be in the future.
3. It is a key criterion of strategy selection, the element that makes your strategies
come alive in the real world.

GatheringCompetitive
Intelligence

Knowledge about the competition may be gained by raising the following questions. To answer each question requires systematic probing and data gathering on
different aspects of competition.
• Who is the competition? now? five years from now?
• What are the strategies, objectives, and goals of each major competitor?

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85• How important is a specific market to each competitor and what is the level of its
commitment?
• What are the relative strengths and limitations of each competitor?
• What weaknesses make competitors vulnerable?
• What changes are competitors likely to make in their future strategies?
• So what? What will be the effects of all competitors’ strategies, on the industry,
the market, and our strategy?

Essentially, knowledge about competitors comprise their size, growth, andprofitability, the image and positioning of their brands, objectives and commitments, strengths and weaknesses, current and past strategies, cost structure, exit
barriers limiting their ability to withdraw, and organization style and culture.
The following procedure may be adopted to gather competitive intelligence:
1. Recognize key competitors in market segments in which the company is active.
Presumably a product will be positioned to serve one or more market segments.
In each segment there may be different competitors to reckon with; an attemptshould be made to recognize all important competitors in each segment. If thenumber of competitors is excessive, it is sufficient to limit consideration to thefirst three competitors. Each competitor should be briefly profiled to indicate total
corporate proportion.
2. Analyze the performance record of each competitor. The performance of a competitor can be measured with reference to a number of criteria. As far as marketing
is concerned, sales growth, market share, and profitability are the important measures of success. Thus, a review of each competitor’s sales growth, market share,and profitability for the past several years is desirable. In addition, any ad hoc reasons that bear upon a competitor’s performance should be noted. For example, acompetitor may have lined up some business, in the nature of a windfall from
Kuwait, without making any strategic moves to secure the business. Similar missteps that may limit performance should be duly pointed out. Occasionally a competitor may intentionally pad results to reflect good performance at year end. Suchtactics should be noted, too. Rothschild advises the following:
To make it really useful, you must probe how each participant keeps its books
and records its profits. Some companies stress earnings; others report theircondition in such a way as to delay the payment of taxes; still other bookkeep
to increase cash availability.
These measurements are important because they may affect the company’s
ability to procure financing and attract people as well as influence stockholders’ and investors’ satisfaction with current management.6
3. Study how satisfied each competitor appears to be with its performance. Referto each competitor’s objective(s) for the product. If results are in concert with the
expectations of the firm’s management and stakeholders, the competitor will besatisfied. A satisfied competitor is most likely to follow its current successful
strategy. On the other hand, if results are at odds with management expectations,the competitor is most likely to come out with a new strategy.
4. Probe each competitor’s marketing strategy. The strategy of each competitor
can be inferred from game plans (i.e., different moves in the area of product,
price, promotion, and distribution) that are pursued to achieve objectives.

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Information on game plans is available partly from published stories on thecompetitor and partly from the salespeople in contact with the competitor’s customers and salespeople.
To clarify the point, consider a competitor in the small appliances business
who spends heavily for consumer advertising and sells products mainly throughdiscount stores. From this brief description, it is safe to conclude that, as a matterof strategy, the competitor wants to establish the brand in the mass market
through discounters. In other words, the competitor is trying to reach customers
who want to buy a reputable brand at discount prices and hopes to make moneyby creating a large sales base.
5. Analyze current and future resources and competencies of each competitor. In
order to study a competitor’s resources and competencies, first designate broad
areas of concern: facilities and equipment, personnel skills, organizational capabilities, and management capabilities, for example. Refer to the checklist in
Exhibit 4-4. Each area may then be examined with reference to different functional areas (general management, finance, research and development, operations, and especially marketing). In the area of finance, the availability of a large
credit line would be listed as a strength under management capabilities. Owninga warehouse and refrigerated trucks is a marketing strength listed under facilities
and equipment. A checklist should be developed to specifically pinpoint thosestrengths that a competitor can use to pursue goals against your firm as well asother firms in the market. Simultaneously, areas in which competitors look particularly vulnerable should also be noted. The purpose here is not to get involved ina ritualistic, detailed account of each competitor but to demarcate those aspects ofa competitor’s resources and competencies that may account for a substantial difference in performance.
6. Predict the future marketing strategy of each competitor. The above competitive
analysis provides enough information to make predictions about future strategic
directions that each competitor may pursue. Predictions, however, must be madequalitatively, using management consensus. The use of management consensus as
the basic means for developing forecasts is based on the presumption that, by
virtue of their experience in gauging market trends, executives should be able to
make some credible predictions about each competitor’s behavior in the future. A
senior member of the marketing research staff may be assigned the task of soliciting executive opinions and consolidating the information into specific predictions
on the moves competitors are likely to make.
7. Assess the impact of competitive strategy on the company’s product/market.
The delphi technique, examined in Chapter 12, can be used to specify the impact
of competitive strategy. The impact should be analyzed by a senior marketing
personnel, using competitive information and personal experiences on the job asa basis. Thereafter, the consensus of a larger group of executives can be obtainedon the impact analysis performed previously.

Sources ofCompetitive
Information

Essentially, three sources of competitive intelligence can be distinguished: (a) whatcompetitors say about themselves, (b) what others say about them, and (c) what
employees of the firm engaged in competitive analysis have observed and learned
about competitors. Information from the first two sources, as shown in Exhibit
4-5, is available through public documents, trade associations, government, andEXHIBIT 4-4
Source of Economic Leverage in the Business System
Facilities and Equipment
1. General Mgmt.
2. Finance3. R&D
4. Operations
5. Marketing

Personnel Skills

Organizational Capabilities

Management Capabilities
Large credit line

Warehousing

Door-to-door selling

Direct sales

Industrial marketing

Retail outlets

Retail selling

Distributor chain

Customer purchasing

Sales offices

Wholesale selling

Retail chain

Service offices

Direct industry selling

Transportation equipment

Department of Defense
selling

Consumer service organization

Department of Defense
marketingTraining facilities forsales staff

Cross-industry selling

Data processing equipment

Applications engineering
Advertising
Sales promotion

Contract administration

Department of Defense
product support
Inventory distribution
and control
Ability to make quick
response to customer
requirements

Forecasting

Loyal set of customers

Computer modeling

Cordial relations withmedia and channels

Product planning
Background of people

Flexibility in all phasesof corporate life

Corporate culture

Consumer financing
Discount policy

Large customer baseDecentralized control
Favorable public image
Future orientation
Ethical standards

Teamwork
87

Product quality

Understanding Competition

Data analysis

Ability to adapt tosociopolitical upheavals
in the marketplace

Sales analysis

Well-informed andreceptive management

CHAPTER 4 Understanding Competition

Servicing

Industrial service organization

State and municipality
marketing87

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EXHIBIT 4-5
Sources of Competitive Intelligence
Public

Trade
Professionals

What competitors
say about themselves• Advertising• Promotional
materials• Press releases• Speeches• Books• Articles• Personnel
changes• Want ads

•
•
•
•
•
•

What others say
about them

•
•
•
•
•

• Suppliers/
vendors• Trade press• Industry study• Customers• Subcontractors

•
•
•
•

Books
ArticlesCase studies
Consultants
Newspaper
reporters
EnvironmentalgroupsConsumergroups“Who’s Who”
Recruiting firms

Manuals
Technical papers
Licenses
Patents
Courses
Seminars

Government

Investors• SEC reports• FIC• Testimony• Lawsuits• Antitrust• Annual meetings• Annual reports• Prospectors• Stock/bondissues• Lawsuits• Antitrust• State/federal
agencies• National plans• Government
programs• Security analyst
reports• Industry studies• Credit reports

investors. Take, for example, information from government sources. Under theFreedom of Information Act, a great amount of information can be obtained at low
cost.
As far as information from its own sources is concerned, the company should
develop a structured program to gather competitive information. First, a teardown program like Ford’s (Exhibit 4-3) may be undertaken. Second, salespeople
may be trained to carefully gather and provide information on the competition,using such sources as customers, distributors, dealers, and former salespeople.
Third, senior marketing people should be encouraged to call on customers andspeak to them indepth. These contacts should provide valuable information oncompetitors’ products and services. Fourth, other people in the company who
happen to have some knowledge of competitors should be encouraged to channel this information to an appropriate office.
Information gathering on the competition has grown dramatically in recent
years. Almost all large companies designate someone specially to seek competitive intelligence. A Fortune article has identified more than 20 techniques to keeptabs on the competition. These techniques, summarized below, fall into sevengroups. Virtually all of them can be legally used to gain competitive insights,

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although some may involve questionable ethics. A responsible company shouldcarefully review each technique before using it to avoid practices that might beconsidered illegal or unethical.
1. Gathering information from recruits and employees of competing companies.
Firms can collect data about their competitors through interviews with new
recruits or by speaking with employees of competing companies. According to
the Fortune article:
When they interview students for jobs, some companies pay special attention to
those who have worked for competitors, even temporarily. Job seekers are eager
to impress and often have not been warned about divulging what is proprietary.
They sometimes volunteer valuable information. . . . Several companies now
send teams of highly trained technicians instead of personnel executives torecruit on campus.
Companies send engineers to conferences and trade shows to question competitors’ technical people. Often conversations start innocently—just a few fellow technicians discussing processes and problems . . . [yet competitors’]
engineers and scientists often brag about surmounting technical challenges, inthe process divulging sensitive information.
Companies sometimes advertise and hold interviews for jobs that don’t exist
in order to entice competitors’ employees to spill the beans. . . . Often applicants
have toiled in obscurity or feel that their careers have stalled. They’re dying toimpress somebody.
In probably the hoariest tactic in corporate intelligence gathering, companies
hire key executives from competitors to find out what they know.
2. Gathering information from competitors’ customers. Some customers may giveout information on competitors’ products. For example, a while back Gillette told alarge Canadian account the date on which it planned to begin selling its new Good
News disposable razor in the United States. The Canadian distributor promptly
called Bic about Gillette’s impending product launch. Bic put on a crash program
and was able to start selling its razor shortly after Gillette introduced its own.
3. Gathering information by infiltrating customers’ business operations.
Companies may provide their engineers free of charge to customers. The close,
cooperative relationship that engineers on loan cultivate with the customer’s staff
often enables them to learn what new products competitors are pitching.
4. Gathering information from published materials and public documents. What
may seem insignificant, a help wanted ad, for example, may provide information
about a competitor’s intentions or planned strategies. The types of people soughtin help wanted ads can indicate something about a competitor’s technologicalthrusts and new product development. Government agencies are another goodsource of information.
5. Gathering information from government agencies under the Freedom of Information Act. Some companies hire others to get this information more discreetly.
6. Gathering information by observing competitors or by analyzing physical evidence. Companies can get to know competitors better by buying their products
or by examining other physical evidence. Companies increasingly buy competitors’ products and take them apart to determine costs of production and evenmanufacturing methods.

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In the absence of better information on market share and the volume of productbeing shipped, companies have measured the rust on the rails of railroad sidings totheir competitors’ plants and have counted tractor-trailers leaving loading bays.
7. Gathering information from competitors’ garbage. Some firms actually purchasesuch garbage. Once it has left a competitor’s premises, refuse is legally considered abandoned property. Although some companies shred paper generated bytheir design labs, they often neglect to shred almost-as-revealing refuse from marketing and public relations departments.7

Organization forCompetitive
Intelligence

Competitive, or business, intelligence is a powerful new management tool thatenhances a corporation’s ability to succeed in today’s highly competitive global
markets. It provides early warning intelligence and a framework for better understanding and countering competitors’ initiatives. Competitive activities can bemonitored in-house or assigned to an outside firm. A recent study indicates thatover 500 U.S. firms are involved or interested in running their own competitive
intelligence activities.8 Usually, companies depend partly on their own people
and partly on external help to scan the competitive environment.
Within the organization, competitive information should be acquired both at
the corporate level and at the SBU level. At the corporate level, competitive intelligence is concerned with competitors’ investment strengths and priorities. At the
SBU level, the major interest is in marketing strategy, that is, product, pricing, distribution, and promotion strategies that a competitor is likely to pursue. The true
payoff of competitive intelligence comes from the SBU review.
Organizationally, the competitive intelligence task can be assigned to an SBU
strategic planner, to a marketing person within the SBU who may be a marketing
research or a product/market manager, or to a staff person. Whoever is given thetask of gathering competitive intelligence should be allowed adequate time andmoney to do a thorough job.
As far as outside help is concerned, three main types of organizations may be
hired to gather competitive information. First, many marketing research firms(e.g., A.C. Nielsen, Frost and Sullivan, SRI International, Predicasts) provide different types of competitive information, some on a regular basis and others on an
ad hoc arrangement. Second, clipping services scan newspapers, financial journals, trade journals, and business publications for articles concerning designatedcompetitors and make copies of relevant clippings for their clients. Third, different brokerage firms specialize in gathering information on various industries.
Arrangements may be made with brokerage firms to have regular access to theirinformation on a particular industry.

SEEKING COMPETITIVE ADVANTAGE
To outperform competitors and to grow despite them, a company must understand why competition prevails, why firms attack, and how firms respond.
Insights into competitors’ perspectives can be gained by undertaking two typesof analysis: industry and comparative analysis. Industry analysis assesses the91

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91

attractiveness of a market based on its economic structure. Comparative analysis
indicates how every firm in a particular market is likely to perform, given the
structure of the industry.
Industry Analysis

Every industry has a few peculiar characteristics. These characteristics are boundby time and thus are subject to change. We may call them the dynamics of theindustry. No matter how hard a company tries, if it fails to fit into the dynamics
of the industry, ultimate success may be difficult to achieve.
An example of how the perspectives of an entire industry may change overtime is provided by the cosmetics industry. The cosmetics business was traditionally run according to personal experience and judgment, by the seat-of-thepants, so to speak, with ultimate dependence on the marketing genius of
inventors. In the 1980s, a variety of pressures began to engulf the industry. The
regulatory climate became tougher. Consumers have become more demanding
and are fewer in number. Although the number of working women continues torise, this increase has not offset another more significant demographic change:
The population of teenagers—traditionally the heaviest and most experimental
makeup users—has been declining. In 1995, there were 15 percent fewer 18- to
24-year-olds than in 1985. As a result, sales of cosmetics are projected to increase
only about 2.5 percent per year to the year 2000. These shifts, along with unstable economic conditions and rising costs, have made profits smaller. In the 1980s,
several pharmaceutical and packaged-goods companies, including ColgatePalmolive Co., Eli Lilly and Co., Pfizer, and Schering Plough, acquired cosmetics
companies. Among these, only Schering Plough, which makes the mass market
Maybelline, has maintained a meaningful business. Colgate, which acquired
Helena Rubenstein, sold the brand seven years later after it languished. At thestart of the 1990s, the industry began to change again. New mass marketers
Procter & Gamble and Unilever entered the arena, bringing with them their great
experience producing mundane products such as soap and toilet paper, sparking
disdain in the glamorous cosmetics trade. However, the mammoth marketing
clout of these giant packaged-goods companies also sparked fear. Procter &Gamble bought Noxell Corporation, producer of Cover Girl and Clarion
makeup, making it the top marketer of cosmetics in mass market outlets.
Unilever acquired Faberge and Elizabeth Arden.9
These changes made competition in the industry fierce. Although capital
investment in the industry is small, inventory and distribution costs are
extremely high, partly because of the number of shades and textures required ineach product line. For example, nail polish and lipstick must be available in morethan 50 different shades.
The cosmetics industry has gone through a tremendous change since the1980s. In those days, success in the industry depended on having a glamorous
product. As has been observed, Revlon was manufacturing lipstick in its factories, but it was selling beautiful lips. Today, however, success rests on such nutsand-bolts matters as sharp positioning to serve a neatly defined segment andsecuring distribution to achieve specific objectives in sales, profit, and market

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share.10 Basic inventory and financial controls, budgeting, and planning are
now utilized to the fullest extent to cut costs and waste: “In contrast to theglitzy, intuitive world of cosmetics, Unilever and P&G are the habitats of organization men in grey-flannel suits. Both companies rely on extensive market
research.”11 This type of shift in direction and style in an industry has important
ramifications for marketing strategy.
The dynamics of an industry may be understood by considering the following factors:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.

Scope of competitors’ businesses (i.e., location and number of industries).
New entrants in the industry.
Other current and potential offerings that appear to serve similar functions or
satisfy the same need.
Industry’s ability to raise capital, attract people, avoid government probing, andcompete effectively for consumer dollars.
Industry’s current practices (price setting, warranties, distribution structure,
after-sales service, etc.).
Trends in volume, costs, prices, and return on investment, compared with otherindustries.
Industry profit economics (the key factors determining profits: volume, materials, labor, capital investment, market penetration, and dealer strength).
Ease of entry into the industry, including capital investment.
Relationship between current and future demand and manufacturing capacity
and its probable effects on prices and profits.
Effect of integration, both forward and backward.
Effect of cyclical swings in the relationship between supply and demand.

To formulate marketing strategy, a company should determine the relevanceof each of these factors in its industry and the position it occupies with respect tocompetitors. An attempt should be made to highlight the dynamics of the company in the industry environment.
Porter’s Model ofIndustry Structure
Analysis

Conceptual framework for industry analysis has been provided by Porter. He
developed a five-factor model for industry analysis, as shown in Exhibit 4-6. The
model identifies five key structural features that determine the strength of thecompetitive forces within an industry and hence industry profitability.
As shown in this model, the degree of rivalry among different firms is a function of the number of competitors, industry growth, asset intensity, product differentiation, and exit barriers. Among these variables, the number of competitors
and industry growth are the most influential. Further, industries with high fixed
costs tend to be more competitive because competing firms are forced to cut priceto enable them to operate at capacity. Differentiation, both real and perceived,among competing offerings, however, lessens rivalry. Finally, difficulty of exitfrom an industry intensifies competition.
Threat of entry into the industry by new firms is likely to enhance competition.
Several barriers, however, make it difficult to enter an industry. Two cost-related
entry barriers are economies of scale and absolute cost advantage. Economies of93

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EXHIBIT 4-6
Porter’s Model of Industry Competition

Source: Michael E. Porter, “Industry Structure and Competitive Strategy: Keys to Profitablility,” Financial Analysis Journal(July–August 1980): 33.

scale require potential entrants either to establish high levels of production or toaccept a cost disadvantage. Absolute cost advantage is enjoyed by firms with proprietary technology or favorable access to raw materials and by firms with production experience. In addition, high capital requirements, high switching costs(i.e., the cost to a buyer of changing suppliers), product differentiation, limitedaccess to distribution channels, and government policy can act as entry barriers.
A substitute product that serves essentially the same function as an industry
product is another source of competition. Since a substitute places a ceiling on theprice that firms can charge, it affects industry potential. The threat posed by a

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substitute also depends on its long-term price/performance trend relative to theindustry’s product.
Bargaining power of buyers refers to the ability of the industry’s customers toforce the industry to reduce prices or increase features, thus bidding away profits. Buyers gain power when they have choices—when their needs can be met bya substitute product or by the same product offered by another supplier. In addition, high buyer concentration, the threat of backward integration, and low
switching costs add to buyer power.
Bargaining power of suppliers is the degree to which suppliers of the industry’s raw materials have the ability to force the industry to accept higher prices or
reduced service, thus affecting profits. The factors influencing supplier power are
the same as those influencing buyer power. In this case, however, industry members act as buyers.
These five forces of competition interact to determine the attractiveness of anindustry. The strongest forces become the dominant factors in determining industry profitability and the focal points of strategy formulation, as the following
example of the network television industry illustrates. Government regulations,which limited the number of networks to three, have had a great influence on the
profile of the industry. This impenetrable entry barrier created weak buyers(advertisers), weak suppliers (writers, actors, etc.), and a very profitable industry.
However, several exogenous events are now influencing the power of buyers andsuppliers. Suppliers have gained power with the advent of cable televisionbecause the number of customers to whom artists can offer their services has
increased rapidly. In addition, as cable television firms reduce the size of the network market, advertisers may find substitute advertising media more costeffective. In conclusion, while the industry is still very attractive and profitable,
the changes in its structure imply that future profitability may be reduced.
A firm should first diagnose the forces affecting competition in its industry
and their underlying causes and then identify its own strengths and weaknesses
relative to the industry. Only then should a firm formulate its strategy, whichamounts to taking offensive or defensive action in order to achieve a secure position against each of the five competitive forces.12 According to Porter, this involves• Positioning the firm so that its capabilities provide the best defense against theexisting array of competitive forces.
• Influencing the balance of forces through strategic moves, thereby improving thefirm’s relative position.
• Anticipating shifts in the factors underlying the forces and responding to them,
hopefully exploiting change by choosing a strategy appropriate to the new competitive balance before rivals recognize it.13

Take, for example, the U.S. blue jeans industry. In the 1970s most firms
except for Levi Strauss and Blue Bell, maker of Wrangler Jeans, took low profits.
The situation can be explained with reference to industry structure (see Exhibit4-7). The extremely low entry barriers allowed almost 100 small jeans manufacturers to join the competitive ranks; all that was needed to enter the industry was95

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95

EXHIBIT 4-7
Structure of Blue Jeans Industry

Source: Ennlus E. Bergsma, “In Strategic Phase, Line Management Needs Business’s Research, Not
Market Research,” Marketing News (21 January 1983): 22.

some equipment, an empty warehouse, and some relatively low-skilled labor. Allsuch firms competed on price.
Further, these small firms had little control over raw materials pricing. The
production of denim is in the hands of about four major textile companies. No
one small blue jeans manufacturer was important enough to affect supplier prices
or output; consequently, jeans makers had to take the price of denim or leave it.
Suppliers of denim had strong bargaining power. Store buyers also were in astrong bargaining position. Most of the jeans sold in the United States were handled by relatively few buyers in major store chains. As a result, a small manufacturer basically had to sell at the price the buyers wanted to pay, or the buyers
could easily find someone else who would sell at their price.
But then along came Jordache. Creating designer jeans with heavy up-front
advertising, Jordache designed a new way to compete that changed industry forces.
First, it significantly lowered the bargaining power of its customers (i.e., store buyers) by creating strong consumer preference. The buyer had to meet Jordache’s
price rather than the other way around. Second, emphasis on the designer’s namecreated significant entry barriers. In summary, Jordache formulated a strategy that96

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neutralized many of the structural forces surrounding the industry and gave itself
a competitive advantage.
Comparative
Analysis

Comparative analysis examines the specific advantages of competitors within agiven market. Two types of comparative advantage may be distinguished: structural and response. Structural advantages are those advantages built into thebusiness. For example, a manufacturing plant in Indonesia may, because of low
labor costs, have a built-in advantage over another firm. Responsive advantages
refer to positions of comparative advantage that have accrued to a business overtime as a result of certain decisions. This type of advantage is based on leveraging the strategic phenomena at work in the business.
Every business is a unique mixture of strategic phenomena. For example, inthe soft drink industry a unit of investment in advertising may lead to a unit ofmarket share. In contrast, the highest-volume producer in the electronics industry is usually the lowest-cost producer. In industrial product businesses, up to apoint, sales and distribution costs tend to decline as the density of sales coverage(the number of salespeople in the field) increases. Beyond this optimum point,
costs tend to rise dramatically. However, cost is only one way of achieving a competitive advantage. A firm may explore issues beyond cost to score over competition. For example, a company may find that distribution through authorized
dealers gives it competitive leverage. Another company may find product differentiation strategically more desirable.
In order to survive, any company, regardless of size, must be different in oneof two dimensions. It must have lower costs than its direct head-to-head competitors, or it must have unique values for which its customers will pay more.
Competitive distinctiveness is essential to survival. Competitive distinctivenesscan be achieved in different ways: (a) by concentrating on particular market segments, (b) by offering products that differ from rather than mirror competingproducts, (c) by using alternative distribution channels and manufacturing
processes, and (d) by employing selective pricing and fundamentally different
cost structures. An analytical tool that may be used by a company seeking a position of competitive advantage/distinction is the business-system framework.
Examination of the business system operating in an industry is useful in analyzing competitors and in searching out innovative options for gaining a sustainable competitive advantage. The business-system framework enables a firm to
discover the sources of greatest economic leverage, that is, stages in the system
where it may build cost or investment barriers against competitors.14 The framework may also be used to analyze a competitor’s costs and to gain insights into
the sources of a competitor’s current advantage in either cost or economic value
to the customer.
Exhibit 4-8 depicts the business system of a manufacturing company. At eachstage of the system—technology, product design, manufacturing, and so on—acompany may have several options. These options are often interdependent. For
example, product design will partially constrain the choice of raw materials.
Likewise, the perspectives of physical distribution will affect manufacturing

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EXHIBIT 4-8
Business System of a Manufacturing Company

Source: Roberto Buaron, “New-Game Strategies,” The McKinsey Quarterly (Spring 1981): 34. Reprinted by permission of the publisher. Also, “How to Win the Market-Share Game? Try Changing the Rules.” Reprinted by permission of the publisher, fromManagement Review (January 1981) © 1981. American Management Association, New York. All rights reserved.

capacity and location and vice versa. At each stage, a variety of questions may byraised, the answers to which provide insights into the strategic alternatives acompany may consider: How are we doing this now? How are our competitors
doing it? What is better about their way? About ours? How else might it be done?
How would these options affect our competitive position? If we change what weare doing at this stage, how would other stages be affected? Answers to thesequestions reveal the sources of leverage a business may employ to gain competitive advantage (see Exhibit 4-9).
The use of the business-system framework can be illustrated with reference
to Savin Business Machines Corporation.15 In 1975, this company with revenues
of $63 million was a minor factor in the U.S. office copier market. The market was
obviously dominated by Xerox, whose domestic copier revenues were approaching $2 billion. At that time, Xerox accounted for almost 80 percent of plain-paper
copiers in the United States. In November 1975, Savin introduced a plain-paper
copier to serve customers who wanted low- and medium-speed machines (i.e.,
those producing fewer than 40 copies per minute). Two years later, Savin’sannual revenues passed $200 million; the company had captured 40 percent of all
new units installed in the low-end plain-paper copier market in the UnitedStates. Savin managed to earn a 64 percent return on equity while maintaining a
conservative 27 percent debt ratio. In early 1980s, its sales surpassed $470 million,
selling more copiers in the United States than any other company.16 Meanwhile

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EXHIBIT 4-9
Sources of Economic Leverage in the Business System

Source: Roberto Buaron, “New-Game Strategies,” The McKinsey Quarterly (Spring 1981): 35. Reprinted by permission of the publisher. Also, “How to Win the Market-Share Game? Try Changing the Rules.” Reprinted by permission of the publisher, fromManagement Review (January 1981) © 1981. American Management Association, New York. All rights reserved.

Xerox, which in 1974 had accounted for more than half of the low-end market,
saw its share shrink to 10 percent in 1978. What reasons may be ascribed to
Savin’s success against mighty Xerox? Through careful analysis of the plainpaper copier business system, Savin combined various options at different stagesof the system to develop a competitive advantage to successfully confront Xerox.
As shown in Exhibit 4-10, by combining a different technology with different
manufacturing, distribution, and service approaches, Savin was able to offer
business customers, at some sacrifice in copy quality, a much cheaper machine.
The option of installing several cheaper machines in key office locations in lieu
of a single large, costly, centrally located unit proved attractive to many large
customers.
At virtually every stage of the business system, Savin took a radically different approach. First, it used a low-cost technology that had been avoided by theindustry because it produced a lower quality copy. Next, its product design was
based on low-cost standardized parts available in volume from Japanese suppliers. Further, the company opted for low-cost assembly in Japan. These businesssystem innovations permitted Savin to offer a copier of comparable reliability andacceptable quality for half the price of Xerox’s equivalent model. (Note: Startingfrom the mid-1980s, the Savin Corp. ran into all sorts of managerial problems. In
1993, it went into bankruptcy.)

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EXHIBIT 4-10
Plain-Paper Copier Strategy: Xerox versus Savin

Source: Peter R. Sawers, “How to Apply Competitive Analysis to Strategic Planning,” Marketing News (18 March 1983): 11.
Reprinted by permission of the American Marketing Association.

SUSTAINING COMPETITIVE ADVANTAGE
A good strategist seeks not only to “win the hill, but hold on to it.” In other words,
a business should not only seek competitive advantage but also sustain it over thelong haul. Sustaining competitive advantage requires erecting barriers against thecompetition.
A barrier may be erected based on size in the targeted market, superior accessto resources or customers, and restrictions on competitors’ options. Scaleeconomies, for example, may equip a firm with an unbeatable cost advantage thatcompetitors cannot match. Preferred access to resources or to customers enables
a company to secure a sustainable advantage if (a) the access is secured under better terms than competitors have and (b) the access can be maintained over thelong run. Finally, a sustainable advantage can be gained if, for various reasons,competitors are restricted in their moves (e.g., pending antitrust action or given
past investments or existing commitments).
In financial terms, barriers are based on competitive cost differentials or on
price or service differentials. In all cases, a successful barrier returns higher margins than the competition earns. Further, a successful barrier must be sustainable

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and, in a practical sense, unbreachable by the competition; that is, it must cost thecompetition more to surmount than it costs the protected competitor to defend.
The nature of the feasible barrier depends on the competitive economics ofthe business. A heavily advertised consumer product with a leading market shareenjoys a significant cost barrier and perhaps a price-realization barrier against its
competition. If a consumer product has, for example, twice the market share of its
competition, it need spend only one-half the advertising dollar per unit to produce the same impact in the marketplace. It will always cost the competition
more, per unit, to attack than it costs the leader to defend.
On the other hand, barriers cost money to erect and defend. The expense of
the barrier may become an umbrella under which new forms of competition can
grow. For example, while advertising is a barrier that protects a leading consumer
brand from other branded competitors, the cost of maintaining the barrier is anumbrella under which a private-label product may hide and grow.
A wide product line, large sales and service forces, and systems capabilities
are all examples of major barriers. Each of these has a cost to erect and maintain.
Each is effective against smaller competitors who are attempting to copy theleader but have less volume over which to amortize barrier costs.
Each barrier, however, holds a protective umbrella over focused competitors.
The competitor with a narrow product line faces fewer costs than the wide-line
leader. The mail-order house may live under the umbrella of costs associated withthe large sales and service force of the leader. The “cherry picker” may produce
components compatible with the systems of the leader without bearing the systems engineering costs.
Exhibit 4-11 shows the relationship between barrier and umbrella strategies
in sustaining competitive advantage. The best position in the system is highbarrier and low umbrella. A product or business with a position strong enoughthat the costs of maintaining the barrier are, on a per unit basis, insignificant is ina high-barrier, low-umbrella position. The low-barrier, low-umbrella quadrant is,
by definition, a commodity without high profitability.
Most interesting is the high-barrier, high-umbrella quadrant. The business isprotected by the existence of the barrier. At the same time, it is at risk because thecost of supporting the barrier is high. Profitability may be high, but the risk ofcompetitive erosion, too, may be substantial. The marketplace issue is the tradeoff between consumer preferences for more service, quality, choice, or “image”
and lower prices from more narrowly focused competitors.
These businesses face profound decisions. Making no change in directionmeans continual threats from focused competition. Yet any change in spending tolower the umbrella means changing the nature of the competitive protection; thatis, eroding the barrier.
Successful marketing strategy requires being aware of the size of the umbrella
and continually testing whether to maintain investment to preserve or heighten
the barrier or to withdraw investment to “cash out” as the barrier erodes.
A sustainable advantage is meaningful in marketing strategy only when thefollowing conditions are met: (a) customers perceive a consistent difference in101

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EXHIBIT 4-11
Strategies for Sustaining Competitive Advantage

Source: Sandra O. Moose, “Barriers and Umbrellas,” Perspectives (Boston: Boston Consulting Group,1980). Reprinted by permission.

important attributes between the firm’s product or service and those of its competitors, (b) the difference is the direct result of a capability gap between the firm
and its competitors, and (c) both the difference in important attributes and thecapability gap can be expected to endure over time.
To illustrate the point, consider competition between the Kellogg Co. andQuaker Oats Co. in the cereal market. Beginning in 1995, Kellogg could not maintain the barrier and the umbrella became too big. Quaker Oats (a relatively small
fourth player in the industry) took advantage of this opportunity and introduced
a line of bagged cereals that were cheaper versions of Kellogg’s (the industry
leader’s) national brands. By skimping on packaging and marketing costs, Quaker
could sell bagged products for about $1 less than boxed counterparts. Since 1995,
bagged cereals have skyrocketed from virtually nothing to account for 8% of all
cereal packages sold in 1998.17 The difference that Kellogg counted on could not be
maintained. The consumer did not care whether cereals are in a bag or box.

SUMMARY

Competition is a strategic factor that affects marketing strategy formulation.
Traditionally, marketers have considered competition as one of the uncontrollable
variables to be reckoned with in developing the marketing mix. It is only in thelast few years that the focus of business strategy has shifted to the competition. It
is becoming more and more evident that a chosen marketing strategy should bebased on competitive advantage to achieve sustained business success. To implement such a perspective, resources should be concentrated in those areas of competitive activity that offer the best opportunity for continuing profitability andsound investment returns.

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There are two very different forms of competition: natural and strategic.
Natural competition implies survival of the fittest in a given environment. In
business terms, it means firms compete from very similar strategic positions, relying on operating differences to separate the successful from the unsuccessful.
With strategic competition, on the other hand, underlying strategy differencesvis-à-vis market segments, product offerings, distribution channels, and manufacturing processes become paramount considerations.
Conceptually, competition may be examined from the viewpoint of economists, industrial organization theorists, and businesspeople. The major thrust of
economic theories has centered on the model of perfect competition. Industrialorganization emphasizes the industry environment (i.e., industry structure,
conduct, and performance) as the key determinant of a firm’s performance. A
theoretical framework of competition from the viewpoint of the businessperson,
other than the pioneering efforts of Bruce Henderson, hardly exists.
Firms compete to satisfy customer needs, which may be classified as existing,latent, or incipient. A firm may face competition from different sources, which
may be categorized as industry competition, product line competition, or organizational competition. The intensity of competition is determined by a combination of factors.
A firm needs a competitive intelligence system to keep track of various facetsof its rivals’ businesses. The system should include proper data gathering andanalysis of each major competitor’s current and future perspectives. This chapter
identified various sources of competitive information, including what competitors say about themselves, what others say about them, and what a firm’s own
people have observed. To gain competitive advantage, that is, to choose those
product/market positions where victories are clearly attainable, two forms ofanalysis may be undertaken: industry analysis and comparative analysis. Porter’s
five-factor model is useful in industry analysis. Business-system framework can
be gainfully employed for comparative analysis.

DISCUSSIONQUESTIONS

1. Differentiate between natural and strategic competition. Give examples.
2. What are the basic elements of strategic competition? Are there any prerequisites to pursuing strategic competition?
3. How do economists approach competition? Does this approach suffice forbusinesspeople?
4. What is the industrial organization viewpoint of competition?
5. Identify, with examples, different sources of competition.
6. How does industry structure affect intensity of competition?
7. What are the major sources of competitive intelligence?
8. Briefly explain Porter’s five-factor model of industry structure analysis.

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NOTESUnderstanding Competition

103

1 Bruce D. Henderson, “New Strategies for the Global Competition,” A Special

Commentary (Boston: Boston Consulting Group, 1981): 5–6.
2 Louis W. Stern and John R. Grabner, Jr., Competition in the Marketplace (Glenview, IL:

Scott, Foresman and Company, 1970): 29.
3 See Michael E. Porter, Competitive Strategy (New York: The Free Press, 1980): Chapter 1.

See also E. T. Grether, Marketing and Public Policy (Englewood Cliffs, NJ: PrenticeHall, 1960): 25; and George Fisk, Marketing Systems: An Introductory Analysis (NewYork: Harper & Row, 1967): 622.
4 Bruce D. Henderson, “The Anatomy of Competition,” Journal of Marketing (Spring1983): 8–9.
5 Wendy Zellner, “How Northwest Gives Competition a Bad Name,” Business Week, (16March 1998): 34.
6 William E. Rothschild, Putting It All Together (New York: AMACOM, 1976): 85.
7 Steven Flax, “How to Snoop on Your Competitors,” Fortune (14 May 1984): 29–33. Also
see Richard Teitelbaum, “The New Race for Intelligence,” Fortune (2 November 1992):
104.
8 Patrick Marren, “Business Intelligence: Inside Out?” Outlook, The Futures Group. (June
1996): 1.
9 “Unilever Is All Made Up with Everywhere to Go,” Business Week (31 July 1989):
33–34. Also see “The Branding of Beauty,” The Economist, (21 October 1995): 67.
10 “L‘Oreal Aiming at High and Low Markets,” Fortune (22 March 1993): 89.
11 Kathleen Deveny and Alecia Swasy, “In Cosmetics, Marketing Cultures Clash,” The
Wall Street Journal (31 October 1989): B1.
12 See George S. Day and Prakash Nedungadi, “Managerial Representations ofCompetetive Strategy,” Journal of Marketing (April 1994): 31–44.
13 Michael E. Porter, “Note on the Structural Analysis of Industries,” Harvard Business
School Case Service (1975): 22.
14 Richard Normann and Rafael Ramirez,“From Value Chain to Value Constellation:
Designing Interactive Strategy,” Harvard Business Review (July–August 1993): 65–77.
15 Roberto Buaron, “New-Game Strategies,” McKinsey Quarterly (Spring 1981): 24–40.
16 Tom Giordano, “From Riches to Rags,” The Hartford Courant (12 December 1993): 61.
17 “Cereal-Box Killers Are on the Loose.” Business Week (5 October 1998): 48.

CHAPTER FIVE

5

Focusing on the
Customer
Consumption is thesole end and purposeof production; and theinterest of the producer ought to beattended to only so
far as it may be necessary for promotingthat of the customer
ADAM SMITH

B

usinesses compete to serve customer needs. Not only are there different typesof customers, but their needs vary, too. Thus, most markets are not homogeneous. Further, the markets that are homogeneous today may not remain so in the
future. In brief, a market represents a dynamic phenomenon that, influenced bycustomer needs, evolves over time.
In a free economy, each customer group tends to want a slightly different service or product. But a business unit cannot reach out to all customers with equal
effectiveness; it must distinguish easily accessible customer groups from hard-toreach customer groups. Moreover, a business unit faces competitors whose ability to respond to customer needs and cover customer groups differs from its own.
To establish a strategic edge over its competition with a viable marketing strategy,
it is important for the business unit to clearly define the market it intends to serve.
It must segment the market, identifying one or more subsets of customers within
the total market, and concentrate its efforts on meeting their needs. Fine targetingof the customer group to serve offers the opportunity to establish competitive
leverage.
This chapter introduces a framework for identifying markets to serve. Various
underlying concepts of market definition are examined. The chapter ends with a
discussion of alternative ways of segmenting a market.

IDENTIFYING MARKETSContemporary approaches to strategic planning require proper definition of themarket; however, questions about how to properly characterize a market make it
difficult to arrive at an acceptable definition. Depending on how the market isdefined, the relative market positions of two companies and their two products
can be reversed, as shown in the following table.
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105

Percentage Market Share
Brands
S
T
U
V
X
Y
Z

Unsegmented (Mass)
32
24
16
8
12
6
2

Segmented
40
30
20
10
60
30
10

Though brand X has a low share in the unsegmented, or mass, market (12percent), it has a much higher share within its own segment of the mass market(60 percent) than does brand S (40 percent). Which of the two shares shown is better for the business: the total mass market for the product category or some segmented portion of that market? The arguments go both ways, some pointing out
the merits of having a larger share of industry volume and others noting thefavorable profit consequences of holding a larger share within a smaller market
niche. Does Sanka compete in the total mass market for coffee with Maxwell
House and Folgers or in a decaffeinated market segment against Brim andNescafe? Does the market for personal computers include intelligent and dumb
terminals as well as word processors, desktop and laptop computers, and intelligent telephones? Grape Nuts has 100 percent of the Grape Nuts market, a smaller
percentage of the breakfast cereal market, an even smaller percentage of the packaged-foods market, a still smaller percentage of the packaged-goods market, atiny percentage of the U.S. food market, a minuscule percentage of the world foodmarket, and a microscopic percentage of total consumer expenditures. All
descriptions of market share are meaningless, however, unless a company defines
the market in terms of the boundaries separating it from its rivals.
Considering the importance of adequately defining the market, it is desirable
to systematically develop a conceptual framework for that purpose. Exhibit 5-1
presents such a framework.
The first logical step in defining the market is to determine customer need.
Based on need, the market emerges. Because customer need provides a broad perspective of the market, it is desirable to establish market boundaries. Traditionally,market boundaries have been defined in terms of product/market scope, but
recent work suggests that markets should be defined multidimensionally.
The market boundary delineates the total limits of the market. An individual
business must select and serve those parts, or segments, of the total market inwhich it is best equipped to compete over the long run. Consider Polaroid. It started
as an instant photography firm. As such, it had only a 7 percent stake in the $15 billion photography industry. Over the years, it carried out a multi-billion dollar market for itself. But in the 1990s, the company realized it had little chance of any
further growth. The developed world was already saturated with cameras, andphotography itself was beginning to lose out to home videomaking. By aiming

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EXHIBIT 5-1
Identifying Markets to Serve

instead at the entire imaging industry—from photocopying to printing and video
as well as photography—Polaroid saw a chance to compete in a rapidly growing,$150 billion global business.1

CUSTOMER NEED
Satisfaction of customer need is the ultimate test of a business unit’s success.
Thus, an effective marketing strategy should aim at serving customer needs andwants better than competitors do. Focus on customers is the essence of marketingstrategy. As Robertson and Wind have said:Marketing performs a boundary role function between the company and its markets.
It guides the allocation of resources to product and service offerings designed to satisfy market needs while achieving corporate objectives. This boundary role functionof marketing is critical to strategy development. Before marshaling a company’s
resources to acquire a new business, or to introduce a new product, or to reposition an
existing product, management must use marketing research to cross the companyconsumer boundary and to assess the likely market response.
The logic and value of consumer needs assessment is generally beyond dispute, yetfrequently ignored. It is estimated, for example, that a majority of new products fail.
Yet, there is most often nothing wrong with the product itself; that is, it works. The
problem is simply that consumers do not want the product.
AT&T’s Picture Phone is a classic example of a technology-driven product thatworks; but people do not want to see each other on a telephone. It transforms a comfortable, low involvement communication transaction into a demanding, high

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107

involvement one. The benefit is not obvious to consumers. Of course, the benefit could
become obvious if transportation costs continue to outpace communication costs, andif consumers could be “taught” the benefits of using a Picture Phone.
Marketing’s boundary role function is similarly important in maintaining a viable
competitive positioning in the marketplace. The passing of Korvette from theAmerican retail scene, for example, can be attributed to consumer confusion as towhat Korvette represented—how it was positioned relative to competition. Korvette’s
strength was as a discount chain—high turnover and low margin. This basic missionof the business was violated, however, as Korvette traded-up in soft goods and fashion items and even opened a store on Manhattan’s Fifth Avenue. The result was that
Korvette became neither a discount store nor a department store and lost its previous
customer base. Sears has encountered a similar phenomenon as it opted for higher
margins in the 1970s and lost its reputation for “value” in the marketplace. The
penalty has been declining sales and profitability for its retail store operation, which
it is now trying valiantly to arrest by reestablishing its “middle America” value orientation. Nevertheless, consumer research could have indicated the beginning of the
problem long before the crisis in sales and profits occurred.2

Concept of Need

Customer need has always formed the basis of sound marketing. Yet, as Ohmae
points out, it is often neglected or ignored:
Think for a moment about aching heads. Is my headache the same as yours? My cold?
My shoulder pain? My stomach discomfort? Of course not. Yet when a pharmaceutical company asked for help . . . [it] asked 50 employees in the company to fill out aquestionnaire—throughout a full year—about how they felt physically at all times ofthe day every day of the year. Then [it] pulled together a list of the symptoms
described, sat down with the company’s scientists, and asked them, item by item: Do
you know why people feel this way? Do you have a drug for this kind of symptom?
It turned out that there were no drugs for about 80 percent of the symptoms, these
physical awarenesses of discomfort. For many of them, some combination of existing
drugs worked just fine. For others, no one had ever thought to seek a particular remedy. The scientists were ignoring tons of profit.
Without understanding customers’ needs—the specific types of discomfort they
were feeling—the company found it all too easy to say, “Headache? Fine, here’s amedicine, an aspirin, for headache. Case closed.” It was easy not to take the next stepand ask, “What does the headache feel like? Where does it come from? What is theunderlying cause? How can we treat the cause, not just the symptom?” Many of these
symptoms, for example, are psychological and culture-specific. Just look at televisioncommercials. In the United States, the most common complaint is headache; in the
United Kingdom, backache; in Japan, stomach ache. In the United States, people saythat they have a splitting headache; in Japan it is an ulcer. How can we truly understand what these people are feeling and why?3

Looking closely at needs is the first step in delivering value to customers.
Traditionally, needs have been classified according to Maslow’s hierarchy ofhuman needs. From lowest to highest, Maslow’s hierarchy identifies five levels ofneeds: physiological, safety, belongingness, self-esteem, and self-actualization.
Needs at each level of the hierarchy can be satisfied only after needs at the levels
below it have been satisfied. A need unsatisfied becomes a source of frustration.

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When the frustration is sufficiently intense, it motivates a relief action—the purchase of a product, for example. Once a need is satisfied, it is forgotten, creating
space for the awareness of other needs. In a marketing context, this suggests that
customers need periodic reminders of their association with a product, particularly when satisfied.
Business strategy can be based on the certainty that needs exist. As we moveup Maslow’s hierarchy, needs become less and less obvious. The challenge in marketing is to expose nonobvious needs, to fill needs at all levels of the hierarchy.
Maslow’s first two levels can be called survival levels. Most businesses operate at Level 2 (safety), with occasional spikes into higher levels. A business mustsatisfy a safety need to have a viable operation. The customer must feel both
physically and economically safe in buying the product. The next higher levels—
belongingness and self-esteem—are customer reward levels, where benefits ofconsuming a product accrue to the customer personally, enhancing his or her
sense of worth. At the highest level, self-actualization, the customer feels a close
identification with the product. Of course, not all needs can be filled, nor would
it be economically feasible to attempt to do so. But a business can move further
toward satisfaction of customer needs by utilizing the insights of the Maslow
hierarchy.

MARKET EMERGENCE
Customer need gives rise to a market opportunity, and a market emerges. To
judge the worth of this market, an estimate of market potential is important. If themarket appears attractive, the strategist takes the next step of delineating the market boundary. This section examines the potential of the market.
Simply stated, market potential is the total demand for a product in a given
environment. Market potential is measured to gain insights into five elements:
market size, market growth, profitability, type of buying decision, and customer
market structure. Exhibit 5-2 summarizes these elements and shows a pro forma
scheme for measuring market potential.
The first element, market size, is best expressed in both units and dollars.
Dollar expression in isolation is inadequate because of distortion by inflation andinternational currency fluctuations. Also, because of inflationary distortion, thescreening criteria for new product concepts and product line extensions should
separately specify both units and dollars. Market size can be expressed as total
market sales potential or company market share, although most companies
through custom utilize market share figures.
The second element, market growth, is meant to reflect the secular trend of theindustry. Again, the screening criteria should be specified for new product concepts and product line extensions. The criteria and projections should be based on
percentage growth in units. Projections in industrial settings often are heavily
dependent on retrofit possibilities and plans for equipment replacement.
The third element in this evaluation of strategic potential is profitability. It
usually is expressed in terms of contribution margin or in one of the family of

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109

EXHIBIT 5-2
Measurement of Market Potential

Low

Potential
MediumHigh

New product concepts< $10 million< $ 2 million$10 to 20 million$ 2 to 5 million> $20 million> $ 5 million< 7 percent< 5 percent

7 to 10 percent
5 to 7 percent> 10 percent> 7 percent< 45 percent< 40 percent

45 to 55 percent
40 to 50 percent> 55 percent> 50 percent

Type of Buying
Decision

Straight Rebuy
Cost
Short delivery
Proven record withpresent suppliers

New Task
Selling effort
ServiceSpecific processexpertise

Modified Rebuy
Product
performance
Life-cycle costs

Customer Market
Structure

Oligopsony
Many different
subsegments
Few large customers
Non-accessible

Market Size

Product line extension
or new market segment
for existing line
New product concept

Market GrowthProfitability(Contribution
Margin)CRITERIA

Criteria

Product line extension
or new market segment
for existing line
New product concept or
product line expansion
New market segment
for existing line

Low

MediumHigh

Data Source

MarketMarket GrowthProfitability
Type of Buying Decision
Customer Market Structure
Overall Rating
Source: Reprinted by permission of Terry C. Wilson, West Virginia University.

Monopsonistic
Competition
Few subsegments
Several significant
customers
Accessible

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return calculations. Most U.S. companies view profitability in terms of return on
investment (ROI), return on sales (ROS), or return on net assets (RONA). Returnon capital employed (ROCE) is often calculated in multinational companies. For
measuring market potential, no one of these calculations appears to function better than another.
The fourth element is the type of buying decision. The basis for a buying decision must be predicated on whether the decision is a straight rebuy, a modified
rebuy, or a new task.
The fifth and final element is the customer market structure. Based on the same
criteria as competitive structure, the market can be classified as monopsony, oligopsony, differentiated competition (monopsonistic competition), or pure competition.

DEFINING MARKET BOUNDARIESThe crux of any strategy formulation effort is market definition:
The problem of identifying competitive product-market boundaries pervades all levels of marketing decisions. Such strategic issues as the basic definition of a business,
the assessment of opportunities presented by gaps in the market, the reaction tothreats posed by competitive actions, and the decisions on major resource allocations
are strongly influenced by the breadth or narrowness of the definition of competitiveboundaries. The importance of share of market for evaluating performance and for
guiding territorial advertising, sales force, and other budget allocations and the growing number of antitrust prosecutions also call for defensible definitions of productmarket boundaries.4

Defining the market is difficult, however, since market can be defined inmany ways. Consider the cooking appliance business. Overall in 1997 about 18
million gas and electric ranges and microwave ovens were sold for householduse. All these appliances serve the basic function of cooking, but their similarity
ends there. They differ in many ways: (a) with reference to fuels—primarily gas
versus electricity; (b) in cooking method—heat versus radiation; (c) with reference to type of cooking function—surface heating, baking, roasting, broiling, etc.;(d) in design—freestanding ranges, built-in countertop ranges, wall ovens,counter-top microwave ovens, combinations of microwave units, and conventional ranges, etc.; and (e) in price and product features.
These differences raise an important question: Should all household cooking
appliances be considered a single market or do they represent several distinct
markets? If they represent several distinct markets, how should these markets be
defined? There are different possibilities for defining the market: (a) with reference to product characteristics; (b) in terms of private brand sales versus manufacturers’ brand sales; (c) with reference to sales in specific regions; and (d) interms of sales target, for example, sales to building contractors for installation in
new houses versus replacement sales for existing homes.
Depending on the criteria adopted to define the market, the size of a market
varies considerably. The strategic question of how the marketer of home cooking
appliances should define the market is explored below.

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Dimensions ofMarket Boundaries

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Traditionally, market boundaries have been defined in terms of product/market
space. Consider the following:
A market is sometimes defined as a group of firms producing identical or closely
related products. . . . A preferable approach is to define the markets in terms of products. . . . [What is meant by] a close relationship among products? Goods and services
may be closely related in the sense that they are regarded as substitutes by consumers,or they may be close in that the factors of production used in each are similar.5

Some identify a market with a generic class of products. One hears of the beermarket, the cake mix market, or the cigarette market. According to others, product markets refer to individuals who have purchased a given class of products.
These two definitions of the market—the market as a class of closely related
products versus the market as a class of people who purchase a certain kind of
product—view it from one of two perspectives: who are the buyers and what are
the products. In the first definition, buyers are implicitly assumed to be homogeneous in their behavior. The second definition suggests that the products andbrands within a category are easily identified and interchangeable and that the
problem is to search for market segments.
In recent years, it has been considered inadequate to perceive market definition as simply a choice of products for chosen markets. Instead, the product may
be considered a physical manifestation of a particular technology to a particularcustomer function for a particular customer group. Market boundaries should
then be determined by choices along these three dimensions.6
Technology. A particular customer function can be performed by different
technologies. In other words, alternative technologies can be applied to satisfy aparticular customer need. To illustrate, consider home cooking appliances again.
In terms of fuel, the traditional alternative technologies have been gas and electricity. In recent years, a new form of technology, microwave radiation, has also
been used. In another industry, alternative technologies may be based on the useof different materials. For example, containers may be made from metal, glass, or
plastic. In defining market boundaries, a decision must be made whether the
products of all relevant technologies or only those of a particular technology are
to be included.
Customer Function. Products can be considered in terms of the functions
they serve or in terms of the ways in which they are used. Some cooking appliances bake and roast, others fry and boil; some perform all these functions andperhaps more. Different functions provide varying customer benefits. In establishing market boundaries, customer benefits to be served should be spelledout.
Customer Group. A group refers to a homogeneous set of customers with similar needs and characteristics. The market for cooking appliances, for example, canbe split into different groups: building contractors, individual households buying
through retail stores, and so on. The retail stores segment can be further broken
down into traditional appliance specialty stores, mass merchandisers, and so on.

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Decisions about market boundaries should indicate which types of customers areto be served.
In addition to these three dimensions for determining market boundaries,
Buzzell recommends a fourth—level of production/distribution.7 A business has
the option of operating at one or more levels of the production/distribution
process. For example, producers of raw materials (e.g., aluminum) or component
products (e.g., semiconductors, motors, compressors) may limit their business toselling only to other producers, they may produce finished products themselves,or they may do both. Decisions about production/distribution levels have a
direct impact on the market boundary definition. This point may be illustrated
with reference to Texas Instruments:
The impact that a business unit’s vertical integration strategy can have on competition
in a market is dramatically illustrated by Texas Instruments’ decision, in 1972, to enter
the calculator business. At the time, it was a principal supplier of calculator components (integrated circuits) to the earlier entrants into the market, including the initial
market leader, Bowmar Instruments. As most readers undoubtedly know, TI quickly
took over a leadership position in calculators through a combination of “pricing down
the experience curve” and aggressive promotion. For purposes of this discussion, theimportant point is one of a finished product. Some other component suppliers also
entered the calculator business, while others continued to supply OEMs. In light ofthese varying strategies, is there a “calculator component market” and “calculator
market,” or do these constitute a single market?8

Exhibit 5-3 depicts the three dimensions of the market boundary definition
from the viewpoint of the personal financial transactions industry. Market boundaries are defined in terms of customer groups, customer functions, and technologies. The fourth dimension, level of production/distribution, is not included in
the diagram because it is not possible to show four dimensions in a single chart.
The exhibit shows a matrix developed around customer groups on the verticalaxis, customer functions on the right axis, and technologies on the left axis. Any
three-dimensional cell in the matrix constitutes an elementary “building block” ofmarket definition. An automatic teller machine (ATM) for cash withdrawals at acommercial bank is an example of such a cell.
Redefining Market
Boundaries

As markets evolve, boundaries may need to be restated. Five sets of “environmental influences” affect product/market boundaries. These influences are technological change (displacement by a new technology); market-oriented productdevelopment (e.g., combining the features of several products into one multipurpose offering); price changes and supply constraints (which influence the perceived set of substitutes); social, legal, or government trends (which influence
patterns of competition); and international trade competition (which changes
geographic boundaries).9 For example, when management introduces a new
product, markets an existing product to new customers, diversifies the businessthrough acquisition, or liquidates a part of the business, the market undergoes aprocess of evolution. Redefinition of market boundaries may be based on any one
or a combination of the three basic dimensions. The market may be extended

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EXHIBIT 5-3
Dimensions of Market Boundary Definition for Personal Financial Transactions

through the penetration of new customer groups, the addition of products serving related customer functions, or the development of products based on newtechnologies. As shown in Exhibit 5-4, these changes are caused by three fundamentally different phenomena: The adoption and diffusion process underlies thepenetration of new customer groups, a process of systemization results in theoperation of products to serve combinations of functions, and the technology substitution process underlies change on a technology dimension.

SERVED MARKET
Earlier in this chapter, it was concluded that the task of market boundary definition amounts to grouping together a set of market cells (see Exhibit 5-3), eachdefined in terms of three dimensions: customer groups, customer functions, andtechnologies. In other words, a market may comprise any combination of theseFocusing on the Customer

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EXHIBIT 5-4
Market Evolution in Three Dimensions
Customer Functions(b) Systematization—Extension to
New Customer Functions

Alternative Technologies(c) Technological Substitution—
Extension to New Technologies

Customer Groups(a) Adoption and Diffusion—
Extension to New Customer
Groups

Source: Derek F. Abell, Defining the Business: The Starting Point of Strategic Planning, © 1980, p. 207.
Reprinted by permission of Prentice-Hall, Inc., Englewood Cliffs, N.J.

cells. An additional question must now be answered. Should a business unit serve
the entire market or limit itself to serving just a part of it? While it is conceivablethat a business unit may decide to serve the total market, usually the served market is considerably narrower in scope and smaller in size than the total market. The
decision about what market to serve is based on such factors as the following:
1. Perceptions of which product function and technology groupings can best be protected and dominated.
2. Internal resource limitations that force a narrow focus.
3. Cumulative trial-and-error experience in reacting to threats and opportunities.

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4. Unusual competencies stemming from access to scarce resources or protectedmarkets.10

In practice, the choice of served market is not based on conscious, deliberate
effort. Rather, circumstances and perceptions surrounding the business unit dictate the decision. For some businesses, lack of adequate resources limits the rangeof possibilities. Dell Computer, for example, would be naive to consider competing against IBM across the board. Further, as a business unit gains experiencethrough trial and error, it may extend the scope of its served market. For example, the U.S. Post Office entered the overnight package delivery market to participate in an opportunity established by the Federal Express Company. The task ofdelineating the served market, however, is full of complications. As Day has
noted:
In practice, the task of grouping market cells to define a market is complicated. First,
there is usually no one defensible criterion for grouping cells. There may be many
ways to achieve the same function. Thus, boxed chocolates compete to some degreewith flowers, records, and books as semicasual gifts. Do all of these products belong
in the total market? To confound this problem, the available statistical and accounting
data are often aggregated to a level where important distinctions between cells arecompletely obscured. Second, there are many products which evolve by adding new
combinations of functions and technologies. Thus, radios are multifunctional products which include clocks, alarms, appearance options. To what extent do these variants dictate new market cells? Third, different competitors may choose different
combinations of market cells to serve or to include in their total market definitions. In
these situations there will be few direct competitors; instead, businesses willencounter each other in different but overlapping markets, and, as a result, may
employ different strategies.11

Strategically, the choice of a business unit’s served market may be based on
the following approaches:
I. Breadth of Product LineA. Specialized in terms of technology, broad range of product uses
B. Specialized in terms of product uses, multiple technologies
C. Specialized in a single technology, narrow range of product uses
D. Broad range of (related) technologies and uses
E. Broad versus narrow range of quality/price levels
II. Types of Customers
A. Single customer segment
B. Multiple customer segments
1. Undifferentiated treatment
2. Differentiated treatment
III. Geographic Scope
A. Local or regional
B. National
C. Multinational

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IV. Level of Production/Distribution
A. Raw or semifinished materials or components
B. Finished products
C. Wholesale or retail distribution

An Example of aServed Market

The choice of served market may be illustrated with reference to one company’s
entry into the snowmobile business. The management of this company considered snowmobiles an attractive market in terms of sales potential. The boundaries of this market are extensive. For example, in terms of technology, asnowmobile may be powered by gas, diesel fuel, or electricity. A snowmobile
may fulfill such customer functions as delivery, recreation, and emergency transportation. Customer groups include household consumers, industrial buyers,
and the military.
Since the company could not cover the total market, it had to define the market it would serve. To accomplish this task, the company developed a product/market matrix (see Exhibit 5-5a). The company could use any
technology—gasoline, diesel, or electric—and it could design a snowmobile forany one of three customer groups: consumer, industrial, or military. The matrix in
Exhibit 5-5a furnished nine possibilities for the company. Considering market
potential and its competencies to compete, the part of the market that looked best
was the diesel-powered snowmobile for the industrial market segment, theshaded area in Exhibit 5-5a.
But further narrowing of the market to be served was necessary. A second
matrix (see Exhibit 5-5b) laid out the dimensions of customer use (function) andcustomer size. Thus, as shown in Exhibit 5-5b, snowmobiles could be designed
for use as delivery vehicles (e.g., used by business firms and the post office), as
recreation vehicles (e.g., rented at resort hotel sites), or as emergency vehicles(e.g., used by hospitals and police forces). Further, the design of the snowmobile
would be affected by whether the company would sell to large, medium, or small
customers. After evaluating the nine alternatives in Exhibit 5-5b, the company
found the large customer, delivery use market attractive, defining its served market as diesel-driven snowmobiles for use as delivery vehicles by large industrial
customers.

Served Market
Alternatives

In the preceding example, the company settled on a rather narrow definition of
the served market. It could, however, expand the scope of the served market as it
gains experience and as opportunities elsewhere in the market appear attractive.
The following is a summary of the served market alternatives available to a business similar to this one.
1. Product/market concentration consists of the company’s niching itself in only
one part of the market. In the above example, the company’s niche was making
only diesel-driven snowmobiles for industrial buyers.
2. Product specialization consists of the company’s deciding to produce only dieseldriven snowmobiles for all customer groups.

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EXHIBIT 5-5
Defined the Served Market

ConsumerMarketIndustrial

MilitaryGas-driven
snowmobiles

Technology

Diesel-driven
snowmobiles

Electric-driven
snowmobiles(a) Technology/Market Matrix

Delivery

Customer Use
Recreation Emergency

Large

CustomerSize

MediumSmall(b) Customer Size/Customer Use Matrix

Source: Philip Kotler, “Strategic Planning and the Marketing Process,” Business (May–June 1980):
6–7. Reprinted by permission of the author.

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3. Market specialization consists of the company’s deciding to make a variety ofsnowmobiles that serve the varied needs of a particular customer group, such asindustrial buyers.
4. Selective specialization consists of the company’s entering several product markets that have no relation to each other except that each provides an individuallyattractive opportunity.
5. Full coverage consists of the company’s making a full range of snowmobiles toserve all market segments.

CUSTOMER SEGMENTATIONIn the snowmobile example, the served market consisted of one segment. But conceivably, the served market could be much broader in scope. For example, thecompany could decide to serve all industrial customers (large, medium, small) byoffering diesel-driven snowmobiles for delivery use. The “broader” served market, however, must be segmented because the market is not homogeneous; that is,
it cannot be served by one type of product/service offering.
Currently, the United States represents the largest market in the world formost products; it is not a homogeneous market, however. Not all customers want
the same thing. Particularly in well-supplied markets, customers generally preferproducts or services that are tailored to their needs. Differences can be expressedin terms of product or service features, service levels, quality levels, or somethingelse. In other words, the large market has a variety of submarkets, or segments,that vary substantially. One of the crucial elements of marketing strategy is tochoose the segment or segments that are to be served. This, however, is notalways easy because different methods for dissecting a market may be employed
and deciding which method to use may pose a problem.
Virtually all strategists segment their markets. Typically, they use SIC codes,
annual purchase volume, age, and income as differentiating variables. Categories
based on these variables, however, may not suffice as far as the development ofstrategy is concerned.
RCA, for example, initially classified potential customers for color television
sets according to age, income, and social class. The company soon realized thatthese segments were not crucial for continued growth because potential buyers
were not confined to those groups. Later analysis discovered that there were“innovators” and “followers” in each of the above groups. This finding led thecompany to tailor its marketing strategy to various segments according to their“innovativeness.” Mass acceptance of color television might have been delayed
substantially if RCA had followed a more traditional approach.
An American food processor achieved rapid success in the French market
after discovering that “modern” Frenchwomen liked processed foods while “traditional” French housewives looked upon them as a threat. A leading industrial
manufacturer discovered that its critical variable was the amount of annual usage
per item, not per order or per any other conventional variable. This proved to be
critical since heavy users can be expected to be more sensitive to price and may
be more aware of and responsive to promotional perspectives.

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Segmentation aims at increasing the scope of business by closely aligning a
product or brand with an identifiable customer group. Take, for example, cigarettes. Thirty years ago, most cigarette smokers chose from among three brands:
Camel, Chesterfield, and Lucky Strike. Today more than 160 brands adorn retailshelves. In order to sell more cigarettes, tobacco companies have been dividing
the smoking public into relatively tiny sociological groups and then aiming one
or more brands at each group. Vantage and Merit, for example, are aimed atyoung women; Camel and Winston are aimed mostly at rural smokers. Cigarettemarketing success hinges on how effectively a company can design a brand to
appeal to a particular type of smoker and then on how well it can reach thatsmoker with sharply focused packaging, product design, and advertising.
What is true of cigarettes applies to many, many products; it applies even toservices. Banks, for example, have been vying with one another for importantcustomers by offering innovative services that set each bank apart from its competition.
These illustrations underscore not only the significance of segmenting themarket but also the importance of carefully choosing segmentation criteria.
Segmentation
Criteria

Segmentation criteria vary depending on the nature of the market. In consumergoods marketing, one may use simple demographic and socioeconomic variables,
personality and lifestyle variables, or situation-specific events (such as use intensity, brand loyalty, and attitudes) as the bases of segmentation. In industrial marketing, segmentation is achieved by forming end use segments, productsegments, geographic segments, common buying factor segments, and customer
size segments. Exhibit 5-6 provides an inventory of different bases for segmentation. Most of these bases are self-explanatory. For a detailed account, however,reference may be made to a textbook on marketing management.
In addition to these criteria, creative analysts may well identify others. For
example, a shipbuilding company dissects its tanker market into large, medium,and small markets; similarly, its cargo ship market is classified into high-,
medium-, and low-grade markets. A forklift manufacturer divides its market on
the basis of product performance requirements. Many consumer-goods companies, General Foods, Procter & Gamble, and Coca-Cola among them, base theirsegments on lifestyle analysis.
Data for forming customer segments may be analyzed with the use of simple
statistical techniques (e.g., averages) or multivariate methods. Conceptually, thefollowing procedure may be adopted to choose a criterion for segmentation:
1. Identify potential customers and the nature of their needs.
2. Segment all customers into groups having
a. Common requirements.
b. The same value system with respect to the importance of these requirements.
3. Determine the theoretically most efficient means of serving each market segment,
making sure that the distribution system selected differentiates each segmentwith respect to cost and price.

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EXHIBIT 5-6
Basis for Customer Segmentation
A. Consumer Markets
1. Demographic factors (age, income, sex, etc.)
2. Socioeconomic factors (social class, stage in the family life cycle)
3. Geographic factors
4. Psychological factors (lifestyle, personality traits)
5. Consumption patterns (heavy, moderate, and light users)
6. Perceptual factors (benefit segmentation, perceptual mapping)7. Brand loyalty patterns
B. Industrial Markets
1. End use segments (identified by SIC code)
2. Product segments (based on technological differences or production economics)
3. Geographic segments (defined by boundaries between countries or by regional
differences within them)
4. Common buying factor segments (cut across product/market and geographic
segments)
5. Customer size segments

4. Adjust this ideal system to the constraints of the real world: existing commitments, legal restrictions, practicality, and so forth.

A market can also be segmented by level of customer service, stage of production, price/performance characteristics, credit arrangements with customers,
location of plants, characteristics of manufacturing equipment, channels of distribution, and financial policies. The key is to choose a variable or variables that so
divide the market that customers in a segment respond similarly to some aspectof the marketer’s strategy.12 The variable should be measurable; that is, it should
represent an objective value, such as income, rate of consumption, or frequencyof buying, not simply a qualitative viewpoint, such as the degree of customer
happiness. Also, the variable should create segments that may be accessible
through promotion. Even if it is feasible to measure happiness, segments basedon the happiness variable cannot be reached by a specific promotional medium.
Finally, segments should be substantial in size; that is, they should be sufficiently
large to warrant a separate marketing effort.
Once segments have been formed, the next strategic issue is deciding which
segment should be selected. The selected segment should comply with the following conditions:
1. It should be one in which the maximum differential in competitive strategy canbe developed.
2. It must be capable of being isolated so that competitive advantage can be preserved.
3. It must be valid even though imitated.

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The success of Volkswagen in the United States in 1960 can be attributed to its
fit into a market segment that had two unique characteristics. First, the segment
served by VW could not be adequately served by a modification to conventional
U.S. cars. Second, U.S. manufacturers’ economies of scale could not be brought tobear to the disadvantage of VW. In contrast, American Motors was equally successful in identifying a special segment to serve with its compact car, the Rambler.
The critical difference was that American Motors could not protect that segmentfrom the superior scale of manufacturing volume of the other three U.S. automobile producers.
The choice of strategically critical segments is not straightforward. It requires
careful evaluation of business strengths as compared with the competition. It also
requires analytical marketing research to uncover market segments in whichthese competitive strengths can be significant.13
Rarely do market segments conveniently coincide with such obvious categories as religion, age, profession, or family income; or, in the industrial sector,
with the size of company. For this reason, market segmentation is emphaticallynot a job for statisticians. Rather, it is a task that can be mastered only by the creative strategist. For example, an industrial company found that the key to segmenting customers is by the phase of the purchase decision process that theyexperienced. Accordingly, three segments were identified: (a) first-time prospects,(b) novices, and (c) sophisticates.14 These three segments valued different benefits, bought from different channels, and carried varying impressions ofproviders.
A technology-consulting firm, Forrester Research Inc., separates people into
ten categories: “fast forwards, techno-strivers, hand-shakers, new age nurturers,
digital hopefuls, traditionalists, mouse potatoes, gadget-grabbers, media junkies,
and sidelined citizens.” Exhibit 5-7 defines each group. For example, “Fast forwards” own on an average 20 technology products per household. Several of
their clients have found this kind of classification useful in identifying segments
to serve.15
Market segmentation has recently undergone several changes. These include: 16• Increased emphasis on segmentation criteria that represent “softer” data such as
attitudes and needs. This is the case in both consumer and business-to-businessmarketing.
• Increased awareness that the bases of segmentation depend on its purpose. For
example, the same bank customers could be segmented by account ownershipprofiles, attitudes towards risk-taking, and socioeconomic variables. Each segmentation could be useful for a different purpose, such as product cross-selling,
preparation of advertising messages, and media selection.
• A move towards “letting the data speak for themselves,” that is finding segments
through the detection of patterns in survey or in-house data. So-called “data mining” methods have become much more versatile over the past decade.
• Greater usage of “hybrid” segmentation methods. For example, a beer producer
might first segment consumers according to favorite brand. Then, within eachbrand group, consumers could be further segmented according to similarities in
attitudes towards beer drinking, occasions where beer is consumed, and so on.

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EXHIBIT 5-7
How Tech Customers Stack Up

OPTIMISTS

CAREERPESSIMISTS122

FAMILYENTERTAINMENTFAST FORWARDS
These consumers are thebiggest spenders, andthey’re early adopters of
new technology for home,office, and personal use.

NEW AGE NURTURERS MOUSE POTATOES
Also big spenders, but
They like the online
focused on technology for world for entertainment
home uses, such as a
and are willing to spend
family PC.
for the latest in technotainment.

TECHNO-STRIVERS
Use technology fromcell phones and pagers toonline services primarily
to gain a career edge.

DIGITAL HOPEFULS
Families with a limited
budget but still interested
in new technology. Good
candidates for the under$1,000 PC.

HAND-SHAKERS
Older consumers—
typically managers—who
don’t touch their computers at work. Theyleave that to younger
assistants.

GADGET-GRABBERS
They also favor online
entertainment but haveless cash to spend on it.

TRADITIONALISTSMEDIA JUNKIESWilling to use techSeek entertainment andnology but slow to
can’t find much of it
upgrade. Not convinced online. Prefer TV andupgrades and other add- other older media.
ons are worth paying for.

SIDELINED CITIZENS Not interested in technology.
MORE AFFLUENTLESS AFFLUENT

Source: Forrester Research, Inc.

• A closer connection between segmentation methods and new product development. Computer choice models (using information about the attribute trade-offs
that consumers make) can now find the best segments for a given product profileor the best product profile for a given market segment.
• The growing availability of computer models (based on conjoint data) to findoptimal additions to product lines—products that best balance the possibility ofcannibalization of current products with competitive draw.
• Research on dynamic product/segment models that consider the possibility ofcompetitive retaliation. Such models examine a company’s vulnerability to competitive reactions over the short term and choose product/segment combinations
that are most resistant to competitive encroachment.
• The development of pattern-recognition and consumer-clustering methods that
seek segments on the basis of data but also respect managerial constraints on
minimal segment size and managerial weightings of selected clustering variables.
• The development of flexible segmentations that permit the manager to loosen aclustering based only on buyer needs (by shifting a small number of people

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between clusters); the aim might be to increase the predictability of some external
criterion, such as household profitability to a company, say, selling mutual funds.

Micromarketing, orSegment-of-One
Marketing

An interesting development in the past few years has been the emergence of a
new segmentation concept called micromarketing, or segment-of-one marketing.
Forced by competitive pressures, mass marketers have discovered that a segment
can be trimmed down to smaller subsegments, even to an individual.
Micromarketing combines two independent concepts: information retrieval andservice delivery. On one side is a proprietary database of customers’ preferences
and purchase behaviors; on the other is a disciplined, tightly engineered
approach to service delivery that uses the database to tailor a service package forindividual customers or a group of customers. Of course, such custom-designed
service is nothing new, but until recently, only the very wealthy could afford it.
Information technology has brought the level of service associated with the oldcarriage trade within reach of the middle class.17
Micromarketing requires:
1. Knowing the customers—Using high-tech techniques, find out who the customers are and aren’t. By linking that knowledge with data about ads andcoupons, fine-tune marketing strategy.
2. Making what customers want—Tailor products to individual tastes. Where once
there were just Oreos, now there are Fudge Covered Oreos, Oreo Double Stufs,
and Oreo Big Stufs.
3. Using targeted and new media—Advertising on cable television and in magazines can be used to reach special audiences. In addition, develop new ways toreach customers. For example, messages on walls in high-school lunchrooms, onvideocassettes, and even on blood pressure monitors may be considered.
4. Using nonmedia—Sponsor sports, festivals, and other events to reach local or
ethnic markets.
5. Reaching customers in the store—Consumers make most buying decisions while
they are shopping, so put ads on supermarket loudspeakers, shopping carts, andin-store monitors.
6. Sharpening promotions—Couponing and price promotions are expensive andoften harmful to a brand’s image. Thanks to better data, some companies areusing fewer, more effective promotions. One promising approach: aiming
coupons at a competitor’s customers.
7. Working with retailers—Consumer-goods manufacturers must learn to “micro
market” to the retail trade, too. Some are linking their computers to retailers’
computers, and some are tailoring their marketing and promotions to an individual retailer’s needs.

An example of micromarketing is provided by a North Carolina bank, First
Wachovia.18 The bank’s staff serves all customers the way it used to serve its best
customer. The staff greets each customer by name and provides personalized
information about her or his finances and how they relate to long-term objectives.
Based on this knowledge, the staff suggests new products. In this way, the commodity retail banking has been turned into a customized, personalized service.
This marketing strategy has resulted in more sales at lower marketing costs andFocusing on the Customer

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powerful switching barriers relative to the competition. Three major investments
are behind this seemingly effortless new level of service: a comprehensive customer database, accessible wherever the customer makes contact with the bank;an extensive training program that teaches a personalized service approach; andan ongoing personal communications program with each customer. Similarly,
Noxell’s Clarion line illustrates how micromarketing can be implemented. Whenthe company introduced its line of mass market cosmetics in drugstores, it looked
for a way to differentiate it in a crowded market. The answer was the Clarion
computer. Customers type in the characteristics of their skin and receive a regimen selected from the Clarion line, thus providing department store-type personal advice without sales pressure in the much more convenient drug channel.

SUMMARY

This chapter examined the role of the third strategic C—the customer—in formulating marketing strategy. One strategic consideration in determining marketingstrategy is the definition of the market. A conceptual framework for defining themarket was outlined.
The underlying factor in the formation of a market is customer need. The concept of need was discussed with reference to Maslow’s hierarchy of needs. Oncea market emerges, its worth must be determined through examining its potential.
Different methods may be employed to study market potential.
Based on its potential, if a market appears worth tapping, its boundaries
must be identified. Traditionally, market boundaries have been defined on thebasis of product/market scope. Recent work on the subject recommends thatmarket boundaries be established around the following dimensions: technology,
customer function, and customer group. Level of production/distribution was
suggested as a fourth dimension. The task of market boundary definition
amounts to grouping together a set of market cells, each defined in terms of these
dimensions.
Market boundaries set the limits of the market. Should a business unit servea total market or just a part of it? Although it is conceivable to serve an entire market, usually the served market is considerably narrower in scope and smaller insize than the total market. Factors that influence the choice of served market were
examined.
The served market may be too broad to be served by a single marketing program. If so, then the served market must be segmented. The rationale for segmentation was given, and a procedure for segmenting the market was outlined.

DISCUSSIONQUESTIONS

1. Elaborate on marketing’s boundary role function. How is it related to customer
needs?
2. What dimensions may be used to define market boundaries?
3. Illustrate the use of these dimensions with a practical example.
4. What is meant by served market? What factors determine the served market?
5. How may a business unit choose the criteria for segmenting the market?

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6. Describe the concept of micromarketing. How may a durable goods company
adopt it to its business?

NOTES”Polaroid: Sharper Focus,” The Economist (24 April 1993): 72.
Thomas S. Robertson and Yoram Wind, “Marketing Strategy,” in Handbook of Business
Strategy (New York: McGraw-Hill Book Co., 1982). See also Yoram Wind and Thomas
S. Robertson, “Marketing Strategy: New Directions for Theory and Research,”
Journal of Marketing (Spring 1983): 12–25.
3 Kenichi Ohmae, “Getting Back to Strategy,” Harvard Business Review(November–December 1988): 155–56.
4 George S. Day and Allan D. Shocker, Identifying Competitive Product-Market Boundaries:
Strategic and Analytical Issues (Cambridge, MA: Marketing Science Institute, 1976): 1.
5 Peter Asch, Economic Theory and the Antitrust Dilemma (New York: John Wiley & Sons,
1970): 168. See also George S. Day, Allan D. Shocker, and Rajendra K. Srivastava,“Customer-Oriented Approaches to Identifying Product Markets,” Journal ofMarketing (Fall 1979): 8–19; and Rajendra K. Srivastava, Robert P. Leone, and Allan
D. Shocker, “Market Structure Analysis: Hierarchical Clustering of Products Basedon Substitution-in-Use,” Journal of Marketing (Summer 1981): 38–48.
6 Derek F. Abell, Defining the Business: The Starting Point of Strategic Planning (Englewood
Cliffs, NJ: Prentice-Hall, 1980).
7 Robert D. Buzzell, “Note on Market Definition and Segmentation,” A Harvard Business
School Note, 1978, distributed by HBS Case Services.
8 Buzzell, “Note on Market Definition and Segmentation,” 6.
9 Day and Shocker, Identifying Competitive Product-Market Boundaries.
10 George S. Day, “Strategic Market Analysis and Definition: An Integrated Approach,”
Strategic Management Journal 2 (1981): 284.
11 Day, “Strategic Market Analysis and Definition,” 288.
12 See Nigel F. Piercy and Neil A. Morgan, “Strategic and Operational Market
Segmentation: A Managerial Analysis,” Journal of Strategic Marketing (June 1993):
123–140.
13 Luis D. Arjona, Rajesh Shah, Alejandro Tinivelli and Adam Weiss, “ Marketing to the
Hispanic Consumer,” The McKinsey Quarterly, No. 3, (1998): 106–115.
14 Thomas S. Robertson and Howard Barich, “A Successful Approach to Segmenting
Industrial Markets,” Planning Review (November/December 1992): 4–11.
15 “Are Tech Buyers Different,” Business Week, (26 January 1998): 64.
16 Paul Green and Abba Krieger, “Slicing and Dicing the Market,” Financial Times, (21September 1998).
17 Edward Feitzinger and Hau L. Lee, “Mass Customization at Hewlett-Packard: The
Power of Postponement,” Harvard Business Review, (January–February 1997):
116–123.
18 Kathleen Deveny, “Segments of One,” The Wall Street Journal (22 March 1991): B4. See
also “Segment-of-One Marketing,” Perspectives (Boston: Boston Consulting Group,1989). Also see Howard Schlossberg, “Packaged-goods Experts: Micromarketing theonly Way to Go,”Marketing News (6 July 1992): 8; and Gregory A. Patterson, “Target‘Micromarkets’ Its Way to Success; No 2 Stores Are Alike,” The Wall Street Journal, (31May 1995): 1.
1

2

CHAPTER SIX

6Scanning theEnvironment
I hold that man is in theright who is most in
league with the future
HENRY IBSEN

An organization is a creature of its environment. Its very survival and all of its
perspectives, resources, problems, and opportunities are generated and conditioned by the environment. Thus, it is important for an organization to monitor
the relevant changes taking place in its environment and formulate strategies toadapt to these changes. In other words, for an organization to survive and prosper, the strategist must master the challenges of the profoundly changing political, economic, technological, social, and regulatory environment. To achieve thisbroad perspective, the strategist needs to develop and implement a systematic
approach to environmental scanning. As the rate and magnitude of change
increase, this scanning activity must be intensified and directed by explicit definitions of purpose, scope, and focus. The efforts of businesses to cope with these
problems are contributing to the development of systems for exploring alternatives with greater sensitivity to long-run implications. This emerging science has
the promise of providing a better framework for maximizing opportunities andallocating resources in anticipation of environmental changes.
This chapter reviews the state of the art of environmental scanning and suggests a general approach that may be used by a marketing strategist. Specifically,
the chapter discusses the criteria for determining the scope and focus of scanning,
the procedure for examining the relevance of environmental trends, the techniques for evaluating the impact of an environmental trend on a particular product/market, and the linking of environmental trends and other “early warning
signals” to strategic planning processes.

IMPORTANCE OF ENVIRONMENTAL SCANNING
Without taking into account relevant environmental influences, a company cannot expect to develop its strategy. It was the environmental influences emerging
out of the energy crisis that were responsible for the popularity of smaller, more
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fuel-efficient automobiles and that brought about the demise of less efficientrotary engines. It was the environmental influence of a coffee bean shortage andgeometric price increases that spawned the “coffee-saver” modification in Mr.
Coffee automatic drip coffee makers. Shopper and merchant complaints from anearlier era contributed to the virtual elimination of deposit bottles; recent pressures from environmental groups, however, have forced their return and haveprompted companies to develop low-cost, recyclable plastic bottles.
Another environmental trend, Americans’ insatiable appetite for eating out(in 1990, restaurant sales accounted for $0.44 of every $1 spent on food; this number is expected to reach $0.63 by the year 2000), worries food companies such as
Kraft. In response, Kraft is trying to make cooking as convenient as eating out(e.g., by providing high-quality convenience foods) to win back food dollars.1
The sad tales of companies that seemingly did everything right and yet lostcompetitive leadership as a result of technological change abound. Du Pont was
beaten by Celanese when bias-ply tire cords changed from nylon to polyester. B.F.
Goodrich was beaten by Michelin when the radial overtook the bias-ply tire. NCR
wrote off $139 million in electro-mechanical inventory and the equipment tomake it when solid-state point-of-sale terminals entered the market. Xerox let
Canon create the small-copier market. Bucyrus-Erie allowed Caterpillar and
Deere to take over the mechanical excavator market. These companies lost eventhough they were low-cost producers. They lost even though they were close to
their customers. They lost even though they were market leaders. They lost
because they failed to make an effective transition from old to new technology.
In brief, business derives its existence from the environment. Thus, it should
monitor its environment constructively. Business should scan the environment
and incorporate the impact of environmental trends on the organization by continually reviewing the corporate strategy.
The underlying importance of environmental scanning is captured in
Darwinian laws: (a) the environment is ever-changing, (b) organisms have theability to adapt to a changing environment, and (c) organisms that do not adapt
do not survive. We are indeed living in a rapidly changing world. Many things
that we take for granted today were not even imagined in the 1960s. As we enter
the next century, many more “wonders” will come to exist.
To survive and prosper in the midst of a changing environment, companies
must stay at the forefront of changes affecting their industries. First, it must berecognized that all products and processes have performance limits and that thecloser one comes to these limits the more expensive it becomes to squeeze out thenext generation of performance improvements. Second, one must take all competition seriously. Normally, competitor analyses seem to implicitly assume that themost serious competitors are the ones with the largest resources. But in the context of taking advantage of environmental shifts, this assumption is frequently
not adequate. Texas Instruments was a $5- to $10-million company in 1955 when
it took on the mighty vacuum tube manufacturers—RCA, GE, Sylvania, andWestinghouse—and beat them with its semiconductor technology. Boeing wasnearly bankrupt when it successfully introduced the commercial jet plane,Scanning the Environment

128PART 2 Strategic Analysis

vanquishing larger and more financially secure Lockheed, McDonnell, andDouglas corporations.
Third, if the environmental change promises potential advantage, one must
attack to win and attack even to play the game. Attack means gaining access to
new technology, training people in its use, investing in capacity to use it, devising strategies to protect the position, and holding off on investments in maturelines. For example, IBM capitalized on the emerging personal computer market
created by its competitor, Apple Computer. By becoming the low-cost producer,
distributor, seller, and servicer of personal computers for business use, IBM tookcommand of the marketplace in less than two years.
Fourth, the attack must begin early. The substitution of one product orprocess for another proceeds slowly and then predictably explodes. One cannot
wait for the explosion to occur to react. There is simply not enough time. B.F.
Goodrich lost 25 percentage points of market share to Michelin in four years.
Texas Instruments passed RCA in sales of active electronic devices in five to six
years.
Fifth, a close tie is needed between the CEO and the operating managers.
Facing change means incorporating the environmental shifts in all aspects of thecompany’s strategy.

WHAT SCANNING CAN ACCOMPLISH
Scanning improves an organization’s abilities to deal with a rapidly changing
environment in a number of ways:
1. It helps an organization capitalize on early opportunities rather than lose these tocompetitors.
2. It provides an early signal of impending problems, which can be defused if recognized well in advance.
3. It sensitizes an organization to the changing needs and wishes of its customers.
4. It provides a base of objective qualitative information about the environment thatstrategists can utilize.
5. It provides intellectual stimulation to strategists in their decision making.
6. It improves the image of the organization with its publics by showing that it issensitive to its environment and responsive to it.
7. It is a means of continuing broad-based education for executives, especially forstrategy developers.

THE CONCEPT OF ENVIRONMENT
Operationally, five different types of environments may be identified—technological, political, economic, regulatory, and social—and the environment may bescanned at three different levels in the organization—corporate, SBU, and product/market level (see Exhibit 6-1). Perspectives of environmental scanning varyfrom level to level. Corporate scanning broadly examines happenings in different
environments and focuses on trends with corporate-wide implications. For

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EXHIBIT 6-1
Constituents of Environment

example, at the corporate level IBM may review the impact of competition aboveand below in the telephone industry on the availability and rates of long-distance
telephone lines to its customers. Emphasis at the SBU level focuses on thosechanges in the environment that may influence the future direction of the business. At IBM, the SBU concerned with personal computers may study such environmental perspectives as diffusion rate of personal computers, newdevelopments in integrated circuit technology, and the political debates inprogress on the registration (similar to automobile registration) of personal computers. At the product/market level, scanning is limited to day-to-day aspects.
For example, an IBM personal computer marketing manager may review the significance of rebates, a popular practice among IBM’s competitors.
The emphasis in this chapter is on environmental scanning from the viewpoint of the SBU. The primary purpose is to gain a comprehensive view of the
future business world as a foundation on which to base major strategic decisions.

STATE OF THE ART
Scanning serves as an early warning system for the environmental forces that
may impact a company’s products and markets in the future. Environmental
scanning is a comparatively new development. Traditionally, corporations evaluated themselves mainly on the basis of financial performance. In general, theScanning the Environment

130PART 2 Strategic Analysis

environment was studied only for the purpose of making economic forecasts.
Other environmental factors were brought in haphazardly, if at all, and intuitively. In recent years, however, most large corporations have started doing systematic work in this area.
A pioneering study on environmental scanning was done by Francis Aguilar.
In his investigation of selected chemical companies in the United States andEurope, he found no systematic approach to environmental scanning. Aguilar’sdifferent types of information about the environment that the companies foundinteresting have been consolidated into five groups: market tidings (market potential, structural change, competitors and industry, pricing, sales negotiations, customers); acquisition leads (leads for mergers, joint ventures); technical tidings (newproducts, processes, and technology; product problems; costs; licensing andpatents); broad issues (general conditions relative to political, demographic,
national issues; government actions and policies); other tidings (suppliers and raw
materials, resources available, other). Among these groups, market tidings wasfound to be the dominant category and was of most interest to managers acrossthe board.
Aguilar also identified four patterns for viewing information: undirected viewing (exposure without a specific purpose), conditioned viewing (directed exposure
but without undertaking an active search), informal search (collection of purposeoriented information in an informal manner), and formal search (a structured
process for collection of specific information for a designated purpose). Bothinternal and external sources were used in seeking this information. The external
comprised both personal sources (customers, suppliers, bankers, consultants, andother knowledgeable individuals) and impersonal sources (various publications,conferences, trade shows, exhibitions, and so on). The internal personal sources
included peers, superiors, and subordinates. The internal impersonal sources
included regular and general reports and scheduled meetings. Aguilar’s study
concluded that while the process is not simple, a company can systematize its
environmental scanning activities for strategy development.2
Aguilar’s framework may be illustrated with reference to the Coca-Cola
Company. The company looks at its environment through a series of analyses. At
the corporate level, considerable information is gathered on economic, social, andpolitical factors affecting the business and on competition both in the UnitedStates and overseas. The corporate office also becomes involved in special studies
when it feels that some aspect of the environment requires special attention. For
example, in the 1980s, to address itself to a top management concern about
Pepsi’s claim that the taste of its cola was superior to Coke’s, the company undertook a study to understand what was going on in the minds of their consumers
and what they were looking for. How was the consumption of Coca-Cola related
to their consumers’ lifestyle, to their set of values, to their needs? This study
spearheaded the work toward the introduction of New Coke.
In the mid-1980s, the corporate office also made a study of the impact ofantipollution trends on government regulations concerning packaging. At thecorporate level, environment was scanned rather broadly. Mostly market tidings,

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technical tidings, and broad issues were dealt with. Whenever necessary, in-depth
studies were done on a particular area of concern, and corporate information wasmade available to different divisions of the company.
At the division level (e.g., Coca-Cola, USA), considerable attention is given to
the market situation, acquisition leads, and new business ventures. The divisionalso studies general economic conditions (trends in GNP, consumption, income),
government regulation (especially antitrust actions), social factors, and even thepolitical situation. Part of this division-level scanning duplicates the efforts of thecorporate office, but the divisional planning staff felt that it was in a position to
do a better job for its own purpose than could the corporate office, which had toserve the needs of other divisions as well. The division also undertakes special
studies. For example, in the early 1980s, it wondered whether a caffeine-free drink
should be introduced and, if so, when.
The information received from the corporate office and that which the division had collected itself was analyzed for events and happenings that could affectthe company’s current and potential business. Analysis was done mostly throughmeetings and discussions rather than through the use of any statistical model. At
the Coca-Cola Company, environmental analysis is a sort of forum. There is relatively little cohesion among managers; the meetings, therefore, respond to a needfor exchange of information between people.
A recent study of environmental scanning identifies four evolutionary phasesof activity, from primitive to proactive (see Exhibit 6-2). The scanning activities inmost corporations can be characterized by one of these four phases.3
In Phase 1, the primitive phase, the environment is taken as somethinginevitable and random about which nothing can be done other than to accept
each impact as it occurs. Management is exposed to information, both strategic
and nonstrategic, without making any effort to distinguish the difference. No discrimination is used to discern strategic information, and the information is rarely
related to strategic decision making. As a matter of fact, scanning takes place
without management devoting any effort to it.
Phase 2, the ad hoc phase, is an improvement over Phase 1 in that management identifies a few areas that need to be watched carefully; however, there is noformal system for scanning and no initiative is taken to scan the environment. In
addition, that management is sensitive to information about specific areas does
not imply that this information is subsequently related to strategy formulation.
This phase is characterized by such statements as this: All reports seem to indicate that rates of interest will not increase substantially to the year 2000, but ourmanagement will never sit down to seriously consider what we might do or not
do as a company to capitalize on this trend in the pursuit of our goals. Typically,
the ad hoc phase characterizes companies that have traditionally done well andwhose management, which is intimately tied to day-to-day operations, recently
happened to hire a young M.B.A. to do strategic planning.
In Phase 3, the reactive phase, environmental scanning begins to be viewed
as important, and efforts are made to monitor the environment to seek information in different areas. In other words, management fully recognizes theScanning the Environment

132PART 2 Strategic Analysis

EXHIBIT 6-2
Four Phases in the Evolution of Environmental Scanning

PHASE 1PHASE 2

PHASE 3

PHASE 4

Primitive

Ad HocReactive

Proactive

Face the environment
as it appears

Watch out for a likely
impact on the environment

Deal with the environment
to protect the future

Predict the environment
for a desired future• Exposure to information
without purpose and• No active search• Unstructured andrandom effect• Structured anddeliberate effort• Be sensitive to information on specific issues• Less specific information collection• Specific informationcollection• Preestablishedmethodology

significance of the environment and dabbles in scanning but in an unplanned,
unstructured fashion. Everything in the environment appears to be important,and the company is swamped with information. Some of the scanned information
may never be looked into; some is analyzed, understood, and stored. As soon as
the leading firm in the industry makes a strategic move in a particular matter, presumably in response to an environmental shift, the company in Phase 3 is quick
to react, following the footsteps of the leader. For example, if the use of cardboard
bottles for soft drinks appears uncertain, the Phase 3 company will understandthe problem on the horizon but hesitate to take a strategic lead. If the leading firm
decides to experiment with cardboard bottles, the Phase 3 firm will quickly
respond in kind. In other words, the Phase 3 firm understands the problems andopportunities that the future holds, but its management is unwilling to be the firstto take steps to avoid problems or to capitalize on opportunities. A Phase 3 company waits for a leading competitor to pave the way.
The firm in Phase 4, the proactive phase, practices environmental scanningwith vigor and zeal, employing a structured effort. Careful screening focuses thescanning effort on specified areas considered crucial. Time is taken to establish
proper methodology, disseminate scanned information, and incorporate it into
strategy. A hallmark of scanning in Phase 4 is the distinction between macro andmicro scanning. Macro scanning refers to scanning of interest to the entire

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corporation and is undertaken at the corporate level. Micro scanning is often
practiced at the product/market or SBU level. A corporate-wide scanning systemis created to ensure that macro and micro scanning complement each other. The
system is designed to provide open communication between different micro scanners to avoid duplication of effort and information.
A multinational study on the subject concluded that environmental scanningis on its way to becoming a full-fledged formalized step in the strategic planning
process. This commitment to environmental scanning has been triggered in partby the recognition of environmental turbulence and a willingness to confront relevant changes within the planning process. Commitment aside, there is yet noaccepted, effective methodology for environmental scanning.4

TYPES OF ENVIRONMENT
Corporations today, more than ever before, are profoundly sensitive to technological, political, economic, social, and regulatory changes. Although environmental changes may be felt throughout an organization, the impact most affects
strategic perspectives. To cope with a changing and shifting environment, themarketing strategist must find new ways to forecast the shape of things to comeand to analyze strategic alternatives and, at the same time, develop greater sensitivity to long-term implications. Various techniques that are especially relevant
for projecting long-range trends are discussed in the appendix at the end of thischapter. Suffice it to say here that environmental scanning necessarily implies a
forecasting perspective.
Technological
Environment

Technological developments come out of the research effort. Two types ofresearch can be distinguished: basic and applied. A company may engage inapplied research only or may undertake both basic and applied research. In either
case, a start must be made at the basic level, and from there the specific effect on
a company’s product or process must be derived. A company may choose not toundertake any research on its own, accepting a secondary role as an imitator. The
research efforts of imitators will be limited mainly to the adaptation of a particular technological change to its business.
There are three different aspects of technology: type of technology, its process,and the impetus for its development. Technology itself can be grouped into fivecategories: energy, materials, transportation, communications and information,and genetic (includes agronomic and biomedical). The original impetus for technological breakthroughs can come from any or all of three sources: meeting
defense needs, seeking the welfare of the masses, and making a mark commercially. The three stages in the process of technological development are invention,
the creation of a new product or process; innovation, the introduction of that
product or process into use; and diffusion, the spread of the product or process
beyond first use.
The type of technology a company prefers is dictated, of course, by the company’s interests. Impetus points to the market for technological development, andScanning the Environment

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the process of development shows the state of technological development andwhether the company is in a position to interface with the technology in any
stage. For example, the invention and innovation stages may call for basic
research beyond the resources of a company. Diffusion, however, may require
adaptation, which may not be as difficult as the other two stages.
The point may be illustrated with reference to aluminum cans.5 Gone are thedays when almost every soda and beer product on store shelves came in identical aluminum cans. Sure, Coke was red and Pepsi was blue, but underneath thepaint was the same sturdy, flip-top container. Just as technical advances allowed
the aluminum industry to seize the can business from steel in the 1960s, today
innovations from plastic, glass, and even good old steel, are undermining aluminum’s hegemony. That is a problem for Aluminum Co. of America and its competitors in the aluminum industry. Over the past 20 years, they have come todominate the $11 billion beverage container market. Cans account for one-fifth of
the aluminum sold in North America, which makes it the industry’s biggest business—bigger than airplane parts or siding for houses. Moreover, the can businesshas been the key to growth for aluminum companies, which scurried to build
mills in the 1980s. Now they find themselves swamped with capacity. Although
the industry produces a staggering 100 billion cans a year, the number has been
flat since 1994. From 1985–1996, glass increased its share of beer packaging from
31% to 37%, while aluminum’s portion shrank from 56% to 51%. Meanwhile, in
soda, innovations such as Coke’s plastic contour bottle are muscling aluminum
aside. Plastic bottles are even finding their way into vending machines, where
aluminum was once invincible. Now plastic industry researchers are working tocome up with a nonporous compound that could be used to hold beer. This materials war has forced aluminum to rethink the plain aluminum can and spend
more on eye-catching shapes and textures. It will be interesting to see how far
they succeed in dominating the beverage market.
Consider another example: Startling things have been happening to thetelevision set in the last few years. For example, Panasonic now offers a colorprojection system with a 60-inch screen. Toshiba Corp. of Japan has developed
large, flat-screen television sets that are so slim that they can hang on the wall
like paintings. Even traditional 19-inch sets aren’t just for looking at anymore;they are basic equipment on which to play video games, to learn how to spell,or to practice math. Videodisc players produce television images from discs;
videocassette recorders tape television shows and play prerecorded videotapes.
With two-way television, the viewer can respond to questions flashed on thescreen. Teleprint enables the conversion of television sets into video-display
tubes so that viewers can scan the contents of newspapers, magazines, catalogs,
and the like and call up any sections of interest.6 Finally, cable television permits
the viewer to call on the system’s library for a game, movie, or even a French
lesson.
The 1990s have been a period of technological change and true innovation.
One of the areas of greatest impact is communications. Until now, electronic communication has largely been confined to the traditional definition of voice

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135(telephone), pictures (television), and graphics (computer), three distinct kinds ofcommunication devices. From now on, electronics will increasingly produce total
communications. Today it is possible to make simultaneous and instantaneouselectronic transmission of voice, pictures, and graphics. People scattered over theface of the globe can now talk to each other directly, see each other, and, if needbe, share the same reports, documents, and graphs without leaving their own
offices or homes. Consider the impact of this innovation on the airline industry.
Business travel should diminish in importance, though its place may well betaken by travel for vacations and learning.
To analyze technological changes and capitalize on them, marketing strategists may utilize the technology management matrix shown in Exhibit 6-3. The
matrix should aid in choosing appropriate strategic options based on a business’s
technological position. The matrix has two dimensions: technology and product.
The technology dimension describes technologies in terms of their relationships
to one another; the product dimension establishes competitive position. The interaction of these two dimensions suggests desirable strategic action. For example,
if a business’s technology is superior to anything else on the market, the company
should enhance its leadership by identifying and introducing new applications
for the technology. On the other hand, if a business’s technology lags behind thecompetition, it should either make a technological leap to the competitive
process, abandon the market, or identify and pursue those elements that are laggards in terms of adopting new technologies.7
Briefly, the rapid development and exploitation of new technologies are causing serious strategic headaches for companies in almost every type of industry. It
has become vital for strategists to be able to recognize the limits of their core technologies, know which new technologies are emerging, and decide when to incorporate new technology in their products.
Political
Environment

In stable governments, political trends may not be as important as in countries
where governments are weak. Yet even in stable countries, political trends may
have a significant impact on business. For example, in the United States one cantypically expect greater emphasis on social programs and an increase in government spending when Democrats are in power in the White House. Therefore,
companies in the business of providing social services may expect greater opportunities during Democratic administrations.
More important, however, are political trends overseas because the U.S. economy is intimately connected with the global economy. Therefore, what goes on in
the political spheres of other countries may be significant for U.S. corporations,particularly multinational corporations.
The following are examples of political trends and events that could affectbusiness planning and strategy:
1. An increase in geopolitical federations.
a. Economic interests: resource countries versus consumer countries.
b. Political interests: Third World versus the rest.

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EXHIBIT 6-3
Technology Management Matrix
TECHNOLOGY POSITION
Different Technology
Product Position

Same Technology

Older Technology

Newer Technology

Behind competitors

Take traditional strategic
actions— Assess marketingstrategy and target
markets— Enhance productfeatures— Improve operational
efficiency

Evaluate viability of yourtechnology— Implement newer
technology— Divest products basedon older technology

Evaluate availability ofresources to sustain technology development andfull market acceptance— Continue to define
new applications andproduct enhancements— Scale back operations

Ahead of competitors

Define new applications
for the technology andenhance products accordingly

Take advantage of all
possible profit

Define new applications
for the technology andenhance products accordingly

Source: Susan J. Levine, “Marketers Need to Adopt a Technological Focus to Safeguard Against Obsolescence,” Marketing News (28October 1988): 16. Reprinted by permission of the American Marketing Association.

2. Rising nationalism versus world federalism.
a. Failure of the United Nations.
b. Trend toward world government or world law system.
3. Limited wars: Middle East, Serbia-Croatia.
4. Increase in political terrorism; revolutions.
5. Third-party gains in the United States; rise of socialism.
6. Decline of the major powers; rise of emerging nations (e.g., China, India, Brazil).
7. Minority (female) president.
8. Rise in senior citizen power in developed nations.
9. Political turmoil in Saudi Arabia that threatens world oil supplies and peace in
the Middle East.
10. Revolutionary change in Indonesia, jeopardizing Japanese oil supplies.
11. Revolutionary change in South Africa, limiting Western access to importantminerals and threatening huge capital losses to the economies of Great Britain,
the United States, and Germany.
12. Instability in other places where the economic consequences could be important, including Mexico, Turkey, Zaire, Nigeria, South Korea, Brazil, Chile, and
the People’s Republic of China.

Already in 1997–1998 we have seen the overwhelming impact that politicalshocks can have on the world economy. The value of the Indonesian rupiah is theperfect illustration: it was not just the product of an arbitrary monetary policy

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that was temporarily out of control but a rational response to problems that were
fundamentally political. The Indonesian government in the 1990s continued toincur huge budget deficits and kept on borrowing, making itself dangerously
dependent on the inflows of foreign capital. As the new government took over in
1998, inflation was high and the country became vulnerable to capital flight, leaving no choice for the government but to devalue the rupiah. The weakened
Indonesian economy, staggered by the deep devaluation of the rupiah, had strong
reverberations for the United States, with hundreds of thousands of jobs and billions of dollars of export business lost.
Marketing strategy is deeply affected by political perspectives. For example,
government decisions have significantly affected the U.S. automotive industry.
Stringent requirements, such as fuel efficiency standards, have burdened theindustry in several ways.8 The marketing strategist needs to study both domestic
and foreign political happenings, reviewing selected published information tokeep in touch with political trends and interpret the information as it relates to theparticular company.
Governments around the world help their domestic industries strengthen
their competitiveness through various fiscal and monetary measures. Politicalsupport can play a key role in an industry’s search for markets abroad. Without
it, an industry may face a difficult situation. For instance, the U.S. auto industry
would benefit from a U.S. government concession favoring U.S. automotive
exports. European countries rely on value-added taxes to help their industries.
Value-added taxes are applied to all levels of manufacturing transactions up to
and including the final sale to the end user. However, if the final sale is forexport, the value-added tax is rebated, thus effectively reducing the price ofEuropean goods in international commerce. Japan imposes a commodity tax on
selected lines of products, including automobiles. In the event of export, thecommodity tax is waived. The United States has no corresponding arrangement.
Thus, when a new automobile is shipped from the United States to Japan, its U.S.
taxes upon export are not rebated and the auto also must bear the cost of theJapanese commodity tax (15 or 20 percent, depending on the size of the vehicle)
when it is sold in Japan. This illustrates how political decisions affect marketingstrategy.
Economic
Environment

Economic trends and events affecting businesses include the following possibilities:
•
•
•
•
•
•
•
•
•
•

Depression; worldwide economic collapse
Increasing foreign ownership of the U.S. economy
Increasing regulation and management of national economies
Several developing nations become superpowers (e.g., Brazil, India, China)
World food production: famine relief versus holistic management
Decline in real world growth or stable growth
Collapse of world monetary system
High inflation
Significant employee-union ownership of U.S. businesses
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It is not unrealistic to say that all companies, small or large, that are engaged
in strategic planning examine the economic environment. Relevant publishedinformation is usually gathered, analyzed, and interpreted for use in planning. In
some corporations, the entire process of dealing with economic information may
be manual and intuitive. The large corporations, however, not only buy specificand detailed economic information from private sources, over and above what
may be available from government sources, but they analyze the information formeaningful conclusions by constructing econometric models. For example, one
large corporation with nine divisions has developed 26 econometric models of itsdifferent businesses. The data used for these models are stored in a database andare regularly updated. The information is available online to all divisions for further analysis at any time. Other companies may occasionally buy informationfrom outside and selectively undertake modeling.
Usually the economic environment is analyzed with reference to the following key economic indicators: employment, consumer price index, housing starts,
auto sales, weekly unemployment claims, real GNP, industrial production, personal income, savings rate, capacity utilization, productivity, money supply(weekly M1: currency and checking accounts), retail sales, inventories, anddurable goods orders. Information on these indicators is available from government sources. These indicators are adequate for short-run analysis and decision
making because, by and large, they track developments over the business cycle
reasonably well. However, companies that try to base strategic plans on these
indicators alone can run into serious trouble. Deficiencies in the data prove mostdangerous when the government moves to take a more interventionist role in theeconomy. Further, when the ability of statistical agencies to respond has beenhampered by unprecedented budget stringency, rapid changes in the structure of
the economy cause a gradual deterioration in the quality of many of the economic
statistics that the government publishes.
The problem of government-supplied data begins with a recondite document
called the Standard Industrial Classification (SIC) Manual, which divides all economic activity into 12 divisions and 84 major groups of industries. The SIC
Manual dictates the organization of and the amount of data available about production, income, employment, and other vital economic indicators. Each majorgroup has a two-digit numerical code. The economy is then subdivided into hundreds of secondary groups, each with a three-digit code, and is further subdivided into thousands of industries, each with four-digit codes. But detail in most
government statistical series is available only at the major group level; data at thethree-digit level are scarce; at the four-digit level, almost nonexistent. Thus, information available from public sources may not suffice.
To illustrate the effect of economic climate on strategy, consider the following
trends. In the more elderly capitalist countries, it is expected that old markets will
become saturated much faster than new markets will take their place. Staple consumer goods, such as cars, radios, and television sets, already outnumber households in North America and in much of Western Europe; other products are fast
approaching the same fate. The slow growth of populations in most of these

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countries means that the number of households is likely to grow at only about 2
percent annually to the year 2000 and that demand for consumer goods is
unlikely to grow any faster. Furthermore, while demand in these markets
decreases, supply will increase, leading to intensified price competition and pressure on profit margins.
For example, as we enter the new century, the auto industry is likely to sufferfrom overcapacity. It is expected that there will be three buyers for every fourcars.9 Already the market concentration in many consumer sectors has fallen significantly, mainly because of increased foreign competition. And the expansion of
production capacity in such primary industries as metals and chemicals, especially in developing countries, may bring some kind of increased competition to
producer goods.
These trends indicate the kind of economic issues that marketing strategists
must take into account to determine their strategies.
SocialEnvironment

The ultimate test of a business is its social relevance. This is particularly true in asociety where survival needs are already being met. It therefore behooves thestrategic planner to be familiar with emerging social trends and concerns. The relevance of the social environment to a particular business will, of course, varydepending on the nature of the business. For a technology-oriented business,scanning the social environment may be limited to aspects of pollution control
and environmental safety. For a consumer-products company, however, theimpact of the social environment may go much further.
An important aspect of the social environment concerns the values consumers hold. Observers have noted many value shifts that directly or indirectly
influence business. Values mainly revolve around a number of fundamental concerns regarding time, quality, health, environment, home, personal finance, anddiversity.10
Orientation Toward Time. Given the scarcity of time and/or money to haveproducts repaired or to buy new ones, consumers look for offerings that endure.
Time has become the scarce resource as the result of the prevalence of dual
income-earning households. Convenience is a critical source of differential
advantage, particularly in foods and services. In addition, youth are making or
influencing more household purchasing decisions than ever before. Moreover, as
the population ages, time pressures become more widespread and acute.
Consumers are going to need innovative and, in some cases, almost customized
solutions. With time generally scarcer than money, offerings that ease time pressures will garner higher margins. For example, today’s average consumer, more
often than not a woman, takes just 21 minutes to do her shopping—from themoment she slams her car door in a supermarket parking lot to the moment she
climbs back in with her purchases. In that time, she buys an average of 18 items,
out of 30,000 to 40,000 choices. She has less time to browse; it is down 25% fromfive years ago. She isn’t even bothering to check prices. She wants the same product, at the same prices, in the same row, week after week. Under such a scenario,

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it does not make sense for P&G to make 55 price changes a day across 110 brands,
offering 440 promotions a year, tinkering with package size, color and contents.
To keep up with time, after 159 years P&G changed the name of its sales department to Customer Business Development, and let consumers drive supply than
to force-feed retailers by making them buy more products than they can sell. To
implement this concept involved everything from truck schedules to helping
clean retailers’ shelves of accumulated grime. It has prompted the tight-lippedcompany to share its consumer research with retailers. Gone are 27 types of promotions. All in all, P&G hopes to save $1.35 billion by the turn of the century.11
Quality. Given the standards set by the influx of imported products,
American consumers have developed a new set of expectations regarding quality; hence, they assign high priorities to those offerings that provide optimal
price/quality. We are witnessing a move toward the adoption of a greater
price/quality orientation in mass markets. There will continue to be a strong general desire for authenticity and lasting quality. Consumers will require fewer andmore durable products rather than more ephemeral, novelty products.
Heightened consumer expectations will translate into trying a manufacturer once.
If the value, the quality, or the intrinsic characteristics that the consumer demands
are not found, the consumer will not return to that manufacturer.
Health. A large and growing segment of the American population has
become increasingly preoccupied with health. Health concerns are a function ofboth an aging population and changing predispositions. America is hungry for
health and is impatient for its achievement. Industry experts are predicting thatnutritional tags, such as “low in fat,” will probably be the newest food fad to
sweep the United States. There is some consensus that a diet rich in soluble fiberand low in fat and a lifestyle that includes plenty of regular exercise reduce cholesterol. As an aging population strives to maintain its youth and vitality, alcoholand tobacco consumption and other unhealthy dietary habits will continue todecline. In short, American consumers have become highly health conscious. The
impact of this trend will not only be felt in the grocery store but in the travel andhospitality sectors of the economy, as well as in an array of services that contribute to lifelong wellness.
Environment. Perhaps the 1990s became the “earth decade.” A growing
number of Americans consider themselves “environmentalists.” Outdoor activities, such as rock-climbing expeditions and whitewater rafting, are superseding
more vicarious, passive ways of spending time. This heightened appreciation of
the outdoors is being translated in choice criteria in the marketplace. Hence, more
and more marketers are pressured into adopting “green” strategies; that is, offering products and services that are beneficial to the environment.12
Home. In a more domesticated society, the many technological innovations ofrecent years are making staying at home more fun. Some of the most beneficial
advances of this home-centered decade are in the design and construction ofhouses that resemble self-contained entertainment/educational activity centers.

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The recent slump in the housing market has rebounded, and opportunities formarketers to provide creative, more personalized, high-value offerings in homefurnishings are evolving.13
Personal Finance. Most experts on consumer behavior expect that in the new
century, people will be more frugal than they were in the past. The slow-andsteady consumer approach spawned by an attitude for upscale products that may
outstrip finances makes every purchase especially important. We are witnessing
several important consumer finance trends. First, consumers continue to seek out
the best price/value before buying and accordingly place downward pressure on
seller profit margins. Second, American consumers may have the income tospend freely, but recent economic difficulties nonetheless have caused them toremain cautious. Finally, quality is insisted upon, and a competitive premium
price is willingly paid for performance and durability.
Diversity of Lifestyles. The predominance of diverse lifestyles is reflected by
the significant increase in the number and the stature of women in the labor market. The increased presence of women in the labor force has dramatically influenced how men and women relate to one another and the personal andprofessional roles assumed by each. With 70 percent of women holding jobs outside the home, millions of men are doing chores their fathers would never havedreamed of. For example, men bought 25 percent of the groceries in the UnitedStates in 1991, up from 17 percent five years earlier.14 There has also been a dramatic change in racial integration and improved race relations. The United States
has also witnessed the development of openly gay and lesbian lifestyles as wellas an increase in the number of unmarried, cohabitating relationships. Significant
changes in attitudes toward work and careers have also resulted in a new senseof independence and individuality. Accordingly, there has been an upsurge in thenumber of people who are self-employed. Experts hold that this pattern of social
diversity will likely continue into the future. Social diversity creates opportunities
for marketers to develop personalized offerings that allow individuals to derive
satisfaction in the pursuit of different living alternatives.
In conclusion, American consumers will continue to search for basic values
and will experience heightened ethical awareness.15 Consumers will still careabout what things cost, but they will value only things that will endure—family,community, earth, faith.
Information on social trends may be derived from published sources. The
impact of social trends on a particular business can be studied in-house or withthe help of outside consultants. A number of consulting firms specialize in studying social trends.
Let us examine the strategic impact of two of the value shifts mentioned
above: orientation toward time and concern for health. Consider the retail industry. Little is being done to support consumers in their quest to reduce shopping
stress, although stress is a major consumer concern. Fast service has been thebasis for growth for a number of well-known firms, among them American
Express, McDonald’s, and Federal Express; however, only a small but significant

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number of businesses have recognized and responded to the consumer’s lack offree time for shopping and service transactions:• Dayton-Hudson has moved away from a maze-like floor design to a center aisle
design, making it easier for customers to find their way through the store. AtChildworld, toys are coordinated in learning centers so that buyers can examineand play with products. Management feels that this arrangement enables buyers
to shop more quickly.
• A new firm, Shopper’s Express, is assisting large chains such as A&P and
Safeway by taking telephone orders and delivering merchandise.
• Rather than forcing the consumer to sit at home for an entire day awaiting a service call, GE, for years, has been making specific service appointments.
• Sears now offers six-day-a-week and evening repair service. In addition, in specifying when a repair person will arrive, Sears assigns a two-hour window.
• Montgomery Ward authorizes 7,700 sales clerks to approve sales checks and handle merchandise returns on their own, eliminating the time needed to get a floor
manager’s approval.
• Burger King uses television monitors that enable drive-up customers to see thewaiter and the order.
• A&P, Shop Rite, and Publix are experimenting with automated grocery checkout
systems that reduce waiting time in checkout lines.
• Wegman’s, a supermarket chain in Rochester, New York, has a computer available for entering deli orders so that the customer does not have to wait to beserved. The customer simply enters the order and picks it up on the way out of
the store.16

More and more companies need to focus on developing shopping support
systems and environments that help customers move through the buying process
quickly. For firms that pride themselves for providing customers with a leisurely
shopping environment, this will be a radical departure. Firms accepting this challenge will be able to support and stay closer to their customers through suchchanges. In addition, firms that help customers reduce shopping time will be able
to differentiate themselves from competitors more easily.
For health reasons, salads and fish are replacing the traditional American dinner of meat and potatoes. Vegetarianism is on the rise. According to Time, about 8
million Americans call themselves vegetarians.17 Increasing varieties of decaffeinated coffee and tea and substitutes for sugar and salt are crowding supermarket shelves. Shoppers are reading the small print to check for artificial
ingredients in foods and beverages that they once bought without a thought.
Smoking is finally declining. Manufacturers and retailers of natural foods arebuilding a healthy “health industry.” Even products that do not easily accommodate healthier choices are being redeveloped in response to consumer concerns.
For example, Dunkin Donuts has yanked the egg yolks from all but four of its 52
varieties to make its donuts cholesterol-free.18 Fast food firms—McDonald’s
Corporation and Hardee’s Food Systems, for example—have introduced low-fat
foods into their menus.19
The nation’s dramatic new awareness of health is prompting these changes.
The desire to feel better, look younger, and live longer exerts a powerful influence

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on what people put into their bodies. This strong force is now moving against awell-entrenched habit that affects millions and dates back to biblical times—the
consumption of too much alcohol.20
Health substitutes for alcoholic beverages, labeled “dealcoholized” beverages, are now being offered to American consumers. For some time, gourmet foodshops have stocked champagne-like bottles of carbonated grape juice and canscontaining a not-fully-brewed mixture of water, malt, corn, yeast, and hops.
Except for their packaging, these alcohol-free imitations failed to resemble wineand beer, especially in the crucial area of taste. New dealcoholized beverages,
however, are fully fermented, or brewed, before their alcohol is separated out—either by pressure or heat—to below an unnoticeable 0.5 percent, the federal maximum before classifying a drink as alcoholic. The taste and body of the new
beverages match that of their former alcoholized selves.
This 0.5 percent level is so low that a drinker would need to consume 24
glasses of dealcoholized wine or 8 cans of dealcoholized beer to obtain theamount of alcohol in one 4-ounce glass of regular wine or one 12-ounce can ofregular beer. Thus, the drinker avoids not only intoxication but also worthlesscalories. A regular glass of wine or beer has about 150 calories, while their dealcoholized copies contain about 40 to 60 calories, respectively. And their prices are
the same.21 Introduced in Europe about five years ago, dealcoholized wines are
slowly making headway in the United States.
Regulatory
Environment

Government influence on business appears to be increasing. It is estimated thatbusinesses spend, on the average, twice as much time fulfilling government
requirements today as they did 10 years ago.22 Consider the case of Frito-Lay,which has long been America’s leading salty snack company.23 In recent years, thePepsiCo Subsidiary, whose offerings include Lay’s Potato Chips and Rold Gold
Pretzels, has boosted its industry market share from 38% to 55%. Because of thisstellar performance, the Justice Department suspects that something must be rancid at Frito-Lay. The Justice Department is said to be looking hard at Frito-Lay’s
use of shelf allowances, a common retailing practice in which manufacturers pay
stores up to $100,000 a foot for desirable shelf space. Among other things, investigators want to know if Frito-Lay has been purchasing more space than it needsin order to muscle out competitors. Since 1990, Frito-Lay has beaten a number ofcompetitors. Anheuser-Busch sold its Eagle Snack division to Frito-Lay in 1996
after persistently losing money since they entered the field in 1979. Another wellknown casualty was Borden, whose market share declined from 12% to 5%.
Dozens of independent regional snack companies have folded in recent years.
Frito-Lay makes no bones about it and asks, Is it really a crime to be better thaneveryone else?
Interestingly, government in recent years has changed its emphasis from regulating specific industries to focusing on problem areas of national interest,
including environmental cleanup, elimination of job discrimination, establishment of safe working conditions, and reduction of product hazards. A number ofsteps have been taken toward deregulation of various industries.

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This shift in focus in the regulatory environment deeply affects the internal
operations of business. To win or even survive in the competitive, free-for-all
environment that follows deregulation, companies in once-regulated industries
must make some hard choices. Astute management can avoid some of the trauma
by developing an explicit strategy to operate in a deregulated environment wellin advance of the event, rethinking relationships with customers, considering
new roles to play in the market, and realigning their organizations accordingly.
To study the impact of the regulatory environment, that is, of laws already on
the books and of pending legislation, legal assistance is required. Small firms may
seek legal assistance on an ad hoc basis. Large firms may maintain offices in
Washington staffed by people with legal backgrounds who are well versed in thecompany’s business, who know important government agencies from the pointof view of their companies, who maintain a close liaison with them, and who passon relevant information to planners in different departments of their companies.

ENVIRONMENTAL SCANNING AND MARKETING STRATEGY
The impact of environmental scanning on marketing strategy can be illustrated
with reference to videotex technology.24 Videotex technology—the merging ofcomputer and communications technologies—delivers information directly to theconsumer. The consumer may instantly view desired textual and visual information from on-line databases on television screens or other video receivers bypushing the appropriate buttons or typing the proper commands.
Possibilities for business and personal use of videotex are as endless as theimagination. Consumers are already utilizing videotex for shopping, travel, personal protection, financial transactions, and entertainment, in greater privacy andautonomy than ever before.
With the mechanism for getting things done most efficiently and cost effectively, marketing strategists have begun to explore the implications of videotex onmarketing decisions. Videotex will alter the demand for certain kinds of goods andservices and the ways in which consumers interact with marketing activities. For
the first time, the average consumer, not just the affluent consumer, can interact
directly with the production process, dictating final product specifications as the
product is being manufactured. As small-batch production becomes more costeffective, this type of consumer-producer interaction will become more common.
Product selection might also be enhanced by videotex, as sellers stock a more
complete inventory at fewer, more central locations rather than dealing withmany retail outlets. Because packages will no longer serve as the communications
vehicle for selling the product, less money will be spent on packaging. Productchanges can also be kept up-to-date. Information on videotex will be current, synthesized, and comprehensive. The user will have the power to access only desired
information at the time it is desired. Advertising messages and articles will beavailable in index form.
Direct consumer interaction with manufacturers will eliminate distribution
channels. Reduced or zero-based inventory will reduce obsolescence and turnover

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costs. Centrally located warehouses and new delivery routes will become increasingly cost-effective. The remaining retail stores will be transformed into showrooms with direct-order possibilities via view-data-like terminals.
Promotional material will become more educational and information-based,
including the provision of product specifications and independent product evaluations. Interactive video channels will provide advertisers and interested shoppers with prepackaged commercials and live shopping programs.
With more accurate price and product information, more perfect competition
will result. Price discrepancies will be reduced. Consumers will engage in morepreshopping planning, price-comparison shopping, and in-home shopping.
The market segment concept will be more important than ever before. The
individualizing possibilities of videotex will enable the seller to measure andreach segments with unparalleled accuracy and will also enable consumers toeffectively self-segment. Advertisers and consumers will benefit from 24-hour,
7-day-a-week salespeople. Everyone will be better prepared through videotex tosatisfy customers.

ENVIRONMENTAL SCANNING PROCEDURE
Like any other new program, the scanning activity in a corporation evolves overtime. There is no way to introduce a foolproof system from the beginning. If conditions are favorable—if there is an established system of strategic planning inplace and the CEO is interested in a structured effort at scanning—the evolutionary period shortens, of course, but the state of the art may not permit the introduction of a fully developed system at the outset. Besides, behavioral andorganizational constraints require that things be done over a period of time. The
level and type of scanning that a corporation undertakes should be custom
designed, and a customized system takes time to emerge into a viable system.
Exhibit 6-4 shows the process by which environmental scanning is linked tomarketing strategy. Listed below and on the next pages are the procedural steps
that explain this relationship.
1. Keep a tab on broad trends appearing in the environment—Once the scope ofenvironmental scanning is determined, broad trends in chosen areas may bereviewed from time to time. For example, in the area of technology, trends inenergy utilization, material science, transportation capability, mechanization andautomation, communications and information processing, and control over natural life may be studied.
2. Determine the relevance of an environmental trend—Not everything happening
in the environment may be relevant for a company. Therefore, attempts must be
made to select those trends that have significance for the company. There cannot
be any hard-and-fast rules for making a distinction between relevant and irrelevant. Consider, for example, the demise of the steam locomotive industry.
Management’s creativity and farsightedness would play an important role in acompany’s ability to pinpoint relevant areas of concern. Described below is oneway (for a large corporation) of identifying relevant trends in the environment:

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EXHIBIT 6-4
Linking Environmental Scanning to Corporate Strategy• Place a senior person in charge of scanning.
• Identify a core list of about 100 relevant publications worldwide.
• Assign these publications to volunteers within the company, one per person.
Selected publications considered extremely important should be scanned by
the scanning manager.
• Each scanner reviews stories/articles/news items in the assigned publicationthat meet predetermined criteria based on the company’s aims. Scanners
might also review books, conference proceedings, lectures, and presentations.
• The scanned information is given a predetermined code. For example, aworldwide consumer-goods company used the following codes: subject (e.g.,politics); geography (e.g., Middle East); function (e.g., marketing); application(e.g., promotion, distribution); and “uniterm,” or keyword, for organizing theinformation. An abstract is then prepared on the story.
• The abstract, along with the codes, is submitted to a scanning committee, consisting of several managers, to determine its relevance in terms of effect on
corporate, SBU, and product/market strategy. An additional relevance code isadded at this time.

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CHAPTER 6 Scanning the Environment147• The codes and the abstract are computerized.
• A newsletter is prepared to disseminate the information companywide.
Managers whose areas are directly affected by the information are encouraged
to contact the scanning department for further analysis.
3. Study the impact of an environmental trend on a product/market—An environmental trend can pose either a threat or an opportunity for a company’s
product/market; which one it turns out to be must be studied. The task of determining the impact of a change is the responsibility of the SBU manager.
Alternatively, the determination may be assigned to another executive who isfamiliar with the product/market. If the whole subject appears controversial, it
may be safer to have an ad hoc committee look into it; or consultants, either internal or external, may be approached. There is a good chance that a manager who
has been involved with a product or service for many years will look at any
change as a threat. That manager may, therefore, avoid the issue by declaring theimpact to be irrelevant at the outset. If such nearsightedness is feared, perhaps it
would be better to rely on a committee or a consultant.
4. Forecast the direction of an environmental trend into the future—If an environmental trend does appear to have significance for a product/market, it is desirable to determine the course that the trend is likely to adopt. In other words,
attempts must be made at environmental forecasting.
5. Analyze the momentum of the product/market business in the face of the environmental trend—Assuming that the company takes no action, what will be theshape of the product/market performance in the midst of the environmental
trend and its future direction? The impact of an environmental trend is usually
gradual. While it is helpful to be the “first” to recognize a trend and take action,
all is not lost if a company waits to see which way the trend proceeds. But how
long one waits depends on the diffusion process, the rate at which the change
necessitated by the trend is adopted. People did not jump to replace their blackand-white television sets overnight. Similar examples abound. A variety of reasons may prohibit an overnight shift in markets due to an environmental trendthat may deliver a new product or process. High prices, religious taboos, legal
restrictions, and unfamiliarity with the product or service would restrictchangeover. In brief, the diffusion process should be predicted before arriving at
a conclusion.
6. Study the new opportunities that an environmental trend appears to provide—
An environmental trend may not be relevant for a company’s current
product/market, but it may indicate promising new business opportunities. For
example, the energy crisis provided an easy entry point for fuel-efficient Hondas
into the United States. Such opportunities should be duly pinpointed and analyzed for action.
7. Relate the outcome of an environmental trend to corporate strategy—Based on
environmental trends and their impacts, a company needs to review its strategy
on two counts: changes that may be introduced in current products/markets andfeasible opportunities that the company may embrace for action. Even if an environmental trend poses a threat to a company’s product/market, it is not necessary for the company to come out with a new product to replace an existing one.
Neither is it necessary for every competitor to embrace the “change.” Even without developing a new product, a company may find a niche in the market toScanning the Environment

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which it could cater despite the introduction of a new product by a competitor.
The electric razor did not make safety razor blades obsolete. Automatic transmissions did not throw the standard shift out of vogue. New markets and new uses
can be found to give an existing product an advantage despite the overall popularity of a new product.

Although procedural steps for scanning the environment exist, scanning isnevertheless an art in which creativity plays an important role. Thus, to adequately
study the changing environment and relate it to corporate strategy, companies
should inculcate a habit of creative thinking on the part of its managers. The experience of one insurance company illustrates the point: in order to “open up” line
managers to new ideas and to encourage innovation in their plans, they are, for awhile, withdrawn from the line organization to serve as staff people. In staff positions, they are granted considerable freedom of action, which enhances their ability to manage creatively when they return to their management positions.

CONDUCTING ENVIRONMENTAL SCANNING: AN EXAMPLE
Following the steps in Exhibit 6-5, an attempt is made here to illustrate how specific trends in the environment may be systematically scanned.
A search of the literature in the area of politics shows that the following federal laws were considered as we approach the next century:
1. Requiring that all ad claims be substantiated.
2. Publishing corporate actions that endanger the environment.
3. Disclosing lobbying efforts in detail.
4. Reducing a company’s right to fire workers at will.
5. Eliminating inside directors.

EXHIBIT 6-5
Systematic Approach to Environmental Scanning
1.
2.

3.
4.
5.
6.

7.
8.
9.

Pick up events in different environments (via literature search).
Delineate events of interest to the SBU in one or more of the following areas: production, labor, markets (household, business, government, foreign), finance, or researchand development. This could be achieved via trend-impact analysis of the events.
Undertake cross-impact analysis of the events of interest.
Relate the trends of the noted events to current SBU strategies in different areas.
Select the trends that appear either to provide new opportunities or to pose threats.
Undertake forecasts of each trend—wild card prediction—most probable occurrence—conservative estimate
Develop three scenarios for each trend based on three types of forecasts.
Pass on the information to strategists.
Repeat Steps 4 to 7 and develop more specific scenarios vis-à-vis different products/
markets. Incorporate these scenarios in the SBU strategy.

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The marketing strategist of a consumer-goods company may want to determine if any of these trends has any relevance for the company. To do so, the strategist may undertake trend-impact analysis. Trend-impact analysis requires theformation of a delphi panel (see Chapter 12) to determine the desirability (0-1),
technical feasibility (0-1), probability of occurrence (0-1), and probable time ofoccurrence (2000, 2005, and beyond 2005) of each event listed. The panel may also
be asked to suggest the area(s) that may be affected by each event (i.e., production, labor, markets [household, business, government, export], finance, or
research and development).
Information about an event may be studied by managers in areas that, according to the delphi panel, are likely to be affected by the event. If their consensus isthat the event is indeed important, scanning may continue (see Exhibit 6-6).
Next, cross-impact analysis may be undertaken. This type of analysis studies
the impact of an event on other events. Where events are mutually exclusive, suchanalysis may not be necessary. But where an event seems to reinforce or inhibit
other events, cross-impact analysis is highly desirable for uncovering the true
strength of an event.
Cross-impact analysis amounts to studying the impact of an event (given its
probability of occurrence) upon other events. The impact may be delineatedeither in qualitative terms (such as critical, major, significant, slight, or none) or inquantitative terms in the form of probabilities.
Exhibit 6-7 shows how cross-impact analysis may be undertaken. Crossimpact ratings, or probabilities, can best be determined with the help of another

EXHIBIT 6-6
Trend-Impact Analysis: An Example
Requiring That All Ad
Claims Be SubstantiatedReducing a Company’s Right
to Fire Workers at Will

Desirability

0.8

0.5

Feasibility

0.6

0.3

Probability of occurrence

0.5

0.1

Probable time of occurrence

1995

Beyond 2000

Event

Area(s) impacted

Household markets
Business markets
Government markets
FinanceResearch and development
Production

Labor
Finance

Decision

Carry on scanning

Drop from further
consideration

Note: Two to three rounds of delphi would be needed to arrive at the above probabilities.

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EXHIBIT 6-7
Cross-Impact Analysis: An Example
Probability of
Occurrence

Event
a. Requiring that all ad claims be substantiatedb. Publishing corporate actions that
endanger workers or environmentc. Disclosing lobbying efforts in detaild. Reducing a company’s right to fire
workers at wille. Eliminating inside directors

Impact
a

0.5
0.4

b

c

d

e

0.1*
0.7**

0.4
0.1
0.6

*This means that requiring that all claims be substantiated has no effect on the probability of
Event d.
**This means that if publishing corporate actions that endanger workers or the environment
occurs (probability 0.4), the probability of requiring that all ad claims be substantiated increases
from 0.5 to 0.7.

delphi panel. To further sharpen the analysis, whether the impact of an event onother events will be felt immediately or after a certain number of years may also
be determined.
Cross-impact analysis provides the “time” probability of the occurrence of anevent and indicates other key events that may be monitored to keep track of thefirst event. Cross-impact analysis is more useful for project-level scanning thanfor general scanning.
To relate environmental trends to strategy, consider the following environmental trends and strategies of a cigarette manufacturer:
Trends
T1:
T2:
T3:
T4:
T5:

Requiring that all ad claims be substantiated.
Publishing corporate actions that endanger workers or the environment.
Disclosing lobbying efforts in detail.
Reducing a company’s right to fire workers at will.
Eliminating inside directors.

Strategies
S1: Heavy emphasis on advertising, using emotional appeals.
S2: Seasonal adjustments in labor force for agricultural operations of the company.
S3: Regular lobbying effort in Washington against further legislation imposing
restrictions on the cigarette industry.
S4: Minimum number of outside directors on the board.

The analysis in Exhibit 6-8 shows that Strategy S1, heavy emphasis on advertising, is most susceptible and requires immediate management action. Among

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CHAPTER 6 Scanning the Environment

EXHIBIT 6-8
Matrix to Determine the Impact of Selected Trends on Different Corporate Strategies
Strategies

Impact (I1)

Trends

S1

S2

S3

S4

+

–

T1

–8

0

+2

–2

8

T2

–4

–2

–6

0

12

T3

0

+4

–4

+2

2

T4

0

–4

0

+6

2

T5

–2

+6

+4

+2

10

+

–

4

–

8

–

14

–

4

–

Scale
+8
+6
+2
+2

Enhance theimplementationof strategy

0
–2
–4
–6
–8

Critical
Major
Significant
SlightNo effect

Inhibit theimplementationof strategy

SlightSignificant
Major
Criticalthe trends, Trend T5, eliminating inside directors, will have the most positive
overall impact. Trends T1 and T2, requiring that all ad claims be substantiated andpublishing corporate actions that endanger the environment, will have a devastating impact. This type of analysis indicates where management concern andaction should be directed. Thus, it will be desirable to undertake forecasts ofTrends T1 and T2. The forecasts may predict when the legislation will be passed,
what will be the major provisions of the legislation, and so on. Three different
forecasts may be obtained:
1. Extremely unfavorable legislation.
2. Most probable legislation.
3. Most favorable legislation.

Three different scenarios (using three types of forecasts) may be developed toindicate the impact of each trend. This information may then be passed on to
product/market managers for action. Product/market managers may repeat
Steps 4 through 7 (see Exhibit 6-5), studying selected trend(s) in depth.

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ORGANIZATIONAL ARRANGEMENTS AND PROBLEMS
Corporations organize scanning activity in three different ways: (a) line managers
undertake environmental scanning in addition to their other work; (b) scanning
is made a part of the strategic planner’s job; (c) scanning responsibility is instituted in a new office of environmental scanning.
Structuring
Responsibility
for Scanning

Most companies use a combination of the first two types of arrangements. The
strategic planner may scan the corporate-wide environment while line managers
concentrate on the product/market environment. In some companies, a new
office of environmental scanning has been established with a responsibility for all
types of scanning.25 The scanning office undertakes scanning both regularly andon an ad hoc basis (at the request of one of the groups in the company).
Information scanned on a regular basis is passed on to all in the organization forwhom it may have relevance. For example, General Electric is organized into sectors, groups, and SBUs. The SBU is the level at which product/market planning
takes place. Thus, scanned information is channeled to those SBUs, groups, andsectors for which it has relevance. Ad hoc scanning may be undertaken at therequest of one or more SBUs. These SBUs then share the cost of scanning and are
the principal recipients of the information.
The environmental scanner serves to split the work of the planner. If the planner already has many responsibilities and if the environment of a corporation iscomplex, it is desirable to have a person specifically responsible for scanning.
Further, it is desirable that both planners (and/or scanners) and line managers
undertake scanning because managers usually limit their scanning perceptions totheir own industry; that is, they may limit their scanning to the environment withwhich they are most familiar. At the corporate level, scanning should go beyond
the industry.
Whoever is assigned to scan the environment should undertake the following
six tasks:
1. Trend monitoring—Systematically and continuously monitoring trends in theexternal environments of the company and studying their impact upon the firm
and its various constituencies.
2. Forecast preparation—Periodically developing alternative scenarios, forecasts,
and other analyses that serve as inputs to various types of planning and issue
management functions in the organization.
3. Internal consulting—Providing a consulting resource on long-term environmental matters and conducting special future research studies as needed to support
decision-making and planning activities.
4. Information center—Providing a center to which intelligence and forecasts
about the external environment from all over the organization can be sent forinterpretation, analysis, and storage in a basic library on long-range environmental matters.
5. Communications—Communicating information on the external environment tointerested decision makers through a variety of media, including newsletters,
special reports, internal lectures, and periodic analyses of the environment.

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153

6. Process improvement—Continually improving the process of environmental
analysis by developing new tools and techniques, designing forecasting systems,
applying methodologies developed elsewhere, and engaging in a continuing
process of self-evaluation and self-correction.

Successful implementation of these tasks should provide increased awareness and understanding of long-term environments and improve the strategicplanning capabilities of the firm. More specifically, environmental inputs arehelpful in product design, formulation of marketing strategies, determination ofmarketing mix, and research and development strategies.
In addition, the scanner should train and motivate line managers to become
sensitive to environmental trends, encouraging them to identify strategic versus
tactical information and to understand the strategic problems of the firm as
opposed to short-term sales policy and tactics.
Time Horizonof Scanning

Scanning may be for a short term or a long term. Short-term scanning is useful for
programming various operations, and the term may last up to two years. Longterm scanning is needed for strategic planning, and the term may vary from three
to twenty-five years. Rarely does the term of scanning go beyond twenty-fiveyears. The actual time horizon is determined by the nature of the product. Forest
products, for example, require a longer time horizon because the company must
make decisions about tree planting almost twenty-five years ahead of harvesting
those trees for lumber. Fashion designers, however, may not extend scanningbeyond four years. As a rule of thumb, the appropriate time horizon for environmental scanning is twice as long as the duration of the company’s strategic plan.
For example, if a company’s strategic plan extends eight years into the future, theenvironmental scanning time horizon should be sixteen years. Likewise, a company with a five-year planning horizon should scan the environment for ten
years. Presumably, then, a multiproduct, multimarket company should have different time horizons for environmental scanning. Using this rule of thumb, a company can be sure not only of discovering relevant trends and their impact on its
products/markets but also of implementing necessary changes in its strategy tomarshal opportunities provided by the environment and to avert environmental
threats.
Discussed below are the major problems companies face in the context ofenvironmental scanning.26 Many of these problems are, in fact, dilemmas that
may be attributed to a lack of theoretical frameworks on the subject.
1. The environment per se is too broad to be tracked by an organization; thus, itis necessary to separate the relevant from the irrelevant environment.
Separating the relevant from the irrelevant may not be easy since, in terms ofperceptible realities, the environment of all large corporations is as broad as
the world itself. Therefore, a company needs to determine what criteria todevelop to select information on a practical basis.
2. Another problem is concerned with determining the impact of an environmental trend, that is, with determining its meaning for business. For example,

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PART 2 Strategic Analysis

3.

4.

5.

6.

7.

8.
9.
10.

11.

SUMMARY

what does the feminist movement mean for a company’s sales and new business opportunities?
Even if the relevance of a trend and its impact are determined, making forecasts of the trend poses another problem. For example, how many women
will be in managerial positions ten years from now?
A variety of organizational problems hinder environmental scanning.
Presumably, managers are the company’s ears and eyes and therefore should
be good sources for perceiving, studying, and channeling pertinent information within the organization. But managers are usually so tied up mentallyand physically within their specific roles that they simply ignore happenings
in the environment. The structuring of organizations by specialized functions
can be blamed for this problem to a certain extent. In addition, organizations
often lack a formal system for receiving, analyzing, and finally disseminating
environmental information to decision points.
Environmental scanning requires “blue sky” thinking and “ivory tower”
working patterns to encourage creativity, but such work perspectives areoften not justifiable in the midst of corporate culture.
Frequently top managers, because of their own values, consider dabbling in
the future a waste of resources; therefore, they adopt unkind attitudes toward
such projects.
Many companies, as a matter of corporate strategy, like to wait and see; therefore, they let industry leaders, the ones who want to be first in the field, act
on their behalf.
Lack of normative approaches on environmental scanning is another problem.
Often, a change is too out of the way. It may be perceived, but its relationshipto the company is not conceivable.
It is also problematic to decide what department of the organization should
be responsible for environmental scanning. Should marketing research undertake environmental scanning? How about the strategic planning office? Whoelse should participate? Is it possible to divide the work? For example, theSBUs may concentrate on their products, product lines, markets, and industry.
The corporate level may deal with the rest of the information.
Often, information is gathered that is overlapping, leading to a waste ofresources. There are frequently informational gaps that require duplication ofeffort.

The environment is ever-changing and complex; thus firms must constantly
scan and monitor it. Environmental scanning may be undertaken at three levelsin the organization: corporate level, SBU level, and product/market level. This
chapter approaches scanning primarily from the SBU viewpoint. The environments discussed are technological, political, economic, social, and regulatory.
Environmental scanning evolves over a long haul. It is sufficient, therefore, tomake a humble beginning rather than designing a fully structured system.
The impact of different environments on marketing strategy was illustrated
by numerous examples. A step-by-step procedure for scanning the environment
was outlined. A systematic approach to environmental scanning, using such techniques as trend-impact analysis, cross-impact analysis, and the delphi method,

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CHAPTER 6 Scanning the Environment155

was illustrated. Feasible organizational arrangements for environmental scanning were examined, and problems that companies face in their scanning endeavors were discussed.

DISCUSSIONQUESTIONS

NOTES

1. Explain the meaning of environmental scanning. Which constituents of theenvironment, from the viewpoint of a corporation, require scanning?
2. Illustrate with examples the relevance of technological, political, economic,
social, and regulatory environments in the context of marketing strategy.
3. Who in the organization should be responsible for scanning the environment?
What role may consultants play in helping corporations in their environmental scanning activity?
4. Explain the use of trend-impact analysis and cross-impact analysis with reference to environmental scanning.
5. How may the delphi technique be useful in the context of environmental scanning? Give an example.
6. What types of responsibilities should be assigned to the person in charge ofenvironmental scanning?
7. How may managers be involved in environmental scanning?

1 Richard Gibson, “Super-Cheap and Midpriced Eateries Bite Fast-Food Chains from

Both Sides,” The Wall Street Journal (22 June 1990): B1.
2 Francis Joseph Aguilar, Scanning the Business Environment (New York: Macmillan Co.,

1967), 40.
Subhash C. Jain, “Environmental Scanning: How the Best Companies Do It,” Long
Range Planning (April 1984): 117–28.
4 Harold E. Klein and Robert E. Linneman, “Environmental Assessment: An
International Study of Corporate Practice,” Journal of Business Strategy (Summer
1984): 66–92. Also see Anil Menon and P. Rajan Varadarajan, “A Model of Marketing
Knowledge Use Within Firms,” Journal of Marketing (October 1992): 53–71.
5 ”What’s Foiling the Aluminum Can,” Business Week, (6 October 1997): 106.
6 ”Shop-Till-You-Drop at the Touch Of a Button,” Financial Times (9 June 1994): 11.
7 Richard N. Foster, Innovation: The Attacker’s Advantage (New York: Summit Books,
1986).
8 “Electric Cars in California,” Business Week (1 October 1990): 40.
9 Alex Taylor III, “Rough Road Ahead,” Fortune, (17 March 1997): 115.
10 Anne B. Fisher, “What Consumers Want in the 1990s,” Fortune (29 January 1990): 108.
11 Raju Narisetti, “P&G, Seeing Shoppers Were Being Confused, Overhauls Marketing,”
The Wall Street Journal, (15 January 1997): A1.
12 Howard Schlossberg, “Report Says Environmental Marketing Claims Level Off,”
Marketing News (24 May 1993): 12.
13 J. Brooke Aker and Cornelia Hanbury, “The Changing Concept of Home,” The Futures
Group Outlook (December 1994): 2.
14 ”Real Men Buy Paper Towels, Too,” Business Week (9 November 1992): 75.
15 See Stan Rapp and Thomas L. Collins, Beyond Maxi-Marketing: The New Power of Caring
And Daring (New York: McGraw-Hill, Inc., 1994), 10–11.
3

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16 “The Time Compressed Shopper,” Marketing Insights (Summer 1991): 36.
17 Time (7 March 1988): 84.
18 “Yolkless Dunkin Donuts,” Business Week (8 April 1991): 70.
19 Richard Gibson, “Lean and Mean: Hardee’s Joins Low-Fat Fray,” The Wall Street Journal(15 July 1991): B1. Also see Eleena De Lisser, “Taco Bell, Low-Price King, Will Offer
Low-Fat Line,” The Wall Street Journal (6 February 1995): B1.
20 John B. Hinge, “Some Companies Serve Up Lighter Liquor,” The Wall Street Journal (25April 1991): B1. See also “Changing the Game,” Marketing Insights (Summer 1990):
68–81.
21 Trish Hall, “Americans Drink Less, and Makers of Alcohol Feel a Little Woozy,” The
Wall Street Journal (14 March 1984): 1; and Allan Luks, “Dealcoholized Beverages:
Changing the Way Americans Drink,” The Futurist (October 1982): 44–49. See also
“The Spirited Battle for Those Who Want to Drink Light,” Business Week (16 June1986): 84; and Michael Rogers, “A Sales Kick from Beer without the Buzz,” Fortune(23 June 1986): 89.
22 Murray L. Weidenbaum, “The Future of Business/Government Relations in the UnitedStates,” in The Future of Business, ed. Max Ways (New York: Pergamon Press, 1978),50. See also Robert Reich, “The Fourth Wave of Regulation,” Across the Board (May1982).
23 John Greenwald, “Frito-Lay Under Snack Attack,” Time, (10 June 1996): 62–63.
24 Paul B. Carroll, “Computer-Ordering Method Helps Newcomer Blossom,” The WallStreet Journal (22 January 1991): B2. See also Bill Saportio, “Are IBM and Sears Crazy?
or Canny?” Fortune (28 September 1987): 74.
25 See R. T. Lenz and Jack L. Engledow, “Environmental Analysis Units and Strategic
Decision-Making: A Field Study of Selected Leading-Edge Corporations,” Strategic
Management Journal 7 (1986): 69–89. See also TFG Reports (November 1990).
26 See Hugh Courtney, Jane Kirkland, and Patrick Viguerie, “Strategy Under
Uncertainty,” Havard Business Review, (November–December, 1997).

APPENDIX

Scanning Techniques
Traditionally, environmental scanning has been implemented mainly with theuse of conventional methods, including marketing research, economic indicators, demand forecasting, and industry studies. But the use of such conventional techniques for environmental scanning is not without pitfalls. These
techniques have failed to provide reliable insights into the future. Discussed
below are a variety of new techniques that have been adapted for use in environmental scanning.

Extrapolation
Procedures

These procedures require the use of information from the past to explore thefuture. Obviously, their use assumes that the future is some function of the past.
There are a variety of extrapolation procedures that range from a simple estimate of the future (based on past information) to regression analysis.

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157

Historical Analogy

Where past data cannot be used to scan an environmental phenomenon, the phenomenon may be studied by establishing historical parallels with other phenomena. Assumed here is the availability of sufficient information on otherphenomena. Turning points in the progression of these phenomena become
guideposts for predicting the behavior of the phenomenon under study.

Intuitive
ReasoningThis technique bases the future on the “rational feel” of the scanner. Intuitive reasoning requires free thinking unconstrained by past experience and personalbiases. This technique, therefore, may provide better results when used by freelance think tanks than when used by managers on the job.

Scenario BuildingThis technique calls for developing a time-ordered sequence of events bearing a
logical cause-and-effect relationship to one another. The ultimate forecast is basedon multiple contingencies, each with its respective probability of occurrence.

Cross-Impact
Matrices

When two different trends in the environment point toward conflicting futures,
this technique may be used to study these trends simultaneously for their effect.
As the name implies, this technique uses a two-dimensional matrix, arraying one
trend along the rows and the other along the columns.
Some of the features of cross-impact analyses that make them attractive forstrategic planning are that (a) they can accommodate all types of eventualities(social or technological, quantitative or qualitative, and binary events or continuous functions), (b) they rapidly discriminate important from unimportantsequences of developments, and (c) their underlying rationale is fully retraceablefrom the analysis.

Morphological
Analysis

This technique requires identification of all possible ways to achieve an objective.
For example, the technique can be employed to anticipate innovations and todevelop optimum configurations for a particular mission or task.

Network Models

There are two types of network methods: contingency trees and relevance trees.
A contingency tree is simply a graphical display of logical relationships among
environmental trends that focuses on branch-points where several alternative
outcomes are possible. A relevance tree is a logical network similar to a contingency tree but is drawn in a way that assigns degrees of importance to various
environmental trends with reference to an outcome.

Missing-Link
Approach

The missing-link approach combines morphological analysis and the network
method. Many developments and innovations that appear promising and marketable may be held back because something is missing. Under these circumstances, this technique may be used to scan new trends to see if they provide
answers to any missing links.

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Model BuildingThis technique emphasizes the construction of models following deductive or
inductive procedures. Two types of models may be constructed: phenomenological models and analytic models. Phenomenological models identify trends as abasis for prediction but make no attempt to explain underlying causes. Analytic
models seek to identify underlying causes of change so that future developments
may be forecast on the basis of a knowledge of their causes.

Delphi Technique

The delphi technique is the systematic solicitation of expert opinion. Based onreiteration and feedback, this technique gathers opinions of a panel of experts on
happenings in the environment.

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7
CHAPTER SEVEN

Measuring Strengths
and Weaknesses
To measure is thefirst step to improve.
SIR WILLIAM PETTY

A

business does not perform well by accident. Good performances occur
because the people directing the affairs of the business interact well with theenvironment, capitalizing on its strengths and eliminating underlying weaknesses. In other words, to operate successfully in a changing environment, thebusiness should plan its future objectives and strategies around its strengths anddownplay moves that bear on its weaknesses. Thus, assessment of strengths andweaknesses becomes an essential task in the strategic process.
In this chapter, a framework will be presented for identifying and describing
a business’s strengths and weaknesses. The framework also provides a systematic
scheme for an objective appraisal of the performance and strategic moves of themarketing side of business.
The appraisal of the marketing function has traditionally been pursued in theform of a marketing audit that stresses the review of current problems. From thestrategic point of view, the review should go further to include the future as well.
Strengths and weaknesses in the context of marketing are relative phenomena. Strengths today may become weaknesses tomorrow and vice versa. This is
why a penetrating look at the different aspects of a business’s marketing programis essential. This chapter is directed toward these ends—searching for opportunities and the means for exploiting them and identifying weaknesses and the ways
in which they may be eliminated.

MEANING OF STRENGTHS AND WEAKNESSES
Strengths refer to the competitive advantages and other distinctive competencies
that a company can exert in the marketplace. Andrews notes that “the distinctive
competence of an organization is more than what it can do; it is what it can doparticularly well.”1 Weaknesses are constraints that hinder movements in certain
directions. For example, a business short of cash cannot afford to undertake alarge-scale promotional offensive. In developing marketing strategy, the businessshould, among other things, dig deeply into its skills and competencies and chart
its future in accordance with these competencies.
160

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CHAPTER 7 Measuring Strengths and Weaknesses161

As an example, in many businesses, service—speed, efficiency, personal
attention—makes a crucial difference in gaining leverage in the marketplace.
Companies that score higher than their rivals in the category of service have a realcompetitive strength. McDonald’s may not be everyone’s idea of the best place intown to dine, but at its level, McDonald’s provides a quality of service that is theenvy of the industry. Whether at a McDonald’s in a rural community or in the
downtown area of a large city, the customer gets exactly the same service. Every
McDonald’s employee is supposed to strictly follow the rules. Cooks must turn,never flip, hamburgers one, never two, at a time. If they haven’t been purchased,
Big Macs must be discarded ten minutes after being cooked; french fries after
seven minutes. Cashiers must make eye contact with and smile at every customer.
Similarly, visitors to Disney World come home impressed with its cleanliness
and with the courtesy and competence of the staff. The Disney World management works hard to make sure that the 14,200 employees are, as described in a
Fortune article, “people who fulfill an expectation of wholesomeness, always
smiling, always warm, forever positive in their approach.”2

STUDYING STRENGTHS AND WEAKNESSES: STATE OF THE ART
A systematic scheme for analyzing strengths and weaknesses is still in embryonicform.3 One finds few scholarly works on the subject of strengths and weaknesses.
An interesting study on the subject was done by Stevenson, who examined six
companies.4 He was interested in the process of defining strengths and weaknesses in the context of strategic planning. He was concerned with the company
attributes examined, the organizational scope of the strengths and weaknesses
identified, the measurement employed in the process of definition, the criteria
used for distinguishing a strength from a weakness, and the sources of information used. Exhibit 7-1 illustrates the process in detail.
Companies should make targeted efforts to identify their competitive
strengths and weaknesses. This is a far from easy process, however. Many companies, especially the large ones, have only the vaguest notion of the nature anddegree of the competencies that they may possess. The sheer multiplicity of production stages and the overlapping among product lines hinder clear-cut assessment of the competitive strength of a single product line. Despite such problems,development of competitive strategy depends on having a complete perspective
on strengths and weaknesses. Success requires putting the best foot forward.
Unique strengths may lie in different areas of the business and may impact
the entire company. Stevenson found a general lack of agreement on suitable definitions, criteria, and information used to measure strengths and weaknesses. In
addition to the procedural difficulties faced by managers in their attempts tomeasure strengths and weaknesses, the need for situational analysis, the need for
self-protection, the desire to preserve the status quo, and the problems of definition and computational capacity complicated the process. Stevenson makes thefollowing suggestions for improvement of the process of defining strengths andweaknesses. The manager should

Organizational structure
Major policies
Top manager’s skills
Information system
Operation procedures
Planning system

With What Organizational
Entity Is the Manager
Concerned?

What Types of
Measurements Can theManager Make?

What Criteria Are
Applicable to Judge aStrength or a Weakness?

How Can the Manager Get
the Information to Make
These Assessments?

The corporation

Measure the existenceof an attribute

Historical experienceof the company

Personal observation

Measure an attribute’s
efficiency

Intracompany competition

Experience

Measure an attribute’s
effectivenessDirect competitors

Control system documents

GroupsDivision
Departments
Individual employees

Other companies
Consultant’s opinions

Customer contacts

Meetings
Planning system documents

Union agreements

Normative judgments
based on management’s understandingof literature

Technical skills

Personal opinions

Superordinate managers

Research skills

Specific targets ofaccomplishment, suchas budgets, etc.

Peers

Employee attitudes
Manager’s attitudes

New product ideas
Production facilities

Subordinate managers

Published documents
Competitive intelligence
Board members
Consultants

Distribution network

Journals

Sales force’s skill

Books

Breadth of product line

Magazines

Quality control procedures

Professional meetings

Stock market reputation

Government economic
indicators

Knowledge of consumer’s needs
Market domination

Measuring Strengths and Weaknesses

Demographic characteristics of personnel

Employees

PART 3 Strategic Capabilities and Direction

Which Attributes Can Be
Examined?

162

EXHIBIT 7-1
Steps in the Process of Assessing Strengths and Weaknesses

Source: Reprinted from “Defining Corporate Strengths and Weaknesses,” by Howard H. Stevenson, Sloan Management Review, Vol. 17, No. 3 (Spring,1976), p. 54, by permission of the publisher. Copyright © 1976 by Sloan Management Review Association. All rights reserved.

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CHAPTER 7 Measuring Strengths and Weaknesses

163• Recognize that the process of defining strengths and weaknesses is primarily an
aid to the individual manager in the accomplishment of his or her task.
• Develop lists of critical areas for examination that are tailored to the responsibility and authority of each individual manager.
• Make the measures and the criteria to be used in evaluation of strengths andweaknesses explicit so that managers can make their evaluations against a common framework.
• Recognize the important strategic role of defining attributes as opposed to efficiency or effectiveness.
• Understand the difference in the use of identified strengths and identified weaknesses.5

Despite the primitive state of the art, today many more companies review theirstrengths and weaknesses in the process of developing strategic plans than did 10
years ago. Strengths and weaknesses may be found in the functional areas of thebusiness, or they may result from some unusual interaction of functions. The following example illustrates how a study of strengths and weaknesses may uncoveropportunities that might otherwise have not been conceived. A national distiller
and marketer of whiskeys may possess such strengths as sophistication in naturalcommodity trading associated with its grain purchasing procedures; knowledge ofcomplex warehousing procedures and inventory control; ability and connections
associated with dealing in state political structures (i.e., state liquor stores, licensing
agencies, and so on); marketing experience associated with diverse wholesale andretail outlets; and advertising experience in creating brand images. If thesestrengths are properly analyzed with a view to seeking diversification opportunities, it appears that the distiller has unique abilities for successfully entering thebusiness of selling building products, such as wood flooring or siding and composition board. The distiller’s experience in commodity trading can be transferred to
trading in lumber; its experience in dealing with political groups can be used togain building code acceptances; and its experience in marketing can apply towholesalers (e.g., hardware stores and do-it-yourself centers) of building products.
The case of XYZ Corporation, on the other hand, illustrates how a company
can get into trouble if it does not carefully consider its strengths and weaknesses.
XYZ was a Northfield, Illinois, company with a penchant for diversifying intobusinesses that were in vogue in the stock market. Until it was reorganized as the
Lori Corporation in 1985, it had been in the following businesses: office copying
machines, mobile homes, jewelry, speedboats and cabin cruisers, computers,
video recording systems, and small buses. Despite entry into some glamorous
fields, XYZ did not share the growth and profits that other companies in some ofthese fields achieved. This is because XYZ entered new and diverse businesses
without relating its moves to its basic skills and competencies. For example,
despite the fact that it was the first company to develop a photocopy process,developing its process even before Xerox, its total market share for all types ofcopier machines and supplies in 1984 was well under 3 percent. XYZ Corporation
could not keep pace with technological improvements nor with service on
installed machines, an essential competency in the copier business. In addition, itMeasuring Strengths and Weaknesses

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PART 3 Strategic Capabilities and Direction

overextended itself so much so that managerial controls were rendered inadequate. The company finally got out of all its trendy businesses and was reorganized in 1985 to design, manufacture, and distribute costume jewelry, fashion
jewelry, and fashion accessories. Beginning in 1990, the company started making
some money for its owners.6

SYSTEMATIC MEASUREMENT OF STRENGTHS AND WEAKNESSESThe strengths and weaknesses of a business can be measured at different levels in
the organization: corporate, SBU, and product/market level. The thrust of thischapter is on the measurement of strengths and weaknesses at the SBU level.
However, as the strengths and weaknesses of the SBU are a composite of thestrengths and weaknesses of different products/markets, the major portion of the
discussion will be devoted to the measurement of the marketing strengths andweaknesses of a product/market.
Exhibit 7-2 illustrates the factors that require examination in order to delineate the strengths and weaknesses of a product/market. These factors, along withcompetitive perspectives, describe the strengths and weaknesses of the product.
Current Strategic
PostureCurrent strategic posture constitutes a very important variable in developing
future strategy. Although it is difficult and painful to try to understand current
strategy if formal planning has not been done in the past, it is worth the effort toprobe current strategy to achieve a good beginning in strategic planning.
The emphasis here is on the study of the current strategy of a product/
market. Before undertaking such a study, however, it is desirable to assess company-wide perspectives by raising such questions as
1. What underlies our company’s success, given competitors’ patterns of doing
business?
2. Are there any characteristics and traits that have been followed regularly?
3. To what strategic posture do these characteristics and traits lead?
4. What are the critical factors that could make a difference in the success of thestrategy?
5. To what extent are critical factors likely to undergo a change? What may be thedirection of change?

These questions cannot be answered entirely objectively; they call for creative
responses. Managers often disagree on various issues. For example, the vice president of marketing of a company that had recently made a heavy investment insales training considered this investment to be a critical success factor. He thoughta well-trained sales staff was crucial for developing new business. On the other
hand, the vice president of finance saw only that the investment in training had
increased overhead. Though disagreements of this sort are inevitable, a review ofcurrent strategy is very important. The operational scheme for studying current
strategy from the point of view of the entire corporation outlined below has beenfound useful.

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EXHIBIT 7-2
Measurement of Product Strengths and Weaknesses

1. Begin with an identification of the actual current scope of the company’s activities. The delineation of customer/product/market emphasis and concentration
will give an indication of what kind of a company the company is currently.
2. An analysis of current scope should be followed by identification of the patternof actual past and existing resource deployments. This description will show
which functions and activities receive the greatest management emphasis andwhere the greatest sources of strength currently lie.
3. Given the identification of scope and deployment patterns, an attempt should bemade to deduce the actual basis on which the company has been competing.
Such competitive advantages or distinctive competencies represent the central
core of present performance and future opportunities.
4. Next, on the basis of observation of key management personnel, the actual performance criteria (specifications), emphasis, and priorities that have governed
strategic choices in the past should be determined.

Current Strategy ofa Product/Market

As far as marketing is concerned, the strategy for a product is formulated around
one or more marketing mix variables. In examining present strategy, the purpose
is to pinpoint those perspectives of the marketing mix that currently dominate

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strategy. The current strategy of a product may be examined by seeking answers
to the following two questions:
1. What markets do we have?
2. How is each market served?

What Markets Do We Have? Answering this question involves consideration of several aspects of the market:
1. Recognize different market segments in which the product is sold.
2. Build a demographic profile of each segment.
3. Identify important customers in each segment.
4. Identify those customers who, while important, also do business with competitors.
5. Identify reasons each important customer may have for buying the product fromus. These reasons may be economic (e.g., lower prices), functional (e.g., productfeatures not available in competing products), and psychological (e.g., “this perfume matches my individual chemistry”).
6. Analyze the strategic perspective of each important customer as it concerns thepurchase of our product. This analysis is relevant primarily for business customers. For example, an aluminum company should attempt to study the strategy
of a can manufacturer as far as its aluminum can business is concerned. Supposethat the price of aluminum is consistently rising and more and more can manufacturers are replacing all-aluminum cans with cans of a new alloy of plastic andpaper. Such strategic perspectives of an important customer should be examined.
7. Consider changes in each customer’s perspectives that may occur in the next few
years. These changes may become necessary because of shifts in the customer’s
environment (both internal and external), abilities, and resources.

If properly analyzed, information concerning what markets a company has
should provide insight into why customers buy the company’s products and how
likely it is that they will do business with the company in the future. For example, a paper manufacturer discovered that most of his customers did businesswith him because, in their opinion, his delivery schedules were more flexible thanthose of other suppliers. The quality of his paper might have been superior, too,
but this was not strategically important to his customers.
How Is Each Market Served? The means the company employs to serve different customers may be studied by analyzing the information contained in
Exhibit 7-3. A careful examination of this information will reveal the current strategy the company utilizes to serve its main markets. For example, analysis of theinformation in Exhibit 7-3 may reveal the following facts pertaining to a breakfast
cereal: Of the seven different segments in the market, the product is extremely
popular in two segments. Customers buy the product mainly for health reasonsor because of a desire to consume “natural” foods. This desire is strong enoughfor customers to pay a premium price for the product. Further, customers are willing to make a trip to another store (other than their regular grocery store) to buy
this product. Different promotional devices keep customers conscious of the“natural” ingredients in the product. This analysis may point toward the following strategy for the product:

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EXHIBIT 7-3
Information for Recognizing Present Market Strategy
1. Basis for segmenting the market
2. Definition of the markets for the product3. Profile of customers in each segment: age, income level, occupation, geographicallocation, etc.
4. Scope and dimensions of each market: size, profitability, etc.
5. Expected rate of growth of each segment
6. Requirements for success in each market
7. Market standing with established customers in each segment: market share, patternof repeat business, expansion of customer’s product use
8. Benefits that customers in different segments derive from the product: economics,
better performance, displaceable costs, etc.
9. Reasons for buying the product in different segments: product features, awareness,
price, advertising, promotion, packaging, display, sales assistance, etc.
10. Customer attitudes in different segments: brand awareness, brand image (mapping), etc.
11. Overall reputation of the product in each segment
12. Purchase or use habits that contribute to these attitudes
13. Reasons that reinforce customer’s faith in the company and product14. Reasons that force customers to turn elsewhere for help in using the product15. Life-cycle status of the product16. Story of the product line: quality development, delivery, service
17. Product research and improvements planned
18. Market share: overall and in different segments
19. Deficiencies in serving or assisting customers in using the product20. Possibility of reducing services in areas where customers are becoming more selfsufficient
21. Resource base: nature of emerging and developing resources—technical, marketing,financial—that could expand or open new markets for the product22. Geographic coverage of the product market
23. Identification of principal channels: dealer or class of trade
24. Buying habits and attitudes of these channels
25. Sales history through each type of channel
26. Industry sales by type of outlet: retail, wholesale, institutional; and by major types ofoutlets within each area: department store, chain store, specialty store, etc.
27. Overall price structure for the product28. Trade discount policy
29. Variations in price in different segments
30. Frequency of price changes
31. Promotional deals offered for the product32. Emphasis on different advertising media
33. Major thrust of advertising copy
34. Sales tips or promotional devices used by salespeopleMeasuring Strengths and Weaknesses

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1. Concentrate on limited segments.
2. Emphasize the naturalness of the product as its unique attribute.
3. Keep the price high.
4. Pull the product through with heavy doses of consumer advertising.

Where strategy in the past has not been systematically formulated, recognition of current strategy will be more difficult. In this case, strategy must be
inferred from the perspectives of different marketing decisions.
Past Performance

Evaluation of past performance is invaluable in measuring strengths and weaknesses because it provides historical insights into a company’s marketing strategy
and its success. Historical examination should not be limited to simply noting thedirections that the company adopted and the results it achieved but should also
include a search for reasons for these results. Exhibit 7-4 shows the type of information that is helpful in measuring past performance.
Strategically, the following three types of analysis should be undertaken tomeasure past performance: product performance profile, market performance
profile, and financial performance profile. Information used for developing a

EXHIBIT 7-4
Information for Measuring Past Performance
The Consumer
Identify if possible the current “light,” “moderate,” and “heavy” users of the product interms of
1. Recent trends in percentage of brand’s volume accounted for by each group.
2. The characteristics of each group as to sex, age, income, occupation, income group,and geographical location.
3. Attitudes toward the product and category and copy appeals most persuasive to eachgroup.
The Product
Identify the current consumer preference of the brand versus primary competition (andsecondary competition, if available), according to
1. Light, moderate, and heavy usage (if available).
2. The characteristics of each group as to sex, age, income, occupation, income group,
geographical location, size of family, etc.
Shipment History
Identify the recent shipment trends of the brand by total units and units/M population(brand development), according to districts, regions, and nation.
Spending History
Identify the recent spending trends on the brand by total dollars, dollar/M population,and per unit sold for advertising, for promotion, and for total advertising and promotion
by districts, regions, and nation.

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EXHIBIT 7-4
Information for Measuring Past Performance (continued)
Profitability History
Identify the recent trends of list price, average retail price (by sales areas), gross profit
margins, and profit before taxes (PBT), in addition to trends in
1. Gross profit as a percentage of net sales.
2. Total marketing as percentage of gross profit and per unit sold.
3. PBT as a percentage of net sales and per unit sold.
4. ROFE (Return of Funds Employed) for each recent fiscal year.
Share of Market History
Identify recent trends of
1. The brand’s share of market nationally, regionally, and district-wide.
2. Consumption by total units and percentage gain/loss versus year ago nationally,
regionally, and district-wide.
3. Distribution by pack size nationally, regionally, and district-wide.
Where applicable, trends in all of the above data should also be identified by store classification: chain versus independent (large, medium, and small).
Total Market History
Identify recent trends of the total market in terms of units and percentage gain/loss versus year ago nationally, regionally, and district-wide per M population, store type,
county size, type of user (exclusive versus partial user), retail price trends, and by user
characteristics (age, income, etc.).
Competitive History (Major Brands), Where Available
Identify significant competitive trends in share; consumption levels by sales areas andstore types; media and promotion expenditures; types of media and promotion; retailprice differentials; etc.

product performance profile is shown in Exhibit 7-5. A product may contribute tocompany performance in six different ways: through profitability, image of product leadership, furnishing a base for further technological growth, support of total
product line, utilization of company resources (e.g., utilization of excess plant
capacity), and provision of customer benefits (vis-à-vis the price paid). An example of this last type of contribution is a product that is a small but indispensable
part of another product or process with low cost relative to the value of the finished product. Tektronics, a manufacturer of oscilloscopes, is an example. An
oscilloscope is sold along with a computer. It is used to help install the computer,to test it, and to monitor its performance. The cost of the oscilloscope is small
when one considers the essential role it plays in the use of the much more expensive computer.
A market performance profile is illustrated in Exhibit 7-6. In analyzing how
well a company is doing in the segments it serves, a good place to begin is with themarginal profit contribution of each customer or customer group. Other measures

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EXHIBIT 7-5
Product Performance Profile Contribution to Company Performance

Product
Line

Profitability

Product
LeadershipTechnological
GrowthSupportof Total
ProductLine

Utilization ofCompany
Resources

ProvisionofCustomer
Benefits-------------

used are market share, growth of end user markets, size of customer base, distribution strength, and degree of customer loyalty. Of all these, only distribution
strength requires some explanation. Distribution and dealer networks can greatly
influence a company’s performance because it takes an enormous effort to cultivate
dealers’ loyalty and get repeat business from them. Distribution strength, therefore,
can make a significant difference in overall performance.
The real value of a strategy must be reflected in financial gains and market
achievements. To measure financial performance, four standards may be
employed for comparison: (a) the company’s performance, (b) competitor’s performance, (c) management expectations, and (d) performance in terms of resources
committed. With these standards, for the purposes of marketing strategy, financial
performance can be measured with respect to the following variables:
1. Growth rate (percentage).
2. Profitability (percentage), that is, rate of return on investment.
3. Market share (percentage as compared with that of principal competitors).
4. Cash flow.

It is desirable to analyze financial performance for a number of years to determine the historical trend of performance. To show how financial performance
analysis may figure in formulating marketing strategy, consider the following
example:EXHIBIT 7-6
Market Performance Profile Contribution to Company PerformanceMarketSegments-------------

Profitability

MarketShare

Growth of
End UserMarkets

Size ofCustomer
Base

Distribution
Strength

Degree ofCustomer
Loyalty171

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171

A maker of confectioneries that offers more than one hundred brands, flavors andpackagings, prunes its lines—regularly and routinely—of those items having the lowest profit contribution, sales volume, and vitality for future growth. . . .
Each individual product has been ranked on these three factors, and an “index
of gross profitability” has been prepared for each in conjunction with annual marketing plans. These plans take into account longer-term objectives for the business,trends in consumer wants and expectations, competitive factors in the marketplace
and, lastly, a deliberately ordered “prioritization” of the company’s resources.
Sales and profit performance are then checked against projected targets at regularintervals through the year, and the indexes of gross profitability are adjusted whennecessary.
The firm’s chief executive emphasizes that even individual items whose indexesof profitability are ranked at the very bottom are nonetheless profitable and paying
their way by any customary standard of return on sales and investment. But the very
lowest-ranking items are regularly reviewed; and, on a judgmental basis, some aremarked for pruning at the next convenient opportunity. This opportunity is most
likely to arrive when stocks of special ingredients and packaging labels for the items
have been exhausted.
In a recent year, the company dropped 16 items that were judged to be too low on
its index of gross profitability. Calculated and selective pruning is regarded within thecompany as a healthy means of working toward the best possible mix of products at
all times. It has the reported advantages of increasing efficiencies in manufacturing asa result of cutting the “down time” between small runs, reducing inventories, andfreeing resources for the expansion of the most promising items—or the developmentof new ones—without having to expand productive capacity. Another important benefit is that the sales force concentrates on a smaller line containing only the most profitable products with the largest volumes. On the negative side, however, it isacknowledged that pruning, as the company practices it, may result in near-term lossof sales for a line until growth of the rest of the items can compensate.

AppraisingMarketingExcellenceMarketing is concerned with the activities required to facilitate the exchange
process toward managing demand. The perspectives of these activities arefounded on marketing strategy. To develop a strategy, a company needs a philosophical orientation. Four different types of orientation may be considered: manufacturing, sales, technology, and marketing. Manufacturing orientationemphasizes a physical product or a service and assumes that the customer will bepleased with it if it has been well conceived and developed. Sales orientation
focuses on promoting the product to make the customer want it. The thrust oftechnology orientation is on reaching the customer through new and varied products made feasible through technological innovations. Under marketing orientation, first the customer group that the firm wishes to serve is designated. Then therequirements of the target group are carefully examined. These requirements
become the basis of product or service conception and development, pricing, promotion, and distribution. Exhibit 7-7 contrasts marketing-oriented companies
with manufacturing-, sales-, and technology-oriented firms.
An examination of Exhibit 7-7 shows that good marketers should think
like general managers. Their approach should be unconstrained by functional

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EXHIBIT 7-7
Comparison of Four Kinds of Companies
Orientation
Manufacturing

Sales

Technology

Marketing

Typical strategy

Lower cost

Increase

Push research

Build share profitability

Normal structure

Functional

Functional or
profit centers

Profit centers

Market or productor brand; decentralized profit
responsibility

Key systems

Plant P&L’s
Budgets

Sales forecasts
Results vs. plan

Performance tests
R&D plansMarketing plans

Traditional skills

Engineering

Sales

Science andengineering

Analysis

Normal focus

Internal efficiencies

Distribution channels; short-termsales results

Product performance

Consumers
Market share

Typical response
to competitive
pressure

Cut costs

Cut price
Sell harder

Improve productConsumer research, planning,
resting, refining

Overall mental set“What we need to
do in this company
is get our costs
down and ourquality up.”

“Where can I sellwhat we make?”“The best productwins the day.”“What will the
consumer buy that
we profitably
make?”

Source: Edward G. Michaels, “Marketing Muscle: Who Needs It?” Business Horizons, May–June, 1982, p. 72. © 1982 by the foundation for the School of Business at Indiana University. Reprinted by permission.

boundaries. Without neglecting either near- or medium-term profitability, theyshould concentrate on building a position for tomorrow.7
Despite the lip service that has been paid to marketing for more than 30 years,
it remains one of the most misunderstood functions of a business. According to
Canning, only a few corporations, Procter & Gamble, Citibank, Avon, McDonald’s,
Emerson Electric, and Merck, for example, really understand and practice truemarketing.8 Inasmuch as marketing orientation is a prerequisite for developing a
successful marketing strategy, it behooves a company to thoroughly examine its
marketing orientation. The following checklist of 10 questions provides a quick
self-test for a company that wants a rough measure of its marketing capabilities.

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173• Has your company carefully segmented the various segments of the consumer
market that it serves?
• Do you routinely measure the profitability of your key products or services ineach of these consumer market segments?
• Do you use market research to keep abreast of the needs, preferences, and buying
habits of consumers in each segment?
• Have you identified the key buying factors in each segment, and do you knowhow your company compares with its competitors on these factors?
• Is the impact of environmental trends (demographic, competitive, lifestyle, governmental) on your business carefully gauged?
• Does your company prepare and use an annual marketing plan?
• Is the concept of “marketing investment” understood—and practiced—in yourcompany?
• Is profit responsibility for a product line pushed below the senior managementlevel?
• Does your organization “talk” marketing?
• Did one of the top five executives in your company come up through marketing?

The number of yes answers to these questions determines the marketing orientation of a company. For example, a score of nine or ten yes answers would
mean that the company has a strong marketing capability; six to eight would indicate that the firm is on the way; and fewer than six yes answers would stress thatthe firm is vulnerable to marketing-minded competitors. Essentially, truly marketing-oriented firms are consumer oriented, take an integrated approach to planning, look further ahead, and have highly developed marketing systems. In such
firms, marketing dominates the corporate culture. A marketing-oriented culture
is beneficial in creating sustainable competitive advantage. It becomes one of theinternal strengths an organization possesses that is hard to imitate, is more
durable, and is not transparent nor transferable.
This analysis reveals the overall marketing effectiveness of the company andhighlights the areas that are weak and require management action. Management
may take appropriate action—management training, reorganization, or installation of measures designed to yield improvements with or without the help of consultants. If weaknesses cannot be addressed, the company must live with them,and the marketing strategist should take note of them in the process of outlining
the business’s future direction. A marketing orientation perspective of a firmlargely reflects its marketing excellence.
Marketing
Environment

Chapter 6 was devoted to scanning the environment at the macro level. This section looks at the environment from the product/market perspective. Environmental scanning at the macro level is the job of a staff person positioned at thecorporate, division, group, or business unit level. The person concerned may goby any of these titles: corporate planner, environmental analyst, environmental
scanner, strategic planner, or marketing researcher.
Monitoring the environment from the viewpoint of products/markets is aline function that should be carried out by those involved in making marketing
decisions because product/market managers, being in close touch with various

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marketing aspects of the product/market, are in a better position to read between
the lines and make meaningful interpretations of the environment. The constituents of the product/market environment are social and cultural effects, political influences, ethical considerations, legal requirements, competition, economic
climate, technological changes, institutional evolution, consumerism, population,
location of consumers, income, expenditure patterns, and education. Not all
aspects of the environment are relevant for every product/market. The scanner,
therefore, should first choose which parts of the environment influence the product/market before attempting to monitor them.
The strategic significance of the product/market environment is well illustrated by the experience of Fanny Farmer Candy Shops, a familiar name in the
candy industry. Review of the environment in the mid-1980s showed that
Americans were watching their waistlines but that they were also indulging inchocolate. In 1983, the average American ate nearly 18 pounds of confections—up from a low of 16 pounds in 1975. Since the mid-1980s, the market for upscalechocolates has been growing rapidly. Chocolates are again popular gifts for dinner parties, providing a new opportunity for candy makers, who traditionallyrelied on Valentine’s Day, Easter, and Christmas for over half of their annual
sales.
Equipped with this analysis of the environment, Fanny Farmer decided to
become a dominant competitor in the upscale segment. It introduced rich, newspecialty chocolates at $14 to $20 per pound, just below $25-per-pound designer
chocolates (a market dominated by Godiva, a subsidiary of Campbell Soup Co.,and imports such as Perugina of Italy) and above Russell Stover and Fannie May
candies, whose chocolates averaged $10 per pound. The company thinks that its
new strategic thrust will advance its position in the candy market, though implementing this strategy will require overcoming a variety of problems.9

ANALYZING STRENGTHS AND WEAKNESSESThe study of competition, current strategic perspectives, past performance, marketing effectiveness, and marketing environment provides insights into information necessary for designating strengths and weaknesses. Exhibit 7-8 provides arundown of areas of strength as far as marketing is concerned. Where feasible,
strengths should be stated in objective terms. Exhibit 7-8 is not an all-inclusive
list, but it indicates the kind of strength a company may have over its competitors. It should be noted that most areas of strength relate to the excellence of personnel or are resource based. Not all factors have the same significance for every
product/market; therefore, it is desirable to first recognize the critical factors that
could directly or indirectly bear on a product’s performance. For example, thedevelopment of an improved product may be strategic for drug companies. On
the other hand, in the case of cosmetics, where image building is usually important, advertising may be a critical factor. After-sale service may have significancefor products such as copying machines, computers, and elevators. Critical factors
may be chosen with reference to Exhibit 3-6. From among the critical factors, an

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175

EXHIBIT 7-8
Areas of Strength
1. Excellence in product design and/or performance (engineering ingenuity)
2. Low-cost, high-efficiency operating skill in manufacturing and/or in distribution
3. Leadership in product innovation
4. Efficiency in customer service
5. Personal relationships with customers
6. Efficiency in transportation and logistics
7. Effectiveness in sales promotion
8. Merchandising efficiency—high turnover of inventories and/or of capital
9. Skillful trading in volatile price movement commodities
10. Ability to influence legislation
11. Highly efficient, low-cost facilities
12. Ownership or control of low-cost or scarce raw materials
13. Control of intermediate distribution or processing units
14. Massive availability of capital
15. Widespread customer acceptance of company brand name (reputation)
16. Product availability, convenience
17. Customer loyalty
18. Dominant market share position, deal from a position of strength
19. Effectiveness of advertising
20. Quality sales force
21. Make and sell products of highest quality
22. High integrity as a company

attempt should be made to sort out strengths. It is also desirable to rate different
strengths for a more objective analysis.10
An example from the personal computer business illustrates the measurement of strengths and weaknesses. In 1987, Apple, IBM, Tandy, and imports from
Taiwan and South Korea were the major competitors. In 1990, the major firms in
the industry included Apple, IBM, Tandy, Compaq Computers, Zenith
Electronics, and imports from Taiwan and South Korea. In 1998, the front-runners
in the business were IBM, Compaq, Apple, Dell, and Packard-Bell. Among these,
Compaq Computer Corp. was the leader in worldwide PC shipments, followed
by IBM. As a matter of fact, in the important U.S. market IBM ranked fourth, trailing even the late-entrant Packard Bell Electronics Inc. Exhibit 7-9 lists the relative
strengths of these firms in 1998.
Success in the personal computer business depends on mastery of the following three critical areas:• Low-cost production—As personal computer hardware becomes increasingly
standardized, the ability to provide the most value for the dollar greatly influences sales. The most vertically integrated companies have the edge.
• Distribution—Retailers have shelf space for just two or three brands; only thosemakers that are able to keep their products in the customer’s line of sight arelikely to survive.

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EXHIBIT 7-9
Relative Strengths of Personal Computer Firms in 1994

Cu
rre
nt
Str
en
Ap
gth
plic
s
ati
on
ss
Bra
oft
nd
wa
im
re
ag
e
De
pth
of
ma
Fin
na
ge
an
me
cia
lm
nt
us
Lo
cle
wco
st
pro
Na
du
tio
ctio
na
n
ls
a
les
Re
tai
for
ld
ce
istr
ibu
Se
tio
rvi
n
ce
su
pp
or t

176

Companies
Apple Computer
Compaq Computer
Packard-BellIBM
Dell Computer

• •
•
•
• •
•

•
•

• •
•
• •
• • •
•
• • • • • •
• • •
• •

• Software—Computer sales suffer unless a wide choice of software packages isoffered to increase the number of applications.

Without these three strengths in place, a company cannot make it in the personal computer business. Thus, Texas Instruments withdrew from the field in
1983 because it did not have enough applications software. Fortune Systems
dropped out in 1984. Zenith Electronics left the field in the early 1990s; Tandy
became an insignificant contestant. Even imports from Taiwan and South Korea
could not cope with changes in the fast-moving PC business, in which prices fall
more than 20 percent a year, and product life cycles have shortened to as little assix months. Introducing a new generation of PCs just three months behind schedule can cost a company 40 percent to 50 percent of the gross profit it had planned
to make on the new line.11
Both IBM and Apple appeared to be in trouble in 1995. By 1998 however, bothof them had been able to overcome their weaknesses in logistics, manufacturing,and research and development. IBM reorganized the PC division and hired seasoned executives to fix the problems. In addition, the company shifted the focus
to push for market share instead of profit to realize production efficiencies andlower parts costs. IBM hopes that with these measures, and the company’s unrivaled assets—the IBM name and the brand equity built over many years—in its

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177

favor, it can create a solid position to enter the next century.12 Apple wrought
remarkable changes, remaking Apple’s products, structure, personnel, manufacturing, distribution, and marketing to once again reemerge as a major factor in the
PC industry.13 The IBM and Apple stories illustrate the importance of analyzing
strengths and weaknesses to define objectives and strategies for the future.
As another example, consider the Walt Disney Company strengths. Its themeparks offer a genuinely distinctive experience built around universally recognizedanimated characters or brand name. The brand is supported by near-flawlessdelivery in every element of the business, coupled with a full range of marketing
communications, all reinforcing the “childhood at any age” theme that Disneyrepresents worldwide. Customers have powerful associations with the brands
that often go back generations.14 These strengths offer the following benefits indeveloping future strategy:• Substantial, often dominant, and sustained market share. Disney occupies thedominant market position in animated features and theme parks, and is a leading
producer of feature films.
• Premium prices. Disney theme parks, hotels, and merchandise command significantly higher prices than competitors’ offerings.
• A track record of extending the brand to new products. The Disney brand waslaunched in 1923 with the first Mickey Mouse cartoon and has since been
extended to films, network and cable television programs and studios, themeparks, hotels, merchandise, and a National Hockey League team, the Mighty
Ducks.
• New markets. From its original focus on children, the brand has been extended
to the full range of demographic groups (“ages 8 to 80”).
• New geographic areas. Disney’s films and products are distributed worldwide.
Theme parks are open or planned in the United States, Europe, and Asia.

Strengths should be further examined to undertake what may be called
opportunity analysis (matching strengths, or competencies, to opportunity).
Opportunity analysis serves as an input in establishing a company’s economic
mission. Opportunity analysis is also useful in developing an individual product’s objectives. In Exhibit 7-10 the objectives for a food product are shown as they
emerged from a study of its strengths. The objectives were to produce a premium
product for an unscored segment and to develop a new channel outlet. In otherwords, at the product level, the opportunity analysis seeks to answer such questions as: What opportunity does the company have to capitalize on a competitor’s
weaknesses? Modify or improve the product line or add new products? Serve theneeds of more customers in existing markets or develop new markets? Improvethe efficiency of current marketing operations?
Opportunities emerge from the changing environment. Thus, environmental
analysis is an important factor in identifying opportunities. Exhibit 7-11 suggests
a simple format for analyzing the impact of the environment.
The concept of opportunity analysis may be illustrated with Procter &Gamble’s moves in the over-the-counter (OTC) drug business. There is an increasing sense in the drug industry that the OTC side of the drug business will growMeasuring Strengths and Weaknesses

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EXHIBIT 7-10
Matching Strengths with Opportunities
Opportunity Furnishedby the Environment

Strength

Likely Impact

Customer loyalty

Incremental product volume increases
Price increases for premium quality/service
New product introductions

Objectives and Goals
Develop a premium
product

A trend of changing taste
An identified geographic
shift of part of the market
A market segment neglectedby the industry

Introduce the existingproduct in a segment
hitherto not served
Develop a new channel
for the product, etc.

New product introductions

Cordial relationships
with channels

Point-of-purchase advertising
Reduction of delivered
costs through distribution
innovations

A product-related subconscious need not solicited by
the competition
A product weakness of thecompetition
A distribution weakness ofthe competition

Tied-in products
Merchandising differentiation

Technical feasibility for
improving existing package
designA discovered new use forthe product or container

EXHIBIT 7-11
Impact of Environmental Trends
Trends

ImpactTiming of Impact

Response Time

UrgencyThreats

Opportunities

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faster than prescription sales will grow. Consumers and insurers are becoming
more interested in OTC medications, partly because of the steep cost of prescription drugs. Further, with the patents of many major medicines expiring, genericdrugs will pose an even greater threat to prescription products. Consequently,
drugmakers are taking another look at the OTC business, where a well-marketedbrand can keep a franchise alive long after exclusive rights have expired. A casein point is the success of Advil, an ibuprofen-based painkiller.
To participate in the growing OTC market, Procter & Gamble has been making inroads into the industry. As a matter of fact, Procter & Gamble is already oneof the largest marketers of OTC drugs. But to expand its position in the field,
Procter & Gamble decided to speed things up by entering into partnerships withdrugmakers and technology companies. By linking its formidable marketingstrength with emerging technological advances in medicine, Procter & Gamble
hopes to propel itself to the forefront of the health market.
Thus, the company is working on new formulations for minoxidil, a baldness
remedy, and other new products promoting hair growth with UpJohn. It joinedwith Syntex to market Aleve, a nonprescription version of Anaprox, an antiinflammatory drug that is popular with arthritis sufferers. It hopes to sell De-Nol,a gastrointestinal medicine made by Dutch drugmaker Gist-Brocades, as an ulcer
treatment. It may use technology from Alcide, a Connecticut maker of disinfectants, in its toothpaste or mouthwash business. Finally, Procter & Gamble has anagreement with Triton Biosciences and Cetus to use Betaseron, a synthetic interferon, that it hopes will fight the common cold.15
In this case, it was Procter & Gamble’s marketing strength that led it to enter
the OTC drug industry. The opportunity was furnished by the environment—a
concern for increasing health care costs—and many drug companies were glad toform alliances with this established OTC marketer.
In recent years flavored coffees have become popular and companies like
Starbucks have established a new style of coffee drinking. Considering this as anopportunity to expand, Dunkin’ Donuts expanded into coffee trendiness by offering four or more blends of fresh-brewed coffee, even hot and cold specialty drinks—all at a fraction of the Starbucks price. Value, together with no-nonsense service,has made Dunkin’ Donuts a favorable place for coffee lovers.
To continue to ride on this opportunity, the chain has decided to be the latest
in fast-food cool, offering in addition to specialty coffee, oven-baked bagels andfat-free muffins. In its redone stores, the tacky old pink décor is giving way to amore upscale “ripe raisin” hue. And not content to stop at morning munchies, thecompany has set its sights on the lunch crowd.16
An interesting observation with regard to opportunity analysis, made byAndrews, is relevant here:
The match is designed to minimize organizational weakness and to maximize
strength. In any case, risk attends it. And when opportunity seems to outrun present
distinctive competence, the willingness to gamble that the latter can be built up to therequired level is almost indispensable to a strategy that challenges the organizationand the people in it. It appears to be true, in any case, that the potential capability ofMeasuring Strengths and Weaknesses

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a company tends to be underestimated. Organizations, like individuals, rise to occasions, particularly when the latter provide attractive reward for the effort required.17

In the process of analyzing strengths, underlying weaknesses should also be
noted. Exhibit 7-12 is a list of typical marketing weaknesses. Appropriate action
must be taken to correct weaknesses. Some weaknesses have SBU-wide bearing;others may be weaknesses of a specific product. SBU weaknesses must be examined, and necessary corrective action must be incorporated into the overall marketing strategy. For example, weaknesses 3, 5, and 6 in Exhibit 7-12 could have
SBU-wide ramifications. These must be addressed by the chief marketing strategist. The remaining three weaknesses can be corrected by the person in chargeof the product/market with which these weaknesses are associated.

CONCEPT OF SYNERGY
Before concluding the discussion of strengths and weaknesses, it will be desirable to briefly introduce the concept of synergy. Synergy, simply stated, is theconcept that the combined effect of certain parts is greater than the sum of theirindividual effects. Let us say, for example, that product 1 contributes X andproduct 2 contributes Y. If they are produced together, they may contribute
X+Y+Z. We can say that Z is the synergistic effect of X and Y being brought
together and that Z represents positive synergy. There can be negative synergy
as well. The study of synergy helps in analyzing new growth opportunities. A
new product, for instance, may have such a high synergistic effect on a company’s existing product(s) that it may be an extremely desirable addition.
Conceptually, business synergies take one of six forms:18
1. Shared Know-How. Units often benefit from sharing knowledge or skills. Theymay, for example, improve their results by pooling their insights into a particular
process, function, or geographic area.
2. Coordinated Strategies. It sometimes works to a company’s advantage to alignthe strategies of two or more of its businesses. Divvying up markets among units
may, for instance, reduce interunit competition. And coordinating responses toshared competitors may be a powerful and effective way to counter competitive
threats.

EXHIBIT 7-12
Typical Marketing Weaknesses
1. Inadequate definition of customer for product/market development
2. Ambiguous service policies
3. Too many levels of reporting in the organizational setup
4. Overlapping channels
5. Lack of top management involvement in new product development
6. Lack of quantitative goals

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3. Shared Tangible Resources. Units can sometimes save a lot of money by sharing
physical assets or resources. By using a common manufacturing facility or
research laboratory, for example, they may gain economies of scale and avoid
duplicated effort.
4. Vertical Integration. Coordinating the flow of products or services from one unit
to another can reduce inventory costs, speed product development, increase
capacity utilization, and improve market access.
5. Pooled Negotiating Power. By combining their purchases, different units cangain greater leverage over suppliers, reducing the cost or even improving thequality of the goods they buy. Companies can also gain similar benefits bynegotiating jointly with other stakeholders, such as customers, governments, or
universities.
6. Combined Business Creation. The creation of new businesses can be facilitatedby combining know-how from different units, by extracting discrete activities
from various units and combining them in a new unit, or by establishing internal
joint ventures or alliances.

Quantitative analysis of synergy is far from easy. However, synergy may beevaluated following the framework illustrated in Exhibit 7-13. This framework
refers to a new product/market entry synergy measurement.
A new product/market entry contribution could take place at three levels:
contribution to the parent company (from the entry), contribution to the newentry (from the parent), and joint opportunities (benefits that accrue to both as aresult of consolidation). As far as it is feasible, entries in Exhibit 7-13 should be
assigned a numerical value, such as increase in unit sales by 20 percent, time saving by two months, reduction in investment requirements by 10 percent, and soon. Finally, various numerical values may be given a common value in the formof return on investment or cash flow.

EXHIBIT 7-13
Measurement of the Synergy of a New Product/Market Entry
SYNERGY MEASURES
Startup Economies

Synergistic
Contribution to:
ParentNew entry
Joint opportunities

Investment

Operating

TimingOperating Economies

Investment

OperatingExpansionof Present
Sales

New
Product
andMarketAreas

Overall
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SUMMARY

This chapter outlined a scheme for the objective measurement of strengths andweaknesses of a product/market, which then become the basis of identifying SBU
strengths and weaknesses. Strengths and weaknesses are tangible and intangible
resources that may be utilized for seeking growth of the product. Factors thatneed to be studied in order to designate strengths and weaknesses are competition, current strategic perspectives, past performance, marketing effectiveness,and marketing environment. Present strategy may be examined with reference tothe markets being served and the means used to serve these markets.
Past performance was considered in the form of financial analysis, ranging
from simple measurements, such as market share and profitability, to developing
product and market performance profiles. Marketing effectiveness was related tomarketing orientation, which may be determined with reference to questions
raised in the chapter. Finally, various aspects of the product/market marketing
environment were analyzed.
These five factors were brought together to delineate strengths and weaknesses. An operational framework was introduced to conduct opportunity analysis. Also discussed was the concept of synergy. The analysis of strengths andweaknesses sets the stage for developing marketing objectives and goals, which
will be discussed in the next chapter.

DISCUSSIONQUESTIONS

1. Why is it necessary to measure strengths and weaknesses?
2. Because it is natural for managers and other employees to want to justify theiractions and decisions, is it possible for a company to make a truly objective
appraisal of its strengths and weaknesses?
3. Evaluate the current strategy of IBM related to personal computers and compare it with the strategy being pursued by Apple Computer.
4. Develop a conceptual scheme to evaluate the current strategy of a bank.
5. Is it necessary for a firm to be marketing oriented to succeed? What may a firm
do to overcome its lack of marketing orientation?
6. Making necessary assumptions, perform an opportunity analysis for a packaged-goods manufacturer.
7. Explain the meaning of synergy. Examine what sort of synergy Procter &Gamble achieved by going into the frozen orange juice business.

NOTES

Kenneth R. Andrews, The Concept of Corporate Strategy (Homewood, IL: Dow JonesIrwin, 1971): 97.
2 Jeremy Main, “Toward Service without a Snare,” Fortune (23 March 1981): 64–66.
3 Philip Kotler, William T. Gregor, and William H. Rodgers III, “The Marketing Audit
Comes of Age,” Sloan Management Review (Winter 1989): 49–62.
4 Howard H. Stevenson, “Defining Corporate Strengths and Weaknesses: An Exploratory
Study,” (Ph.D. diss., Harvard Business School, 1969).
5 Howard H. Stevenson, “Defining Corporate Strengths and Weaknesses,” Sloan
Management Review (Spring 1976): 66.
1

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183

Moody’s Industrial Manual (1197): 5842–5845.
Benson P. Shapiro, “What the Hell Is ‘Market Oriented’?” Harvard Business Review(November–December 1988): 119–125.
8 Gordon Canning, Jr., “Is Your Company Marketing Oriented?” Journal of Business
Strategy (May–June 1988): 34–36.
9 David Tuller, “Repackaging Chocolates,” Working Women (January 1987): 45–46;
updated based on interview with a company executive.
10 Bart Ziegler, “IBM Tries, And Fails, to Fix PC Business,” The Wall Street Journal, (22February 1995): B1. Also see “It Just May Be The Year of the Apple,” Business Week (16January 1995): 4.
11 Jeffrey A. Schmidt, “The Strategic Review,” Planning Review, (July/August 1998):
14–19.
12 ”Blue Is the Color,” The Economist, (6 June 1998): 65.
13 David Kirkpatrick, “The Second Coming of Apple,” Fortune, (9 November 1998): 87.
14 Frank Rose, “Mickey Online,” Fortune, (28 September 1995): 273.
15 ”Where P&G’s Brawn Doesn’t Help Much,” Business Week, (10 November 1997): 112.
16 ”Dunkin’ Donuts is on a Coffee Rush,” Business Week, (16 March 1998): 7.
17 Andrews, The Concept of Corporate Strategy, 100.
18 Michael Goold and Andrew Campell, “Desperately Seeking Synergy,” Harvard Business
Review, (September–October 1998): 130–139.
6
7

CHAPTER EIGHT“Would you tell me please,which way I ought togo from here?” said
Alice. “That depends
a good deal on where
you want to get to,”said the Cheshire Cat

8Developing
Marketing Objectives
and Goals

LEWIS CARROLL(ALICE IN WONDERLAND)

An organization must have an objective to guide its destiny. Although theobjective in itself cannot guarantee the success of a business, its presence willcertainly mean more efficient and financially less wasteful management of operations.
Objectives form a specific expression of purpose, thus helping to remove any
uncertainty about the company’s policy or about the intended purpose of any
effort. To be effective, objectives must present startling challenges to managers,
jolting them away from traditional in-a-rut thinking. If properly designed, objectives permit the measurement of progress. Without some form of progress measurement, it may not be possible to know whether adequate resources are being
applied or whether these resources are being managed effectively. Finally, objectives facilitate relationships between units, especially in a diversified corporation,
where the separate goals of different units may not be consistent with somehigher corporate purpose.
Despite its overriding importance, defining objectives is far from easy: there
is no mechanical or expert instant-answer method. Rather, defining goals as the
future becomes the present is a long, time-consuming, and continuous process.
In practice, many businesses run either without any commonly accepted objectives and goals or with conflicting objectives and goals. In some cases, objectives
may be understood in different ways by different executives. At times, objectives
may be defined in such general terms that their significance for the job is notunderstood. For example, a product manager of a large company once observedthat “our objective is to satisfy the customer and increase sales.” After crosschecking with the vice president of sales, however, she found that the company’s
goal was making a minimum 10 percent after-tax profit even when it meant losing market share. “Our objective, or whatever you choose to call it, is to grow,”

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the vice president of finance of another company said. “This is a profit-oriented
company, and thus we must earn a minimum profit of 15 percent on everything
we do. You may call this our objective.” Different companies define their objectives differently. It is the task of the CEO to set the company’s objectives and goals
and to obtain for them the support of his or her senior colleagues, thus paving theway for other parts of the organization to do the same.
The purpose of this chapter is to provide a framework for goal setting in alarge, complex organization. A first step in planning is usually to state objectives so that, knowing where you are trying to go, you can figure out how to getthere. However, objectives cannot be stated in isolation; that is, objectives cannot be formed without the perspectives of the company’s current business, its
past performance, resources, and environment. Thus, the subject matter discussed in previous chapters becomes the background material for defining
objectives and goals.

FRAMEWORK FOR DEFINING OBJECTIVESThis chapter deals with defining objectives and goals at the SBU level. Because
SBU objectives should bear a close relationship to corporate strategic direction,
this chapter will start with a discussion of corporate direction and will thenexamine SBU objectives and goals. Product/market objectives will also be discussed, as they are usually defined at the SBU level and derived from SBU
objectives.
The framework discussed here assumes the perspectives of a large corporation. In a small company that manufactures a limited line of related products, corporate and SBU objectives may be identical. Likewise, in a company with a few
unrelated products, an SBU’s objectives may be no different from those of the
product/market.
It is desirable to define a few terms one often confronts in the context of objective setting: mission, policy, objective, goal, and strategic direction. A mission(also referred to as corporate concept, vision, or aim) is the CEO’s conception of
the organization’s raison d’être, or what it should work toward, in the light oflong-range opportunity. A policy is a written definition of general intent or company position designed to guide and regulate certain actions and decisions, especially those of major significance or of a recurring nature. An objective is along-range purpose that is not quantified or limited to a time period (e.g., increasing the return on stockholders’ equity). A goal is a measurable objective of thebusiness, judged by management to be attainable at some specific future datethrough planned actions. An example of a goal is to achieve 10 percent growth insales within the next two years. Strategic direction is an all-inclusive term thatrefers to the network of mission, objectives, and goals. Although we recognize thedistinction between an objective and a goal, we will consider these terms simultaneously in order to give the discussion more depth.
The following are frequently cited types of frustrations, disappointments, or
troubling uncertainties that should be avoided when dealing with objectives:

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1. Lack of credibility, motivation, or practicality.
2. Poor information inputs.
3. Defining objectives without considering different options.
4. Lack of consensus regarding corporate values.
5. Disappointing committee effort to define objectives.
6. Sterility (lack of uniqueness and competitive advantage).

Briefly, if objectives and goals are to serve their purpose well, they should
represent a careful weighing of the balance between the performance desired andthe probability of its being realized:
Strategic objectives which are too ambitious result in the dissipation of assets and thedestruction of morale, and create the risk of losing past gains as well as future opportunities. Strategic objectives which are not ambitious enough represent lost opportunity and open the door to complacency.1

CORPORATE STRATEGIC DIRECTION
Corporate strategic direction is defined in different ways. In some corporations, ittakes the form of a corporate creed, or code of conduct, that defines perspectives
from the viewpoint of different stakeholders. At other corporations, policy statements provide guidelines for implementing strategy. In still others, corporate
direction is outlined in terms of objective statements. However expressed, corporate direction consists of broad statements that represent a company’s position onvarious matters and serve as an input in defining objectives and in formulating
strategy at lower echelons in the organization.
A company can reasonably expect to achieve a leadership position or superior financial results only when it has purposefully laid out its strategic direction.
Every outstanding corporate success is based on a direction that differentiates thefirm’s approach from that of others. Specifically, strategic direction helps in
1. Identifying what “fits” and what needs the company is well suited to meet.
2 Analyzing potential synergies.
3. Undertaking risks that simply cannot be justified on a project basis (e.g., willingness to pay for what might appear, on a purely financial basis, to be a premium
for acquisition).
4. Providing the ability to act fast (presence of strategic direction not only helps inadequately and quickly scanning opportunities in the environment but capitalizing on them without waiting).
5. Focusing the search for opportunities and options more clearly.

Corporate Strategic
Direction:
An Example

To illustrate the point, consider the corporate direction of Dow Chemical
Company, which has persisted for more than 60 years.2 Herbert Dow founded
and built Dow Chemical on one fundamental and energizing idea: start with acheap and basic raw material; then develop the soundest, lowest-cost process
possible. This idea, or direction, defined certain imperatives Dow has pursued
consistently over time:

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1. First, don’t copy or license anyone else’s process. In other words, as Dow himself
put it, “Don’t make a product unless you can find a better way to do it.”
2. Second, build large, vertically integrated complexes to achieve maximum
economies of scale; that is, maintain cost leadership by building the most technologically advanced facilities in the industry.
3. Third, locate near and tie up abundant sources of cheap raw materials.
4. Fourth, build in bad times as well as good. In other words, become the largevolume supplier for the long pull and preempt competitors from coming in. Be
there, in place, when the demand develops.
5. Fifth, maintain a strong cash flow so that the corporation can pursue its vision.

Over the years, Dow has consistently acted in concert with this direction, or
vision. It has built enormous, vertically integrated complexes at Midland,Michigan; Freeport, Texas; Rotterdam, Holland; and the Louisiana Gulf Coast.
And it has pursued with almost fanatical consistency the obtaining of secure, lowcost sources of raw materials.
Strategic Direction and Organizational Perspectives. Pursuing this direction
has, in turn, mandated certain human and organizational characteristics of thecompany and its leadership. For example, Dow has been characterized as a company whose management shows “exceptional willingness to take sweeping but
carefully thought out gambles.”3 The company has had to make leaps of faithabout the pace and direction of future market and technological developments.
Sometimes, as in the case of shale oil, these have taken a very long time to materialize. Other times, these leaps of faith have resulted in failure. But as Ben
Branch, a top Dow executive for many years, was fond of saying, “Dow encourages well-intentioned failure.”
To balance this willingness to take large risks, the company has had to maintain an extraordinary degree of organizational flexibility to give it the ability torespond quickly to unexpected changes. For example, “Dow places little emphasis on, and does not publish, organization charts, preferring to define areas ofbroad responsibility without rigid compartments. Its informal style has given thecompany the flexibility to react quickly to change.”4
Changing the Strategic Direction. Over the years, Dow’s direction has had toexpand to accommodate a changing world, its own growth, and expanding horizons of opportunity. The expansion of its direction, or vision, has included, forexample:1. Recognition of the opportunities and the need to diversify downstream intohigher-value-added, technologically more sophisticated intermediate and end-use
products, with the concomitant requirement for greater technical selling capability after World War II.
2. The opportunity and the imperative to expand abroad. In fact, Herbert Dow’s
core vision may have initially been retarded expansion abroad, since raw material
availability was not as good in Europe or in Japan as it was in the United Statesand since it was harder to achieve comparable economies of scale.

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3. The need to reorganize and decentralize foreign operations, setting them up on asemiautonomous basis to give them room for growth and flexibility.

But throughout its history, Dow’s leadership has consistently held to a
guiding concept that perhaps has been best articulated as this: “In this business, it’s who’s there with the vision, the money, and the guts to seize an
opportunity.”5In the 1980s, Xerox Corporation faced the task of redefining its strategic
direction in response to a new technological era. There were three different
schools of thought within the company. One school believed it should stick to
its core competency—copying—and that paper would be there for a long time.
Another view, held by a smaller group, felt Xerox ought to quickly transform
itself into a systems company. Based on its leading-edge technology at Palo
Alto Research Center, this view suggested getting out of the paper world as
quickly as possible. A third school of thought said that the company shouldfinesse the differences and focus on being “the” office company. After all, it
was reasoned, the company had a worldwide direct sales force that reachedinto almost every office around the world; it could sell anything through that
direct sales force.
Looking carefully at the future, the company concluded that paper would not
go away, but that its use would change. The creation, storage, and communication of documents will increasingly be in electronic form; however, for many
years, people will prefer the paper document display to the electronic document
display. They will print out their electronic documents closer to their end use andthen throw them away, thereby making paper a transient display medium. Xerox
chose to bridge the gap between the paper and electronic world. The strategic
direction was defined to not remain the copier company, but to become the document company.6
Corporate Strategic Direction and Strategy Development. What can be concluded from this brief history of Dow Chemical’s corporate direction? First, it
seems clear that, for more than 50 years, all of Dow’s major strategic and operating decisions have been amazingly consistent. They have been consistent because
they have been firmly grounded in some basic beliefs about where and how tocompete. The direction has evidently made it easier to make the always difficult
and risky long-term/short-term decisions, such as investing in research for thelong haul or aggressively tying up sources of raw materials.
This direction, or vision, has also driven Dow to be aggressive in generating
the cash required to make risky investments possible. Most important, top management seems never to have eschewed its leadership role in favor of becoming
merely stewards of a highly successful enterprise. They have been constantly
aware of the need to question and reshape Dow’s direction, while maintaining
those elements that have been instrumental in achieving the company’s long-termcompetitive success. Dow illustrates that corporate direction gives coherence to awide range of apparently unrelated decisions, serving as the crucial link among
them.

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Corporate Strategic
Direction andMarketing Strategy

189

Without exception, the corporate direction of all successful companies is based
not only on a clear notion of the markets in which they compete but also on specific concepts of how they can sustain an economically attractive position in
those markets. Their direction is grounded in deep understanding of industry
and competitive dynamics and company capabilities and potential. Corporate
direction should focus in general on continually strengthening the company’s
economic or market position, or both, in some substantial way. For example,
Dow was not immobilized by existing industry relationships, current market
shares, or its past shortcomings. It sought and found new ways to influenceindustry dynamics in its favor. Corporate direction should foster creative thinking about realistic and achievable options, driving product, service and new
business decisions. Its impact can actually be measured in the marketplace. In
other words, in addition to having thought through the questions of where andhow to compete, top management should also make realistic judgments about(a) the capital and human resources that are required to compete and where
they should come from, (b) the changes in the corporation’s functional and cultural biases that must be accomplished, (c) the unique contributions that are
required of the corporation (top management and staff) to support pursuit of
the new direction by the SBUs, and (d) a guiding notion of the timing or pace ofchange within which the corporation should realistically move toward the new
vision.
Mentioned below is the strategic direction of a number of companies:7
Merck• Corporate social responsibility• Unequivocal excellence in all aspectsof the company• Science-based innovation• Honesty and integrity• Profit, but profit from work that
benefits humanity

Sony• Elevation of the Japanese culture
and national status• Being a pioneer—not following others;
doing the impossible• Encouraging individual ability
and creativity

Nordstrom• Service to the customer above all else
• Hard work and individual
productivity• Never being satisfied• Excellence in reputation;
being part of something special

Walt Disney• No cynicism• Nurturing and promulgationof “wholesome American values”• Creativity, dreams, and imagination• Fanatical attention to consistency anddetail• Preservation and control of the Disneymagic

Philip Morris• The right to freedom of choice• Winning—beating others in a good fight• Encouraging individual initiative• Opportunity based on merit;no one is entitled to anything• Hard work and continuous
self-improvement

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As can be noted, strategic direction is not an abstruse construct based on theinspiration of a solitary genius. It is a hard-nosed, practical concept based on thethorough understanding of the dynamics of industries, markets, and competitionand of the potential of the corporation for influencing and exploiting these
dynamics. It is only rarely the result of a flash of insight; much more often it is the
product of deep and disciplined analysis.
Formulating
Corporate Strategic
Direction

Strategic direction frequently starts out fuzzy and is refined through a messy
process of trial and error. It generally emerges in its full clarity only when it iswell on its way to being realized. Likewise, changes in corporate direction occur
by a long process and in stages.
Changing an established direction is much more difficult than starting fromscratch because one must overcome inherited biases and set norms of behavior.
Change is effected through a sequence of steps. First, a need for change is recognized. Second, awareness of the need for change is built throughout the organization by commissioning study groups, staff, or consultants to examine problems,
options, contingencies, or opportunities posed by the sensed need. Third, broad
support for the change is sought through unstructured discussions, probing of
positions, definition of differences of opinion, and so on, among executives.
Fourth, pockets of commitment are created by building necessary skills or technologies within the organization, testing options, and taking opportunities tomake decisions to build support. Fifth, a clear focus is established, either by creating an ad hoc committee to formulate a position or by expressing in written
form the specific direction that the CEO desires. Sixth, a definite commitment tochange is obtained by designating someone to champion the goal and be accountable for its accomplishment. Finally, after the organization arrives at the new
direction, efforts are made to be sensitive to the need for further change in direction, if necessary.

Specific Statements
about Corporate
Strategic Direction

Many companies make specific statements to designate their direction. Usuallythese statements are made around such aspects as target customers and markets, principal products or services, geographic domain, core technologies, concern for survival, growth and profitability, company philosophy, company
self-concept, and desired public image. Some companies make only brief statements of strategic direction (sometimes labeled corporate objectives); others
elaborate on each aspect in detail. Avon products expressed its strategic direction rather briefly: “to be the company that best understands and satisfies the
product, service and self-fulfillment needs of women globally.”8 IBM defines its
direction, which it calls principles, separately for each functional area. For
example, in the area of marketing, the IBM principle is: “The marketplace is thedriving force behind everything we do.” In technology, it is “at our core, we area technology company with an overriding commitment to quality.”9 Apple
Computer states its direction five years into the future with detailed statements
under the following headings: corporate concept, internal growth, external

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growth, sales goal, financial, planning for growth and performance, management and personnel, corporate citizenship, and stockholders and financial community. Exhibit 8-1 shows the strategic direction of the Hewlett-Packard
Corporation. As can be noted, this company defines its strategic perspective
through brief statements.
No matter how corporate strategic direction is defined, it should meet thefollowing criteria. First, it should present the firm’s perspectives in a way thatenables progress to be measured. Second, the strategic direction should differentiate the company from others. Third, strategic direction should define the business that the company wants to be in, not necessarily the business that it is in.
Fourth, it should be relevant to all the firm’s stakeholders. Finally, strategic
direction should be exciting and inspiring, motivating people at the helm.10

EXHIBIT 8-1
Hewlett-Packard’s Corporate Direction
ProfitTo achieve sufficient profit to finance our company growth and to provide the resources
we need to achieve our other corporate objectives
Customers
To provide products and services of the greatest possible value to our customers, thereby
gaining and holding their respect and loyalty
Field of Interest
To enter new fields only when the ideas we have, together with our technical, manufacturing and marketing skills, assure that we can make a needed and profitable contribution in the field
GrowthTo let our growth be limited only by our profits and our ability to develop and produce
technical products that satisfy real customer needs
PeopleTo help our own people share in the company’s success, which they make possible: toprovide job security based on their performance, to recognize their individual achievements, and to help them gain a sense of satisfaction and accomplishment from their work
Management
To foster initiative and creativity by allowing the individual great freedom of action in
attaining well-defined objectives
CitizenshipTo honor our obligations to society by being an economic, intellectual and social asset toeach nation and each community in which we operate
Source: Company records.

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SBU OBJECTIVESAn SBU was defined in Chapter 1 as a unit comprising one or more products having a common market base whose manager has complete responsibility for integrating all functions into a strategy against an identifiable external competitor.
We will examine the development and meaning of SBUs again in this chapter tomake it clear why objectives must be defined at this level. Abell’s explanation is
as follows:
The development of marketing planning has paralleled the growing complexity ofbusiness organizations themselves. The first change to take place was the shift fromfunctionally organized companies with relatively narrow product lines and servedmarket focus to large diversified firms serving multiple markets with multiple product lines. Such firms are usually divided into product or market divisions, divisions
may be divided into departments, and these in turn are often further divided into
product lines or market segments. As this change gradually took place over the lasttwo decades, “sales planning” was gradually replaced by “marketing planning” inmost of these organizations. Each product manager or market manager drew up amarketing plan for his product line or market segment. These were aggregated
together into an overall divisional “marketing plan.” Divisional plans in turn were
aggregated into the overall corporate plan.
But a further important change is now taking place. There has been over the last
decade a growing acceptance of the fact that individual units or subunits within a corporation, e.g., divisions, product departments, or even product lines or market segments, may play different roles in achieving overall corporate objectives. Not all units
and subunits need to produce the same level of profitability; not all units and subunits
have to contribute equally to cash flow objectives.
This concept of the organization as a “portfolio” of units and subunits having different objectives is at the very root of contemporary approaches to strategic marketing
planning. It is commonplace today to hear businesses defined as “cash cows,” “stars,”“question marks,” “dogs,” etc.* It is in sharp contrast to practice in the 1960s and earlier which emphasized primarily sales and earnings (or return on investment) as amajor measure of performance. Although different divisions or departments wereintuitively believed to have different capabilities to meet sales and earning goals, thesedifferences were seldom made explicit. Instead, each unit was expected to “pull its
weight” in the overall quest for growth and profits.
With the recognition that organizational entities may differ in their objectives androles, a new organizational concept has also emerged. This is the concept of a “business unit.” A business unit may be a division, a product department, or even a product line or major market, depending on the circumstances. It is, however, usuallyregarded by corporate management as a reasonably autonomous profit center.
Usually it has its own “general manager” (even though he may not have that title, he
has general managerial responsibilities). Often it has its own manufacturing, sales,
research and development, and procurement functions although in some cases someof these may be shared with other businesses (e.g., pooled sales). A business unit usually has a clear market focus. In particular it usually has an identifiable strategy and* These items are defined in Chapter 10.

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an identifiable set of competitors. In some organizations (the General ElectricCompany, for example), business units are clearly identified and defined. In otherorganizations, divisions or product departments are treated as relatively autonomous
business units although they are not explicitly defined as such.
A business unit will usually comprise several “program” units. These may be product lines, geographic market segments, end-user industries to which the company
sells, or units defined on the basis of any other relevant segmentation dimension.
Program units may also sometimes differ in their objectives. In such cases, the conceptof a portfolio exists both in terms of business units within a corporate structure (orsubstructure, such as a group) or in terms of programs within a business unit. Usually,
however, the business unit is a major focus of strategic attention, and strategic market
plans are of prime importance at this level.11

As Abell notes, a large, complex organization may have a number of SBUs,
each playing its unique role in the organization. Obviously, then, at the corporate
level, objectives can be defined only in generalities. It is only at each SBU levelthat more specific statements of objectives can be made. Actually, it is the SBU
mission and its objectives and goals that product/market managers need to consider in their strategic plans.

BUSINESS MISSION
Defining theBusiness Mission:
The Traditional
Viewpoint

Mission is a broad term that refers to the total perspectives or purpose of a business. The mission of a corporation was traditionally framed around its productline and expressed in mottoes: “Our business is textiles,” “We manufacture cameras,” and so on. With the advent of marketing orientation and technologicalinnovations, this method of defining the business mission has been decried. It has
been held that building the perspectives of a business around its product limits
the scope of management to enter new fields and thus to make use of growth
opportunities. In a key article published in 1960, Levitt observed:
The railroads did not stop growing because the need for passengers and freight transportation declined. That grew. The railroads are in trouble today not because theneed was filled by others (cars, trucks, airplanes, even telephones), but because it was
not filled by the railroads themselves. They let others take customers away fromthem because they assumed themselves to be in the railroad business rather than in
the transportation business. The reason they defined their industry wrong was
because they were railroad-oriented instead of transportation-oriented; they were
product-oriented instead of customer-oriented.12

According to Levitt’s thesis, the mission of a business should be definedbroadly: an airline might consider itself in the vacation business, a publisher inthe education industry, an appliance manufacturer in the business of preparing
nourishment.
Recently, Levitt’s proposition has been criticized, and the question has beenraised as to whether simply extending the scope of a business leads far enough.
The Boston Consulting Group, for example, has pointed out that the railroads
could not have protected themselves by defining their business as transportation:

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Unfortunately, there is a prevalent notion that if one merely defines one’s business inincreasingly general terms such as transportation rather than railroading the road tosuccessful competitive strategy will be clear. Actually, that is hardly ever the case.
More often, the opposite is true. For example, in the case of the railroads, passengers
and freight represent very different problems, and short haul vs. longer haul are completely different strategic issues. Indeed, as the unit train demonstrates, just coal handling is a meaningful strategic issue.13

In the early 1980s, Coca-Cola extended its business mission from being a softdrink marketer to a beverage company. Subsequently, the company bought threewine companies. A few years later, the company decided to leave the wine business. What happened is simply this: Although soft drinks and wine both are partsof the beverage industry, the management skills required to run a soft drink business are quite different from those required for the wine business. Coca-Colaoverlooked some basics. For example, because wine must be aged, inventory
costs run much higher than for soft drinks. Further, grapes must be bought aheadof time. Coke added to its work by vastly overestimating the amount of grapes itneeded. Another key characteristic of the wine business is a requirement forheavy capital investment; Coke did not want to make that investment.14
As the Coca-Cola example illustrates, the problem with Levitt’s thesis is that
it is too broad and does not provide a common thread: a relationship between afirm’s past and future that indicates where the firm is headed and that helps management to institute directional perspectives. The common thread may be foundin marketing, production technology, finance, or management. ITT took advantage of its managerial abilities when it ventured into such diverse businesses as
hotels and bakeries. Merrill Lynch found a common thread via finance in entering the real estate business. Bic Pen Company used its marketing strength to
involve itself in the razor blade business. Thus, the mission cannot be defined bymaking abstract statements that one hopes will pave the way for entry into newfields.
It would appear that the mission of a business is neither a statement of current business nor a random extension of current involvements. It signifies thescope and nature of business, not as it is today, but as it could be in the future. The
mission plays an important role in designating opportunities for diversification,either through research and development or through acquisitions. To be meaningful, the mission should be based on a comprehensive analysis of the business’s
technology and customer mission. Examples of technology-based definitions arecomputer companies and aerospace companies. Customer mission refers to thefulfillment of a particular type of customer need, such as the need for basic nutrition, household maintenance, or entertainment.
Whether the company has a written business mission statement or not isimmaterial. What is important, however, is that due consideration is given totechnological and marketing factors (as related to particular segments and theirneeds) in defining the mission. Ideally, business definitions should be based on a
combination of technology and market mission variables, but some companies
venture into new fields on the basis of one variable only. For example, Texas

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Instruments entered the digital watch market on the basis of its lead in integrated
circuits technology. Procter & Gamble added over-the-counter remedies to its
business out of its experience in fulfilling the ordinary daily needs of customers.
To sum up, the mission deals with these questions: What type of business do
we want to be in at some future time? What do we want to become? At any given
point, most of the resources of a business are frozen or locked into current uses,
and the outputs in services or products are for the most part defined by current
operations. Over an interval of a few years, however, environmental changes placedemands on the business for new types of resources. Further, because of personnel attrition and depreciation of capital resources, management has the option ofchoosing the environment in which the company will operate and acquiring commensurate new resources rather than replacing the old ones in kind. This explains
the importance of defining the business’s mission. The mission should be so
defined that it has a bearing on the business’s strengths and weaknesses.
Defining theBusiness Mission:
A New Approach

In his pioneering work on the subject, Abell has argued against defining a business as simply a choice of products or markets.15 He proposes that a business be
defined in terms of three measures: (a) scope; (b) differentiation of the company’sofferings, one from another, across segments; and (c) differentiation of the company’s offerings from those of competitors. The scope pertains to the breadth of abusiness. For example, do life insurance companies consider themselves to be in
the business of underwriting insurance only or do they provide complete family
financial planning services? Likewise, should a manufacturer of toothpaste define
the scope of its business as preventing tooth decay or as providing complete oral
hygiene? There are two separate contexts in which differentiation can occur: differentiation across segments and across competitors. Differentiation across segments measures the degree to which business segments are treated differently. An
example is personal computers marketed to young children as educational aids
and to older people as financial planning aids. Differentiation across competitors
measures the degree to which competitors’ offerings differ.
These three measures, according to Abell, should be viewed in three dimensions: (a) customer groups served, (b) customer functions served, and (c) technologies used. These three dimensions (and a fourth one, level of production/
distribution) were examined at length in Chapter 5 in the context of defining market boundaries and will not be elaborated further here. An example will illustrate
how a business may be defined using Abell’s thesis.
Customer groups describe who is being satisfied; customer functions
describe what needs are being satisfied; technologies describe how needs arebeing satisfied. Consider a thermometer manufacturer. Depending on whichmeasure is used, the business can be defined as follows:
Customer Groups
Households
Restaurants
Health care facilities

Customer Functions
Body temperature
Cooking temperature
Atmospheric temperature

Technologies Used
Mercury-base
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The manufacturer can confine the business to just health care facilities or
broaden the scope to include restaurants and households. Thermometers can beprovided only for measurement of body temperature or the line can be extended
to offer cooking or atmospheric thermometers. The manufacturer could decideto produce only mercury-base thermometers or could also produce alcohol-baseor electronic-digital thermometers. The decisions that the manufacturer makes
about customer groups, customer functions, and technologies ultimately affects
the definition of the business in terms of both scope and differentiation. Exhibits
8-2 and 8-3 graphically show how business can be defined narrowly or broadly
around these three dimensions. In Exhibit 8-2, the manufacturer limits the business to service health care facilities only, offering just mercury-base thermometers for measuring body temperatures. In Exhibit 8-3, however, the definition has
been broadened to serve three customer groups: households, restaurants, andhealth care facilities; two types of thermometers: mercury-base and alcohol-base;and three customer functions. The manufacturer could further expand the definition of the business in all three directions. Physicians could be added as a customer group. A line of electronic-digital thermometers could be offered. Finally,
thermometers could be produced to measure temperatures of industrial
processes.

EXHIBIT 8-2
Defining Business Mission—Narrow Scope

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EXHIBIT 8-3
Defining Business Mission—Broader Scope

An adequate business definition requires proper consideration of the strategic three Cs: customer (e.g., buying behavior), competition (e.g., competitive definitions of the business), and company (e.g., cost behavior, such as efficiencies via
economies of scale; resources/skills, such as financial strength, managerial talent,engineering/manufacturing capability, physical distribution system, etc.; and differences in marketing, manufacturing, and research and development requirements and so on, resulting from market segmentation).
Typology ofBusinessDefinitions

Abell proposed defining business in terms of three measures: scope, differentiation across segments, and differentiation across competitors. According to Abell,scope and both kinds of differentiation are related to one another in complex
ways. One way to conceptualize these interrelationships is in terms of a typologyof business definitions. Three alternative strategies for defining a business are recommended: (a) a focused strategy, (b) a differentiated strategy, and (c) an undifferentiated strategy.
• Focused strategy—A business may choose to focus on a particular customer
group, customer function, or technology segment. Focus implies a certain
basis for segmentation along one or more of these dimensions, narrow scope

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involving only one or a few chosen segments, and differentiation from competitors through careful tailoring of the offering to the specific need of thesegment(s) targeted.
• Differentiated strategy—When a business combines broad scope with differentiation across any or all of the three dimensions, it may be said to follow a differentiated strategy. Differentiation across segments may also be related to competitive
differentiation. By tailoring the offering to the specific needs of each segment, acompany automatically increases the chance for competitive superiority. Whether
or not competitive differentiation also results is purely a function of the extent towhich competitors have also tailored their offerings to the same specific segments. If they have, segment differentiation may be substantial, yet competitive
differentiation may be small.
• Undifferentiated strategy—When a company combines broad scope across any or
all of the three dimensions with an undifferentiated approach to customer group,
customer function, or technology segments, it is said to follow an undifferentiated strategy.16

Each of these strategies can be applied to the three dimensions (customer
groups, customer functions, and technologies) separately. In other words, 27 different combinations are possible: (a) focused, differentiated, or undifferentiatedacross customer groups; (b) focused, differentiated, or undifferentiated acrosscustomer functions; (c) focused, differentiated, or undifferentiated across technologies, and so on.
A focused strategy serves a specific customer group, customer function, or
technology segment. It has a narrow scope. Docutel Corporation’s strategy in thelate 1960s exemplified a focused strategy relative to customer function. When
Docutel first pioneered the development of the automated teller machine (ATM),
it defined customer function very narrowly, concentrating on one function only—
cash dispensing.
A differentiated strategy combines broad scope with differentiation across
one or more of the three dimensions. A differentiated strategy serves several customer groups, functions, or technologies while tailoring the product offered toeach segment’s specific needs. An example of a differentiated strategy applied tocustomer groups is athletic footwear. Athletic footwear serves a broad range ofcustomer groups and is differentiated across those groups. Tennis shoes are tailored to meet the needs of one specific customer group; basketball shoes,
another.
An undifferentiated strategy combines a broad scope across one or more of
the three dimensions. This strategy is applied to customer groups in a businessthat serves a wide range of customer groups but does not differentiate its offerings among those groups. Docutel’s strategy was focused with respect to customer function but not with respect to customer groups: they offered exactly thesame product to commercial banks, savings and loans, mutual savings banks, andcredit unions. To sum up, the strategy that a business chooses to follow, based on
the amount of scope and differentiation applied to the three dimensions, determines the definition of the business.

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SBU OBJECTIVES AND GOALSThe objectives and goals of the SBU may be stated in terms of activities (manufacturing a specific product, selling in a particular market); financial indicators(achieving targeted return on investment); desired positions (market share, quality leadership); and combinations of these factors. Generally, an SBU has a seriesof objectives to cater to the interests of different stakeholders. One way of organizing objectives is to split them into the following classes: measurement objectives, growth/survival objectives, and constraint objectives. It must beemphasized that objectives and goals should not be based just on facts but on values and feelings as well. What facts should one look at? How should they beweighed and related to one another? It is in seeking answers to such questions
that value judgments become crucial.
The perspectives of an SBU determine how far an objective can be broken
down into minute details. If the objective applies to a number of products, only
broad statements of objectives that specify the role of each product/market fromthe vantage point of the SBU are feasible. On the other hand, when an SBU is created around one or two products, objectives may be stated in detail.
Exhibit 8-4 illustrates how SBU objectives and goals can be identified andsplit into three groups: measurement, growth/survival, and constraint.
Measurement objectives and goals define an SBU’s aims from the point of view ofthe stockholders. The word profit has been traditionally used instead of measurement. But, as is widely recognized today, a corporation has several corporate
publics besides stockholders; therefore, it is erroneous to use the word profit. On
the other hand, the company’s very existence and its ability to serve different
stakeholders depend on financial viability. Thus, profit constitutes an importantmeasurement objective. To emphasize the real significance of profit, it is more
appropriate to label it as a measurement tool.
It will be useful here to draw a distinction between corporate objectives
and measurement objectives and goals at the level of an SBU. Corporate objectives define the company’s outlook for various stakeholders as a general concept, but the SBU’s objectives and goals are specific statements. For example,
keeping the environment clean may be a corporate objective. Using this corporate objective as a basis, in a particular time frame an SBU may define prevention of water pollution as one of its objectives. In other words, it is notnecessary to repeat the company’s obligation to various stakeholders in defining an SBU’s objectives as this is already covered in the corporate objectives.
Objectives and goals should underline the areas that need to be covered during
the time horizon of planning.
Growth objectives and goals, with their implicit references to getting ahead,
are accepted as normal goals in a capitalistic system. Thus, companies often aim
at growth. Although measurements are usually stated in financial terms, growthis described with reference to the market. Constraint objectives and goals dependon the internal environment of the company and how it wishes to interact withthe outside world.

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EXHIBIT 8-4
Illustration of an SBU ’s Objectives
I. SBU
Cooking Appliances
II. Mission
To market to individual homes cooking appliances that perform such functions as
baking, boiling, and roasting, using electric fuel technology
III. Objectives (general statements in the following areas):
A. Measurement
1. Profitability
2. Cash flow
B. Growth/Survival
1. Market standing
2. Productivity
3. Innovation
C. Constraint
1. Capitalize on our research in certain technologies
2. Avoid style businesses with seasonal obsolescence
3. Avoid antitrust problems
4. Assume responsibility to public
IV. Goals
Specific targets and time frame for achievement of each objective listed above

An orderly description of objectives may not always work out, and the three
types of objectives and goals may overlap. It is important, however, that the final
draft of objectives be based on investigation, analysis, and contemplation.

PRODUCT/MARKET OBJECTIVES
Product/market objectives may be defined in terms of profitability, market share,or growth. Most businesses state their product/market purpose through a combination of these terms. Some companies, especially very small ones, may use justone of these terms to communicate product/market objectives. Usually, product/market objectives are stated at the SBU level.
Profitability

Profits in one form or another constitute a desirable goal for a product/market
venture. As objectives, they may be expressed either in absolute monetary terms
or as a percentage of capital employed or of total assets.
At the corporate level, emphasis on profit in a statement of objectives is sometimes avoided because it seems to convey a limited perspective of the corporate
purpose. But at the product/market level, an objective stated in terms of profitability provides a measurable criterion with which management can evaluate

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performance. Because product/market objectives are an internal matter, the corporation is not constrained by any ethical questions in its emphasis on profits.
An ardent user of the profitability objective is Georgia-Pacific Company. The
company aims at achieving a return of 20 percent on stockholders’ equity. The
orthodox view has been that, in an industry where product differentiation is not
feasible, the goal of profitability is irrelevant. But Georgia-Pacific’s CEO, Marshall
Hahn, insists on the profit goal, and the outcome has been very satisfactory.
Georgia-Pacific’s overall performance has been twice as good as any other competitor in the industry.17 Similarly, Chrysler Corporation, before it was acquiredby the German automaker, shunned market share in favor of profits. In 1993, forexample, Chrysler earned more from the auto business than GM and Ford combined, or the nine Japanese automakers.18
How can the profitability goal be realized in practice? First, the corporate
management determines the desired profitability, that is, the desired rate of
return on investment. There may be a single goal set for the entire corporation, or
goals may vary for different businesses. Using the given rate of return, the SBU
may compute the percentage of markup on cost for its product(s). To do so, thenormal rate of production, averaged over the business cycle, is computed. The
total cost of normal production then becomes the standard cost. Next, the ratio ofinvested capital (in the SBU) to a year’s standard cost (i.e., capital turnover) is
computed. The capital turnover multiplied by the rate of return gives the markup
percentage to be applied to standard cost. This markup is an average figure that
may be adjusted both among products and over time.
Market Share

In many industries, the cigarette industry, for example, gaining a few percentage
points in market share has a positive effect on profits. Thus, market share has traditionally been considered a desirable goal to pursue. In recent years, extensive
research on the subject has uncovered new evidence on the positive impact ofmarket share on profitability.19
The importance of market share is explainable by the fact that it is related tocost. Cost is a function of scale or experience. Thus, the market leader may havea lower cost than other competitors because superior market share permits theaccumulation of more experience. Prices, however, are determined by the cost
structure of the least effective competitor. The high-cost competitor must generate enough cash to hold market share and meet expenses. If this is not accomplished, the high-cost competitor drops out and is replaced by a more effective,
lower-cost competitor. The profitability of the market leader is ascertained by thesame price level that determines the profit of even the least effective competitor.
Thus, higher market share may give a competitive edge to a firm.
One strong proponent of market share goal is Eastman Kodak Co. The company takes a long-term view and commits itself to obtaining a big share of growthmarkets. It keeps building new plants even though its first plant for a product has
yet to run at full capacity. It does so hoping large-scale operations will provide a
cost advantage that it can utilize in the form of lower prices to customers. Lower
prices in turn lead to a higher market share.

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Kodak has 80 percent of the U.S. consumer film market and 50 percent of the
global business. Yet even with such a high share, the company does not believe in
simply maintaining market share. For Kodak, there are only two alternatives:
grow the share or it will decline. After all, in the film business, one point of global
market share amounts to $40 million in revenues.20
While market share is a viable goal, tremendous foresight and effort areneeded to achieve and maintain market share positions. A company aspiring
toward a large share of the market should carefully consider two aspects: (1) its
ability to finance the market share and (2) its ability to effectively defend itself
against antitrust action that may be instigated by large increases in market share.
For example, when General Electric considered entering the computer business,
it found that to meet its corporate profitability objective it had to achieve a specific market share position. To realize its targeted market share position requiredhuge investment. The question, then, was whether General Electric should gamble in an industry dominated by one large competitor (IBM) or invest its monies
in fields where there was the probability of earning a return equal to or higher
than returns in the computer field. General Electric decided to get out of the computer field.
Fear of antitrust suits also prohibits the seeking of higher market shares. A
number of corporations—Kodak, Gillette, Xerox, and IBM, for example—havebeen the target of such action.
These reasons suggest that, although market share should be pursued as adesirable goal, companies should opt not for share maximization but for an optimal market share. Optimal market share can be determined in the following
manner:1. Estimate the relationship between market share and profitability.
2. Estimate the amount of risk associated with each share level.
3. Determine the point at which an increase in market share can no longer be
expected to earn enough profit to compensate the company for the added risks towhich it would expose itself.

The advantages of higher market share do not mean that a company with alower share may not have a chance in the industry. There are companies that earna respectable return on equity despite low market shares. Examples of such corporations are Crown Cork and Seal, Union Camp, and Inland Steel. The following characteristics explain the success of low-share companies: (a) they compete
only in those market segments where their strengths have the greatest impact, (b)they make efficient use of their modest research and development budgets, (c)they shun growth for growth’s sake, and (d) they have innovative leaders.21
Briefly, market share goals should not be taken lightly. Rather, a firm should
aim at a market share after careful examination.
The following example illustrates the importance of market share. Exhibit
8-5 shows the experience of the industry leader in an industrial product. With an
initially high share of a growing and competitive market, management shifted its
emphasis from market share to high earnings. A manager with proven skills was

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EXHIBIT 8-5
Relationship between Market Share and After-Tax Profit

put in charge of the business. Earnings increased for six years at the expense ofsome slow erosion in market share. In the seventh year, however, market sharefell so rapidly that, though efforts to hold profits were redoubled, they dropped
sharply. Share was never regained. The manager had been highly praised andrichly rewarded for his profit results up to 1990. These results, however, wereachieved in exchange for a certain unreported damage to the firm’s long-termcompetitiveness. Only by knowing both and by weighing the gain in current
income against the degree of market share liquidation that entailed could the true
value of performance be judged. In other words, reported earnings do not tell thetrue story unless market share is constant. Loss of market share is liquidation ofan unbooked asset upon which the value of all other assets depends. Gain inmarket share is like an addition to cost potential, just as real an asset as credit rating, brand image, organization resources, or technology. In brief, market shareguarantees the long-term survival of the business. Liquidation of market share to
realize short-term earnings should be avoided. High earnings make sense only
when market share is stable.
GrowthGrowth is an accepted phenomenon of a modern corporation. All institutions
should progress and grow. Those that do not grow invite extinction. Static corporations are often subject to proxy fights.

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There are a variety of reasons that make growth a viable objective: (a) growth
expectations of the stockholders, (b) growth orientation of top management, (c)employees’ enthusiasm, (d) growth opportunities furnished by the environment,(e) corporate need to compete effectively in the marketplace, and (f) corporate
strengths and competencies that make it easy to grow. Exhibit 8-6 amplifies thesereasons under the following categories: customer reasons; competitive reasons;company reasons; and distributor, dealer, and agent reasons.

EXHIBIT 8-6
Reasons for Growth
Customer Reasons
The product line or sizes too limited for customer convenience
Related products needed to serve a specific market
Purchasing economies: one source, one order, one bill
Service economies: one receiving and processing; one source of parts, service, and otherassistance
Ability to give more and better services
Production capacity not enough to fill needs of important customers who may themselves be growing
Competitive Reasons
To maintain or better industry position; growth is necessary in any but a declining industry
To counter or better chief competitors on new offerings
To maintain or better position in specific product or market areas where competition ismaking strong moves
To permit more competitive pricing ability through greater volume
To possess greater survival strength in price wars, product competition, and economic
slumps by greater size
Company Reasons
To fulfill the growth expectations of stockholders, directors, executives, and employees
To utilize available management, selling, distribution, research, or production capacity
To supplement existing products and services that are not growth markets or are on
downgrade of the profit cycle
To stabilize seasonal or cyclical fluctuations
To add flexibility by broadening the market and product base of opportunities
To attain greater borrowing and financial influence with size
To be able to attract and pay for better management personnel
To attain the stability of size and move to management by planning
Distributor, Dealer, and Agent Reasons
To add products, sizes, and ranges necessary to attract interest of better distributors,
dealers, and agents
To make additions necessary to obtain needed attention and selling effort from existing
distributors, dealers, and agents

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An example of growth encouraged by corporate strength is provided by R.J.
Reynolds Industries. In the early 1980s, the company was in an extremely strong
cash position, which helped it to acquire Heublein, Del Monte Corp., andNabisco. H. S. Geneen’s passion for growth led ITT into different industries (bakeries, car rental agencies, hotels, insurance firms, parking lots) in addition to its
traditional communications business. Any field that promised growth was
acceptable to him. Thus, the CEO’s growth orientation is the most valuable prerequisite for growth. Similarly, growth ambitions led Procter & Gamble to venture
into cosmetics and over-the-counter health remedies.
For most managers today, growth is the Holy Grail. When charting strategy,
they focus on ways to expand revenues, believing that higher sales will bringhigher profits. The assumption is that a company able to capture a large proportion of revenues in an industry—a large market share—will reap scale efficiencies,
brand awareness, or other advantages that will translate directly into greater
profits. If you can grow faster than your competitors, the thinking goes, profits
will surely follow.
Unfortunately, profits do not necessarily follow revenues. Consider the recent
experience of Gucci, one of the world’s top names in luxury leather goods. In the
1980s, Gucci sought to capitalize on its prestigious brand by launching an aggressive strategy of revenue growth. It added a set of lower-priced canvas goods to its
product line. It pushed its goods heavily into department stores and duty-freechannels. In addition, it allowed its name to appear on a host of licensed items
such as watches, eyeglasses, and perfumes. The strategy worked—sales soared—
but it carried a high price: Gucci’s indiscriminate approach to expanding its products and channels tarnished its sterling brand. Sales of its high-end goods fell,leading to erosion of profitability. Although the company was eventually able toretrench and recover, it lost a whole generation of image-conscious shoppers insome countries.
Gucci’s misstep highlights the problem with growth: the strategies businesses
use to expand their top line often have the unintended consequence of eroding
their bottom line. Gucci attempted to extend its brand to gain sales—a common
growth strategy—but ended up alienating its most profitable customer segments
and attracting new segments that were less profitable. It was left with a larger setof customers but a much less attractive customer mix.22
Other Objectives

In addition to the commonly held objectives of profitability, market share, andgrowth (discussed above), a company may sometimes pursue a unique objective.
Such an objective might be technological leadership, social contribution, thestrengthening of national security, or international economic development.
Technological Leadership. A company may consider technological leadership a worthwhile goal. In order to accomplish this, it may develop new products or processes or adopt innovations ahead of the competition, even when
economics may not justify doing so. The underlying purpose in seeking thisobjective is to keep the name of the company in the forefront as a technologicalDeveloping Marketing Objectives and Goals

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leader among security analysts, customers, distributors, and other stakeholders.
To continue to be in the forefront of computer technology, in 1987 IBM entered
the field of supercomputers, an area that it had previously shunned because themarket was limited.23
Social Contribution. A company may pursue as an objective something thatwill make a social contribution. Ultimately, that something may lead to higher
profitability, but initially it is intended to provide a solution to a social problem.
A beverage company, for example, may attack the problem of litter by not offering its product in throwaway bottles. As another example, a pharmaceutical company may set its objective to develop and market an AIDS-preventive medicine.
Strengthening of National Security. In the interest of strengthening national
defense, a company may undertake activities not otherwise justifiable. For example, concern for national security may lead a company to deploy resources todevelop a new fighter plane. The company may do so despite little encouragement from the air force, if only because the company sincerely feels that the country will need the plane in the coming years.
International Economic Development. Improvement in human welfare, theeconomic progress of less-developed countries, or the promotion of a worldwide
free enterprise system may also serve as objectives. For example, a company may
undertake the development of a foolproof method of birth control that can be easily afforded and conveniently used.

PROCESS OF SETTING OBJECTIVESAt the very beginning of the process of setting objectives, an SBU should attempt
to take an inventory of objectives as they are currently understood. For example,
the SBU head and senior executives may state the current objectives of the SBU
and the type of SBU they want it to be in the future. Various executives perceive
current objectives differently; and, of course, they will have varying ambitions for
the SBU’s future. It will take several top-level meetings and a good deal of effort
on the part of the SBU head to settle on final objectives.
Each executive may be asked to make a presentation on the objectives andgoals he or she would like the SBU to adopt for the future. Executives should be
asked to justify the significance of each objective in terms of measuring performance, satisfying environmental conditions, and achieving growth. It is foreseeable that executives will have different objectives; they may express the same
objectives in terms that make them appear different, but there should emerge, on
analysis, a desire for a common destiny for the SBU. Disharmony of objectives
may sometimes be based on diverse perceptions of a business’s resource potential and corporate strategy. Thus, before embarking on setting SBU objectives, it is
helpful if information on resource potential and corporate strategy is circulated.
Before finalizing the objectives, it is necessary that the executive team show aconsensus; that is, each one should believe in the viability of the set objectives and

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willingly agree to work toward their achievement. A way must be found to persuade a dissenting executive to cooperate. For example, if a very ambitious executive works with stability-oriented people, in the absence of an opportunity to becreative, the executive may fail to perform routine matters adequately, thus
becoming a liability to the organization. In such a situation, it may be better toencourage the executive to look for another job. This option is useful for the organization as well as for the dissenting executive. This type of situation occurs whenmost of the executives have risen through the ranks and an “outsider” joins them.
The dynamism of the latter is perceived as a threat, which may result in conflict.
The author is familiar with a $100 million company where the vice president offinance, an “outsider,” in his insistence on strategic planning came to be perceived as such a danger by the old-timers that they made it necessary for him toquit.
To sum up, objectives should be set through a series of executive meetings.
The organizational head plays the role of mediator in the process of screening
varying viewpoints and perceptions and developing consensus from them.
Once broad objectives have been worked out, they should be translated into
specific goals, an equally challenging task. Should goals be set so high that only an
outstanding manager can achieve them, or should they be set so that they are
attainable by the average manager? At what level does frustration inhibit a manager’s best efforts? Does an attainable budget lead to complacency? Presumably acompany should start with three levels of goals: (a) easily attainable, (b) mostdesirable, and (c) optimistic. Thereafter, the company may choose a position somewhere between the most desirable goals and the optimistic goals, depending on
the organization’s resources and the value orientation of management. In no case,however, should performance fall below easily attainable levels, even if everything
goes wrong. Attempts should be made to make the goals realistic and achievable.
Overly elusive goals can discourage and affect motivation. As a matter of fact, realistic goals may provide higher rewards. In 1992, Eastman Kodak lowered its 6 percent annual revenue growth from the core film and photographic paper businessto 3 percent. Subsequently, its stock price went up from $40 to $50.24
There are no universally accepted standards, procedures, or measures fordefining objectives. Each organization must work out its own definitions of objectives and goals—what constitutes growth, what measures to adopt for their evaluation, and so on. For example, consider the concept of return on investment,
which for decades has been considered a good measure of corporate performance. A large number of corporations consider a specified return on investment
as the most sacrosanct of goals. But ponder its limitations. In a large, complex
organization, ROI tends to optimize divisional performance at the cost of total
corporate performance. Further, its orientation is short-term. Investment refers toassets. Different projects require a varying amount of assets before beginning toyield results, and the return may be slow or fast, depending on the nature of the
project. Thus, the value of assets may lose significance as an element in performance measurement. As the president of a large company remarked, “Profits areoften the result of expenses incurred several years previously.” The president sug-

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gested that the current amount of net cash flow serves as a better measure of performance than the potential amount of net cash flow: “The net cash contribution
budget is a precise measure of expectations with given resources.”
The following six sources may be used to generate objectives and goals:
1. Focus on material resources (e.g., oil, minerals, forest).
2. Concern with fabricated objects (e.g., paper, nylon).
3. Major interest in events and activities requiring certain products or services, suchas handling deliveries (Federal Express).
4. Emphasis on the kind of person whose needs are to be met: “Babies Are Our
Business” (Gerber).
5. Catering to specific parts of the body: eyes (Maybelline), teeth (Dr. West), feet
(Florsheim), skin (Noxzema), hair (Clairol), beard (Gillette), and legs (Hanes).
6. Examination of wants and needs and seeking to adapt to them: generic use to besatisfied (nutrition, comfort, energy, self-expression, development, conformity,etc.) and consumption systems (for satisfying nutritional needs, e.g.).

Whichever procedure is utilized for finally coming out with a set of objectives
and goals, the following serve as basic inputs in the process. At the corporate
level, objectives are influenced by corporate publics, the value system of top management, corporate resources, the performance of business units, and the external
environment. SBU objectives are based on the strategic three Cs of customer, competition, and corporation. Product/market objectives are dictated by product/
market strengths and weaknesses and by momentum. Strengths and weaknesses
are determined on the basis of current strategy, past performance, marketing
excellence, and marketing environment. Momentum refers to future trends—
extrapolation of past performance with the assumption that no major changes
will occur either in the product/market environment or in its marketing mix.
Identified above are the conceptual framework and underlying information
useful in defining objectives at different levels. Unfortunately, there is no computer model to neatly relate all available information to produce a set of acceptable objectives. Thus, whichever conceptual scheme is followed and no matter
how much information is available, in the final analysis objective-setting remains
a creative exercise.
Once an objective has been set, it may be tested for validity using the following criteria:
1. Is it, generally speaking, a guide to action? Does it facilitate decision making byhelping management select the most desirable alternative courses of action?
2. Is it explicit enough to suggest certain types of action? In this sense, “to makeprofits” does not represent a particularly meaningful guide to action, but “tocarry on a profitable business in electrical goods” does.
3. Is it suggestive of tools to measure and control effectiveness? “To be a leader in
the insurance business” and “to be an innovator in child care services” are suggestive of measuring tools in a helpful way; but statements of desires merely toparticipate in the insurance field or child care field are not.
4. Is it ambitious enough to be challenging? The action called for should in mostcases be something in addition to resting on one’s laurels. Unless the enterprise

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sets objectives that involve reaching, there is the threat that the end of the roadmay be at hand.
Canon illustrates this point clearly. In 1975, Canon was a mediocre Japanesecamera company. It was scarcely growing and had recently turned unprofitable
for the first time since 1949. It set a few enormously aggressive goals, most ofthem quantitative. Its key goals were to increase sales fivefold over the next
decade, to achieve 3 percent productivity improvement per month, to cut in half
the time required to develop new products, and to build the premier manufacturing organization.
To achieve these goals, Canon established policies that focused on continuous improvement through the elimination of waste, broadly defined. Amongother new policies, Canon put in place a number of organizational measures topromote active employee cooperation. A prime objective was to increase thenumber of suggestions per employee to 30 per year by 1982, up from one in
1975. This goal was achieved and then surpassed: by 1986, each employee wascontributing, on average, 50 suggestions annually.
Planning within the company was refocused on methods to reach targets
and, more importantly, on identifying internal capabilities required to achievetargets. Another policy was to make every performance measure visual, so
employees could see at a glance where they were in relation to goals. In each factory, for example, there are visual representations of ongoing improvement
activity in relation to goals.
By 1982, Canon had achieved each of its goals. It is now a significant andvigorous competitor in cameras, copiers, and computers.25
5. Does it suggest cognizance of external and internal constraints? Most enterprises
operate within a framework of external constraints (e.g., legal and competitive
restrictions) and internal constraints (e.g., limitations in financial resources).
In the late 1970s, Toyota set as its goal to defeat General Motors. It realized that to
do so, it needed scale. To achieve scale, it needed first to defeat Nissan. Toyota initiated a battle against Nissan in which it rapidly introduced a vast array of new
autos, capturing market share from Nissan. That battle won, Toyota could turn its
attention to its long-term goal—besting General Motors. Targeting the leader is agreat way to build momentum and create an organizational challenge.
6. Can it be related to both the broader and the more specific objectives at higher
and lower levels in the organization? For example, can SBU objectives be related
to corporate objectives, and in turn, do they also relate to the objectives of one ofits products/markets?

SUMMARY

The thrust of this chapter was on defining objectives and goals at the SBU level.
Objectives may be defined as general statements of the long-term purpose thebusiness wants to pursue. Goals are specific targets the corporation would like toachieve within a given time frame. Because SBU objectives should bear a close
relationship to overall corporate direction, the chapter first examined the networks of mission, objectives, and goals that make up a company’s corporate
direction. The example of the Dow Chemical Company was given.

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The discussion of SBU objectives began with the business mission, which
defines the total perspectives or purpose of a business. In addition to presenting
the traditional viewpoint on business mission, a new framework for defining thebusiness was introduced. SBU objectives and goals were defined in terms ofeither financial indicators or desired positions or combinations of these factors.
Also considered were product/market objectives. Usually set at the SBU level,
product/market objectives were defined in terms of profitability, market share,
growth, and several other aspects. Finally, the process of setting objectives wasoutlined.

DISCUSSIONQUESTIONS

NOTES

1. Define the terms policy, objective, and goal.
2. What is meant by corporate direction? Why is it necessary to set corporate
direction?
3. Does corporate direction undergo change? Discuss.
4. How does the traditional view of the business mission differ from the new
approach?
5. Examine the perspectives of the new approach to defining the business mission.
6. Using the new approach, how may an airline define its business mission?
7. In what way is the market share objective viable?
8. Give examples of product/market objectives in terms of technological leadership, social contribution, and strengthening of national security.

1

Perspectives on Corporate Strategy (Boston: Boston Consulting Group, 1970): 44.

2 The discussion on Dow Chemical Company draws heavily on information provided by

the company.
3 “The Right Move Early,” Forbes (8 January 1990): 130–131.
4 Lee Smith, “Dow vs. Du Pont: Rival Formulas for Leadership,” Fortune (10 September1979): 74.
5 “Dow Chemical’s Drive to Change Its Market and Its Image,” Business Week (9 June1986): 92.
6 Roger E. Levien, “Technological Transformation at Xerox,” in Strategic Management:

Bridging Strategy and Performance (New York: The Conference Board, Inc., 1992):
21–22.
7 James C. Collins and Jerry F. Porras, “Behind your Company’s Vision,” Harvard Business
Review, (September–October 1996): 65–78.
8 Robert F. McCracken, “Bringing Vision to Avon,” in Strategic Management: Bridging
Strategy and Performance (New York: The Conference Board, Inc., 1993): 25.
9 ”Blue is the Colour,” The Economist, (6 June 1998): 65.
10 ”The Vision Thing,” The Economist (9 November 1991): 81.
11 Derek F. Abell, “Metamorphosis in Marketing Planning,” in Research Frontiers inMarketing: Dialogues and Directions, ed. Subhash C. Jain (Chicago: American
Marketing Association, 1978): 257.
12 Theodore Levitt, “Marketing Myopia,” Harvard Business Review (July–August 1960): 46.

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13 Perspectives on Corporate Strategy: 42.
14 “Coca-Cola: A Sobering Lesson from Its Journey into Wine,” Business Week (3 June

1985): 96.
15 Derek F. Abell, Defining the Business: The Starting Point of Strategic Planning (Englewood

Cliffs, NJ, Prentice Hall, 1980).
16 Abell, Defining the Business: 174–75.
17 Erik Calonius, “America’s Toughest Papermaker,” Fortune (26 February 1990): 80.
18 Alex Taylor III, “Will Success Spoil Chrysler?” Fortune (10 January 1994): 88.
19 See Robert D. Buzzell and Bradley T. Gale, The PIMS Principles (New York: The Free

Press, 1987).
20 Edward W. Desmond, “What’s Ailing Kodak?” Fortune (27 October 1997): 185.
21 Carolyn Y. Woo and Arnold C. Cooper, “The Surprising Case for Low Market Share,”

Harvard Business Review (November–December 1982): 106–13.
22 Orit Gadiesh and James L. Gilbert, “Profit Pools: A Fresh Look at Strategy,”

HarvardBusiness Review (May–June, 1998): 139–148.
23 Time (28 March 1988): 36.
24 ”Higher Rewards in Lowered Goals,” Fortune (8 March 1993): 75.
25 Robert Reiner, “Goal Setting,” in Perspectives (Boston: Boston Consulting Group, Inc.,
1988).

9
CHAPTER NINE

Strategy SelectionT

wo things were achieved in the previous chapters. First, the internal andexternal information required for formulating marketing strategy was identified, and the methods for analyzing information were examined. Second, using
the available information, the formulation of objectives was covered. This chapter
takes us to the next step toward strategy formulation by establishing a framework
for it.
Our principal concern in this chapter is with business unit strategy. Among
several inputs required to formulate business unit strategy, one basic input is thestrategic perspective of different products/markets that constitute the business
unit. Therefore, as a first step toward formulating business unit strategy, a scheme
for developing product/market strategies is introduced.
Bringing product/market strategies within a framework of business unit
strategy formulation emphasizes the importance of inputs from both the top
down and the bottom up. As a matter of fact, it can be said that strategic decisions
in a diversified company are best made at three different levels: jointly by product/market managers and the SBU manager when questions of implementation
are involved, jointly by the CEO and the SBU manager when formulation of strategy is the concern, and by the CEO when the mission of the business is at issue.

All men can see thetactics whereby I
conquer, but what none
can see is the strategy
out of which victoryis achieved.
SUN–T ZUCONCEPTUAL SCHEME
Exhibit 9-1 depicts the framework for developing marketing strategy. As delineated earlier, marketing strategy is based on three key factors: corporation, customer, and competition. The interaction among these three factors is rather
complex. For example, the corporation factor impacts marketing strategy formulation through (a) business unit mission and its goals and objectives, (b) perspectives of strengths and weaknesses in different functional areas of the business at
different levels, and (c) perspectives of different products/markets that constitutethe business unit. Competition affects the business unit mission as well as themeasurement of strengths and weaknesses. The customer factor is omnipresent,
affecting the formation of goals and objectives to support the business unit mission and directly affecting marketing strategy.

PRODUCT/MARKET STRATEGY
The following step-by-step procedure is used for formulating product/market
strategy:
213

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EXHIBIT 9-1
Framework for Formulating Marketing Strategy

1. Start with the present business. Predict what the momentum of the businesswill be over the planning period if no significant changes are made in the policies or methods of operation. The prediction should be based on historical performance.
2. Forecast what will happen to the environment over the planning period. This
forecast will include overall marketing environment and product/market environment.
3. Modify the prediction in Step 1 in light of forecasted shifts in the environment
in Step 2.
4. Stop if predicted performance is fully satisfactory vis-à-vis objectives. Continue
if the prediction is not fully satisfying.
5. Appraise the significant strengths and weaknesses of the business in comparison with those of important competitors. This appraisal should include any factors that may become important both in marketing (market, product, price,promotion, and distribution) and in other functional areas (finance, research anddevelopment, costs, organization, morale, reputation, management depth, etc.).
6. Evaluate the differences between your marketing strategies and those of yourmajor competitors.
7. Undertake an analysis to discover some variation in marketing strategy that would
produce a more favorable relationship in your competitive posture in the future.

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8. Evaluate the proposed alternate strategy in terms of possible risks, competitive
response, and potential payout.
9. Stop if the alternate strategy appears satisfactory in terms of objectives.
10. Broaden the definition of the present business and repeat Steps 7, 8, and 9 if
there is still a gap between the objective and the alternative strategy. Here,redefining the business means looking at other products that can be supplied toa market that is known and understood. Sometimes this means supplying existing products to a different market. It may also mean applying technical or financial abilities to new products and new markets simultaneously.
11. The process of broadening the definition of the business to provide a wider
horizon can be continued until one of the following occurs:a. The knowledge of the new area becomes so thin that a choice of the sector to
be studied is determined by intuition or by obviously inadequate judgment.
b. The cost of studying the new area becomes prohibitively expensive becauseof lack of related experience.
c. It becomes clear that the prospects of finding a competitive opportunity are
remote.
12. Lower the objectives if the existing business is not satisfactory and if broadening
the definition of the business offers unsatisfactory prospects.

There are three tasks involved in this strategy procedure: information analysis, strategy formulation, and implementation. At the product/market level, thesetasks are performed by either the product/market manager or an SBU executive.
In practice, analysis and implementation are usually handled entirely by the
product/market manager; strategy formulation is done jointly by the product/
market manager and the SBU executive.
Essentially, all firms have some kind of strategy and plans to carry on theiroperations. In the past, both plans and strategy were made intuitively. However,
the increasing pace of change is forcing businesses to make their strategies explicit
and often to change them. Strategy per se is getting more and more attention.
Any approach to strategy formulation leads to a conflict between objectives
and capabilities. Attempting the impossible is not a good strategy; it is just a
waste of resources. On the other hand, setting inadequate objectives is obviously
self-defeating. Setting the proper objectives depends upon prejudgment of thepotential success of the strategy; however, you cannot determine the strategy
until you know the objectives. Strategy development is a reiterative process
requiring art as well as science. This dilemma may explain why many strategies
are intuitively made rather than logically and tightly reasoned. But there are concepts that can be usefully applied in approximating opportunities and in speeding up the process of strategy development. The above procedure is designed not
only to analyze information systematically but also to formulate or change strategy in an explicit fashion and implement it.
Measuring theMomentumThe first phase in developing product/market plans is to predict the future stateof affairs, assuming that the environment and the strategy remain the same.
This future state of affairs may be called momentum. If the momentum projects

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PART 4 Strategy Formulationa desirable future, no change in strategy is needed. More often, however, thefuture implied by the momentum may not be the desired future.
The momentum may be predicted using modeling, forecasting, and simulation techniques. Let us describe how these techniques were applied at a bank.
This bank grew by opening two to three new branches per year in its trading area.
The measurement of momentum consisted of projecting income statement andbalance sheet figures for new branches and merging them with the projected
income statement and balance sheet of the original bank. A model was constructed to project the bank’s future performance. The first step in construction of
the model was the prediction of Bijt , that is, balances for an account of type i inarea j and in time period t. Account types included checking, savings, and certificates of deposit; areas were chosen to coincide with counties in the state. County
areas were desirable because most data at the state level were available by county
and because current branching areas were defined by counties. Balances were
projected using multiple linear regression. County per capita income and rate of
population growth were found to be important variables for predicting total
checking account balances, and these variables, along with the last period’s savings balance, were shown to be important in describing savings account balances.
The next step was to predict Mjt (i.e., the market share of the bank being considered in area j and time period t). This was done using a combination of data of
past performances and managerial judgment. The total expected deposit level forthe branch being considered, Dit , was then calculated as:
Dit =∑ (B M )
ijt

jt

jb

For the existing operations of the bank, past data were utilized to produce a
10-year set of deposit balances. These deposit projections were added to those of
new branches. Turning to other figures, certain line items on the income statement could be attributed directly to checking accounts, others to savings
accounts. The remaining figures were related to the total of account balances.
For this model, ratios of income and expense items to appropriate deposit
balances were predicted by a least-squares regression on historical data. This was
not considered the most satisfactory method because some changing patterns of
incurring income and expenses were not taken into account. However, moresophisticated forecasting techniques, such as exponential smoothing and BoxJenkins, were rejected because of the potential management misunderstanding
they could generate.
Once the ratio matrix was developed, income statements could be generated
by simply multiplying the ratios by the proper account balance projection toarrive at the 10-year projection for income statement line items. These income
statements, in conjunction with the bank’s policy on dividends and capitalization, were then used to generate a 10-year balance sheet projection. The net
results were presented to the bank’s senior executive committee to be reviewed
and modified. After incorporating executive judgment, final 10-year income

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statements and balance sheets were obtained, indicating the bank’s momentum
into the future.
Gap Analysis

In the banking example, momentum was extrapolated from historical data. Little
attention was given to either internal or external environmental considerations indeveloping the momentum. However, for a realistic projection of future outcomes, careful analysis of the overall marketing environment as well as the product/market environment is necessary.
As a part of gap analysis, therefore, the momentum should be examined andadjusted with reference to environmental assumptions. The industry, the market,
and the competitive environment should be analyzed to identify important
threats and opportunities. This analysis should be combined with a careful evaluation of product/market competitive strengths and weaknesses. On the basis of
this information, the momentum should be evaluated and refined.
For example, in the midst of continued concern about recession in 1998, thechairman of the Federal Reserve System, Alan Greenspan, decided to increase themoney supply. To do so, the prime and short-term interest rates were decreased.
For instance, the rate of interest on many 30-month certificates of deposit went
down from 5.25 percent in 1997 to 4.75 percent in 1998. This increase led many
depositors to choose other forms of investment over certificates of deposit. In theillustration discussed in the last section, the impact of such a decline in interest
rates was not considered in arriving at the momentum (i.e., in making forecastsof deposit balances). As a part of gap analysis, this shift in the environment would
be duly taken into account and the momentum would be adequately adjusted.
The “new” momentum should then be measured against objectives to see if
there is a gap between expectation and potential realization. More often than not,there will be a gap between desired objectives and what the projected momentum, as revised with reference to environmental assumptions, can deliver. How
this gap may be filled is discussed next.

Finding the Gap

The gap must be filled to bring planned results as close to objectives as possible.
Essentially, gap filling amounts to reformulating product/market strategy.1 A
three-step procedure may be used for examining current strategy and coming up
with a new one to fill the gap. These steps are issue assessment, identification of
key variables, and strategy selection. The experience of some companies suggeststhat gap filling should be assigned to a multifunctional team. Nonmarketingpeople often provide fresh inputs; their objectivity and healthy skepticism are
generally of great help in sharpening focus and in maintaining businesswide perspectives. The process the team follows should be carefully structured and theanalytical work punctuated with regular review meetings to synthesize findings,
check progress, and refocus work when desirable. The SBU staff should be deeply
involved in the evaluation and approval of the strategies.
Issue Assessment. The primary purpose of this step is to raise issues about
the status quo to evaluate the business’s competitive standing in view of present

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PART 4 Strategy Formulationand expected market conditions. To begin, a team would typically workthrough a series of general questions about the industry to identify those few
issues that will most crucially affect the future of the business. The following
questions might be included: How mature is the product/market segment
under review? What new avenues of market growth are conceivable? Is theindustry becoming more cyclical? Are competitive factors changing (e.g., Is
product line elaboration declining and cost control gaining in importance?)? Is
our industry as a whole likely to be hurt by continuing inflation? Are new regulatory restrictions pending?
Next, the company should evaluate its own competitive position, for which
the following questions may be raised: How mature is our product line? How do
our products perform compared with those of leading competitors? How does
our marketing capability compare? What about our cost position? What are ourcustomers’ most common criticisms? Where are we most vulnerable to competitors? How strong are we in our distribution channels? How productive is ourtechnology? How good is our record in new product introduction?
Some critical issues are immediately apparent in many companies. For example, a company in a highly concentrated industry might find it difficult to hold on
to its market share if a stronger, larger competitor were to launch a new lowpriced product with intensive promotional support. Also, in a capital-intensive
industry, the cyclical pattern and possible pressures on pricing are usually critical. If a product’s transport costs are high, preemptive investments in regional
manufacturing facilities may be desirable. Other important issues may be concerned with threats of backward integration by customers or forward integration
by suppliers, technological upset, new regulatory action, or the entry of foreigncompetition into the home market. Most strategy teams supplement this brainstorming exercise with certain basic analyses that often lead to fresh insights anda more focused list of critical business issues. Three such issues that may be mentioned here are profit economics analysis, market segmentation analysis, andcompetitor profiling.
Profit Economics Analysis. Profit economics analysis indicates how productcosts are physically generated and where economic leverage lies. The contribution of the product to fixed costs and profits may be calculated by classifying theelements of cost as fixed, variable, or semivariable and by subtracting variable
cost from product price to yield contribution per item sold. It is then possible totest the sensitivity of profits to possible variations in volume, price, and cost elements. Similar computations may be made for manufacturing facilities, distribution channels, and customers.
Market Segmentation Analysis. Market segmentation analysis shows alternate
methods of segmentation and whether there are any segments not being properly
cultivated. Once the appropriate segment is determined, efforts should be madeto project the determinants of demand (including cyclical factors and any constraints on market size or growth rate) and to explain pricing patterns, relative
market shares, and other determinants of profitability.

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Competitor Profiling. Profiling competitors may involve examining their sales
literature, talking with experts or representatives of industry associations, andinterviewing shared customers and any known former employees of competitors.
If more information is needed, the team may acquire and analyze competingproducts and perhaps even arrange to have competitors interviewed by a third
party. With these data, competitors may be compared in terms of product featuresand performance, pricing, likely product costs and profitability, marketing andservice efforts, manufacturing facilities and efficiency, and technology and product development capabilities. Finally, each competitor’s basic strategy may beinferred from these comparisons.
Identification of Key Variables. The information on issues described above
should be analyzed to isolate the critical factors on which success in the industry
depends.2 In any business, there are usually about five to ten factors with a decisive effect on performance. As a matter of fact, in some industries one single
factor may be the key to success. For example, in the airline industry, with its highfixed costs, a high load factor is critical to success. In the automobile industry, astrong dealer network is a key success factor because the manufacturer’s sales
crucially depend on the dealer’s ability to finance a wide range of model choices
and offer competitive prices to the customer. In a commodity component market,
such as switches, timers, and relays, both market share and profitability are heavily influenced by product range. An engineer who is designing circuitry normallyreaches for the thickest catalog with the richest product selection. In this industry,
therefore, the manufacturer with a wide selection can collect more share points
with only a meager sales force.
Key factors may vary from industry to industry. Even within a single company, factors may vary according to shifts in industry position, product superiority, distribution methods, economic conditions, availability of raw materials, andthe like. Therefore, suggested here is a set of questions that may be raised to identify the key success factors in any given situation:
1. What things must be done exceptionally well to win in this industry? In particular, what must we do well today to lead the industry in profit results and competitive vitality in the years ahead?
2. What factors have caused or could cause companies in this industry to fail?
3. What are the unique strengths of our principal competitors?
4. What are the risks of product or process obsolescence? How likely are they tooccur and how critical could they be?
5. What things must be done to increase sales volume? How does a company in thisindustry go about increasing its share of the market? How could each of theseways of growing affect profits?
6. What are our major elements of cost? In what ways might each of them be
reduced?
7. What are the big profit leverage points in this industry (i.e., What would be thecomparative impact on profits of equal management efforts expended on each ofa whole series of possible improvement opportunities?)?

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8. What key recurring decisions must be made in each major functional segment of
the business? What impact on profits could a good or bad decision in each ofthese categories have?
9. How, if at all, could the performance of this function give the company a competitive advantage?

Once these key factors have been identified, they should be examined withreference to the current status of the product/market to define alternative strategies that may be pursued to gain competitive advantage over the long term. Eachalternative strategy should be evaluated for profit payoff, investment costs, feasibility, and risk.
It is important that strategy alternatives be described as specifically as possible. Simply stating “maintain product quality,” “provide high-quality service,” or”expand market overseas” is not enough. Precise and concrete descriptions, suchas “extend the warranty period from one year to two years,” “enter U.K., French,and German markets by appointing agents in these countries,” and “provide a$100 cash rebate to every buyer to be handed over by the company directly,” areessential before alternatives can be adequately evaluated.
Initially, the strategy group may generate a long list of alternatives, but informal discussion with management can soon pare these down to a handful. Eachsurviving alternative should be weighted in terms of projected financial consequences (sales, fixed and variable costs, profitability, investment, and cash flow)
and relevant nonfinancial measures (market shares, product quality and reliability indices, channel efficiency, and so on) over the planning period.
At this time, due attention should be paid to examining any contingencies
and to making appropriate responses to them. For example, if market share
increases by only half of what was planned, what pricing and promotional
actions might be undertaken? If customer demand instantly shoots up, how canorders be filled? What ought to be done if the Consumer Product Safety
Commission should promulgate new product usage controls? In addition, if thebusiness is in a cyclical industry, each alternative should also be tested against
several market-size scenarios, simultaneously incorporating varying assumptions about competitive pricing pressures. In industries dominated by a few competitors, an evaluation should be made of the ability of the business to adapt eachstrategy to competitive actions—pricing moves, shifts in advertising strategy, or
attempts to dominate a distribution channel, for example.
Strategy Selection. After information on trade-offs between alternative
strategies has been gathered as discussed above, a preferred strategy should bechosen for recommendation to management. Usually, there are three core marketing strategies that a company may use: (a) operational excellence, (b) productleadership, and (c) customer intimacy. Operational excellence strategy amounts
to offering middle-of-the-market products at the best price with the least inconvenience. Under this strategy, the proposition to the customer is simple: low
price or hassle-free service or both. Wal-Mart, Price/Costco, and Dell Computer
epitomize this kind of strategy.3 The product leadership strategy concentrates onStrategy Selection

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offering products that push performance boundaries. In other words, the basic
premise of this strategy is that customers receive the best product. Moreover,product leaders don’t build their propositions with just one innovation: they
continue to innovate year after year. Johnson & Johnson, for instance, is a product leader in the medical equipment field. With Nike, the superior value does notreside just in its athletic footwear, but also in the comfort customers can takefrom knowing that whatever product they buy from Nike will represent thehottest style and technology on the market.4
For product leaders, competition is not about price or customer service, it isabout product performance. The customer intimacy strategy focuses not on what
the market wants but on what specific customers want. Businesses following thisstrategy do not pursue one-time transactions; they cultivate relationships. They
specialize in satisfying unique needs, which often only they recognize, through aclose relationship with and intimate knowledge of the customer. The underlying
proposition of this strategy is: we have the best solution for you, and provide all
the support you need to achieve optimum results.5 Long-distance telephone carrier Cable and Wireless, for example, follows this strategy with a vengeance,
achieving success in a highly competitive market by consistently going the extra
mile for its selectively chosen, small business customers. Exhibit 9-2 summarizes
the differentiating aspects of the three core strategies examined above.

EXHIBIT 9-2
Distinguishing Aspects of Different Core Marketing Strategies
Core Strategy
Managerial
Attributes

Operational
Excellence

Product
Leadership

Customer
Intimacy

Strategic
Direction

Sharpen distribution
systems and provide
no-hassle service

Nurture ideas,translate them into
products, and market
them skillfully

Provide solutions andhelp customers run
their businesses

Organizational
Arrangement

Has strong, central
authority and afinite level of
empowerment

Acts in an ad hoc,organic, loosely knit,
and ever-changing
way

Pushes empowerment close tocustomer contact

Systems
Support

Maintain standard
operating procedures

Reward individuals’
innovative capacityand new productsuccess

Measure the cost ofproviding service andof maintaining customer loyalty

Corporate
CultureActs predictably andbelieves “one size
fits all”

Experiments andthinks “out-of-thebox”

Is flexible and thinks“have it your way”

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The core strategy combines one or more areas of the marketing mix.6 For
example, the preferred strategy may be product leadership. Here the emphasis of
the strategy is on product, the area of primary concern. However, in order tomake an integrated marketing decision, appropriate changes may have to bemade in price, promotion, and distribution areas. The strategic perspectives inthese areas may be called supporting strategies. Thus, once core strategy has been
selected, supporting strategies should be delineated. Core and supporting strategies should fit the needs of the marketplace, the skills of the company, and thevagaries of the competition.
The concept of core and supporting strategies may be examined with reference to the Ikea furniture chain.7 Ikea, the giant Swedish home-furnishings business, has done well in the U.S. market by pursuing operational excellence as itscore strategy. Where other Scandinavian furniture stores have faltered in the
United States, Ikea keeps growing. Despite its poor service, customers keep
coming to buy trendy furniture at bargain basement prices. The company has
well aligned its supporting strategies of product, promotion, and distribution
with its core strategy. For example, it selects highly visible sites easily accessible
from major highways to generate traffic. Few competitors can match the selection
offered by its cavernous 200,000-square-foot branches, which on average are fivetimes larger than full-line competitors. The products are stylish and durable aswell as functional; the quality is good. Advertising attempts to mold Ikea’s image
as hip and appealing. Ikea’s enticing in-store models, easy-to-find price tags, andattractive displays create instant interest in the merchandise. But all these supporting strategies are fully price relevant. The company is so price conscious thatit has used components from as many as four different manufacturers to make asingle chair. Briefly, Ikea follows a strategy to satisfy the desire for contemporary
furniture at moderate prices.
It is rather common for firms competing in the same industry to choose different core and supporting strategies through which to compete. The chosen strategy reflects the particular strength of the firm, the specific demands of the market,
and the competitive thrust. As has been noted:
Coca-Cola was born a winner, but Pepsi had to fight to survive by distinguishing itself
from the leader. For most of its history, Pepsi differentiated itself purely on price:“Twice as much for a nickel, too.” Only in the early 1970s did Pepsi start to believe thatits product actually may be as good as if not better than Coke’s. The resulting strategy
was: “The Pepsi challenge.”
The first belief of Coca-Cola was that its product was sacred. The resulting strategy
was simple: “Don’t touch the recipe” and “don’t put lesser products under the samebrand name” (call them “Tab”). Coca-Cola’s second belief was that anyone should be
able to buy Coke within a few steps of anywhere on earth. This belief drove the company to make its product available in every conceivable outlet and required a distribution strategy that allowed all outlets a reasonable profit at competitive prices.
While Coca-Cola was driven by a product focus, Pepsi developed a more marketoriented perspective. Pepsi was the first to offer new sizes and packages. When consumer trends toward health, fitness and sweeter taste emerged, Pepsi again was theStrategy Selection

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innovator: It was the first to market diet and light varieties and it quickly sweetened
its formula. Unencumbered by reverence for its base brand, it introduced the newvarieties as extensions of the Pepsi signature. Where Coca-Cola feared a dilution of its
brand name, Pepsi saw an opportunity to exploit the cost advantages and advertisingof an umbrella brand.8

It is important to remember that the core strategy is formulated around thecritical variable(s) that may differ from one segment to another for the same product. This is well supported by the following quotation taken from a case study ofthe petroloids business. Petroloids, a family of such unique materials as oils,
petro-rubbers, foams, adhesives, and sealants, are manufactured substances
based on the synthesis of organic hydrocarbons:
Major producers competed with one another on a variety of dimensions. Among themost important were price, technical assistance, advertising and promotion, and product availability. Price was used as a competitive weapon primarily in those segmentsof the market where products and applications had become standardized. However,where products had been developed for highly specialized purposes and represented
only a small fraction of a customer’s total material cost, the market was often less pricesensitive. Here customers were chiefly concerned with the physical properties of the
product and operating performance.
Technical assistance was an important means of obtaining business. A sizable percentage of total petroloid sales were accounted for by products developed to meet theunique needs of particular customers. Products for the aerospace industry were a primary example. Research engineers of petroloid producers were expected to work
closely with customers to define performance requirements and to insure the development of acceptable products.
Advertising and promotional activities were important marketing tools in thosesegments which utilized distribution channels and/or which reached end users as
opposed to OEM’s. This was particularly true of foams, adhesives, and sealants whichwere sold both to industrial and consumer markets. A variety of packaged consumer
products were sold to hardware, supermarkets, and “do-it-yourself” outlets by ourcompany as well as other competitors. Advertising increased awareness and stimulated interest among the general public while promotional activities improved theeffectiveness of distribution networks. Since speciality petroloid products accounted
for only a small percentage of a distributor’s total sales, product promotion insured
that specific products received adequate attention.
Product availability was a fourth dimension on which producers competed. With
manufacturing cycles from 2–16 weeks in length and thousands of different products,
no supplier could afford to keep all his items in stock. In periods of heavy demand,
many products were often in short supply. Those competitors with adequate supplies
and quick deliveries could readily attract new business.9

Apparently, strategy development is difficult because different emphases
may be needed in different product/market situations. Emphasis is built around
critical variables that may themselves be difficult to identify. Luck plays a part inmaking the right move; occasionally, sheer intuition suffices. Despite all this, acareful review of past performance, current perspectives, and environmental
changes go a long way in choosing the right areas on which to concentrate.

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Reformulation of current strategy may range from making slight modifications
in existing perspectives to coming out with an entirely different strategy. For example, in the area of pricing, one alternative for an automobile manufacturer may be
to keep prices stable from year to year (i.e., no yearly price increases). A different
alternative is to lease cars directly to consumers instead of selling them. The decision on the first alternative may be made by the SBU executive. But the second
alternative, being far-reaching in nature, may require the review and approval of
top management. In other words, how much examination and review a product/market strategy requires depends on the nature of the strategy (in terms of thechange it seeks from existing perspectives) and the resource commitment required.
Another point to remember in developing core strategy is that the emphasisshould always be placed on searching for new ways to compete. The marketingstrategist should develop strategy around those key factors in which the businesshas more freedom than its competitors have. The point may be illustrated with reference to Body Shop International, a cosmetic company that spends nothing on
advertising, even though it is in one of the most image-conscious industries in thebusiness world.10 Based in England, this company operates in 37 nations. Unlike
typical cosmetic manufacturers, which sell through drugstores and department
stores, Body Shop sells its own franchise stores. Further, in a business in whichpackaging costs often outstrip product costs, the Body Shop offers its products inplain, identical rows of bottles and gives discounts to customers who bring Body
Shop bottles in for refills. The company has succeeded because it is so different
from its rivals. Instead of assailing its customers with promotions and ads, it educates them. A great deal of Body Shop’s budget is spent on training store personnel on the detailed nature of how its products are made and how they ought to be
used. Training, which is accomplished through newsletters, videotapes, and classroom study, enables salesclerks to educate consumers on hair care, problem skintreatments, and the ecological benefits of such exotic products as rhassoul andmud shampoo, white grape skin tonic, and peppermint foot lotion. Consumers
have also responded to Body Shop’s environmental policies: the company uses
only natural ingredients in its products, doesn’t use animals for lab testing, andpublicly supports saving whales and preserving Brazilian rain forests.
Another example is provided by Enterprise Rent-a-Car Company. While
Hertz, Avis, and other members of the car rental industry were aggressively competing to win a point or two of the business and vacation travelers market at airports, Enterprise invaded the hinterlands with a completely different
strategy—”one that relies heavily on doughnuts, ex-college frat house jocks, andyour problems with your family car.”11 The company’s approach is simple: It aims
to provide a spare family car. Say a person’s car has been hit or has broken down,
or is in for routine maintenance. Once upon a time, the person could have asked
his spouse for a ride or he could have borrowed her car, but now she is commuting to her own job. “Lo and behold, even before you have time to kick the repair
shop’s Coke machine, a well-dressed, intelligent young Enterprise agent materializes with some paperwork and a car for you.”12 Typically, an Enterprise car
rents for one-third less than one from an airport.

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Instead of massing 10,000 cars at a few dozen airports, Enterprise sets up
inexpensive rental offices just about everywhere. As soon as one branch grows toabout 150 cars, the company opens another a few miles away. The company
claims that 90% of the American population lives within 15 minutes of anEnterprise office. Once a new office opens, employees fan out to develop relationships with the service managers of every good-size auto dealership and body
shop in the area. When a person’s car is being towed, he/she is in no mood tofigure out which local rent-a-car company to use. Enterprise knows that the recommendations of the garage service managers will carry enormous weight, so it
has turned courting them into an art form.
The end result is Enterprise has bypassed everybody in the industry. It owns
over 400,000 cars and operates in more locations than Hertz. The company
accounts for more than 20% of the $15 billion-a-year car rental business, versus
17% for Hertz and about 12% for Avis.
In the final analysis, companies with the following characteristics are most
likely to develop successful strategies:
1. Informed opportunism—Information is the main strategic advantage, and flexibility is the main strategic weapon. Management assumes that opportunity willkeep knocking but that it will knock softly and in unpredictable ways.
2. Direction and empowerment—Managers define the boundaries, and their subordinates figure out the best way to do the job within them. Managers give up
some control to gain results.
3. Friendly facts, congenial controls—Share information that provides context andremoves decision making from the realm of mere opinion. Managers regard
financial controls as the benign checks and balances that allow them to be creative and free.
4. A different mirror—Leaders are open and inquisitive. They get ideas fromalmost anyone in and out of the hierarchy: customers, competitors, even nextdoor neighbors.
5. Teamwork, trust, politics, and power—Stress the value of teamwork and trust
the employees to do the job. Be relentless at fighting office politics, since politics
are inevitable in the workplace.
6. Stability in motion—Keep changing but have a base of underlying stability.
Understand the need for consistency and norms, but also realize that the only
way to respond to change is to deliberately break the rules.
7. Attitudes and attention—Visible management attention, rather than exhortation,
gets things done. Action may start with words, but it must be backed by symbolic
behavior that makes those words come alive.
8. Causes and commitment—Commitment results from management’s ability toturn grand causes into small actions so that everyone can contribute to the central
purpose.

DETERMINING SBU STRATEGY
SBU strategy concerns how to create competitive advantage in each of the
products/markets it competes with. The business-unit-level strategy is determined

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PART 4 Strategy Formulationby the three Cs (customer, competition, and company). The experience of different
companies shows that, for the purposes of strategy formulation, the strategic threeCs can be articulated by placing SBUs on a two-by-two matrix with industry maturity or attractiveness as one dimension and strategic competitive position as theother.
Industry attractiveness may be studied with reference to the life-cycle stageof the industry (i.e., embryonic, growth, mature, or aging). Such factors as growthrate, industry potential, breadth of product line, number of competitors, market
share perspectives, purchasing patterns of customers, ease of entry, and technology development determine the maturity of the industry. As illustrated in Exhibit
9-3, these factors behave in different ways according to the stage of industry
maturity. For example, in the embryonic stage, the product line is generally
narrow, and frequent changes to tailor the line to customer needs are common. In
the growth stage, product lines undergo rapid proliferation. In the mature stage,
attempts are made to orient products to specific segments. During the aging
stage, the product line begins to shrink.
Going through the four stages of the industry life cycle can take decades or a
few years. The different stages are generally of unequal duration. To cite a few
examples, personal computers and solar energy devices are in the embryonic category. Home smoke alarms and sporting goods in general fall into the growth category. Golf equipment and steel represent mature industries. Men’s hats and rail cars
are in the aging category. It is important to remember that industries can experience
reversals in the aging processes. For example, roller skates have experienced atremendous resurgence (i.e., moving from the aging stage back to the growth stage)
because of the introduction of polyurethane wheels. It should also be emphasizedthat there is no “good” or “bad” life-cycle position. A particular stage of maturity
becomes “bad” only if the expectations or strategies adopted by an industry participant are inappropriate for its stage of maturity. The particular characteristics ofthe four different stages in the life cycle are discussed in the following paragraphs.
Embryonic industries usually experience rapid sales growth, frequentchanges in technology, and fragmented, shifting market shares. The cash deployment to these businesses is often high relative to sales as investment is made inmarket development, facilities, and technology. Embryonic businesses are generally not profitable, but investment is usually warranted in anticipation of gaining
position in a developing market.
The growth stage is generally characterized by a rapid expansion of sales as
the market develops. Customers, shares, and technology are better known than in
the embryonic stage, and entry into the industry can be more difficult. Growthbusinesses are usually capital borrowers from the corporation, producing low-togood earnings.
In mature industries, competitors, technology, and customers are all known
and there is little volatility in market shares. The growth rate of these industries
is usually about equal to GNP. Businesses in mature industries tend to provide
cash for the corporation through high earnings.
The aging stage of maturity is characterized by

EXHIBIT 9-3
Industry Maturity Guide
Stages of Industry Maturity
MatureAging

Growth rate

Accelerating; meaningfulrate cannot be calculated
because base is too small

Substantially faster than
GNP; industry sales
expanding significantly

Growth at rate equal to or
slower than GNP; more
subject to cyclicality

Industry volume declining

Industry
potential

Usually difficult todetermine

Demand exceeds current
industry volume but issubject to unforeseen
developments

Well known; primary markets approach saturation

Saturation is reached;supply capability exceeds
demandProduct line

Line generally narrow;frequent changes tailoredto customer needs

Product lines undergo
rapid proliferation; someevidence of productsoriented toward multiple
industry segments

Product line turnover but
Product line shrinking but
little or no change intailored to major customer
breadth; products frequently needs
oriented toward narrowindustry segments

Number ofcompetitors

Few competing at first but
number increasing rapidly

Number and types are
unstable; increase to peakfollowed by shakeout andconsolidation

Generally stable or declining Declines or industry may
slightly
break up into many small
regional suppliersMarket sharestability

Volatile; share difficult tomeasure; share frequently
concentrated

Rankings can change; a
few firms have major
sharesLittle share volatility; firms
with major shares are entrenched; significant niche
competition; firms withminor shares are unlikely togain major sharesSome change as marginal
firms drop out; as market
declines, market share
generally becomes moreconcentrated

Purchasing
patterns

Varies; some customers
have strong loyalties;
others have none

Some customer loyalty;buyers are aggressive butshow evidence of repeat
or add-on purchases;
some price sensitivity

Suppliers are well known;
buying patterns are established; customers generally
loyal to limited number of
acceptable suppliers;
increasing price sensitivity

Strong customer loyalty as
number of alternatives
decreases; customers andsuppliers may be tied toeach other

Ease of entry(exclusive ofcapital considerations)

Usually easy; opportunity
may not be apparent

Usually easy; presence ofcompetitors is offset by
growthDifficult; competitors areentrenched; growth slowing

Little incentive

Technology

Important to match performance to market needs;
industries started on technological breakthrough orapplication; multiple
technologies

Fewer competing technologies; significant productline refinements or extensions likely; performanceenhancement is important

Process and materials
refinement; technologies
developed outside thisindustry are used inseeking efficiencies

Minimal role in ongoingproducts; new technology
sought to renew growth

Strategy Selection

Growth227

Embryonic

CHAPTER 9 Strategy Selection

Descriptors

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PART 4 Strategy Formulation

1. Falling demand for the product and limited growth potential.
2. A shrinking number of competitors (survivors gain market share through attrition).
3. Little product line variety.
4. Little, if any, investment in research and development or plant and equipment.

The competitive position of an SBU should depend not only on market share
but also on such factors as capacity utilization, current profitability, degree of
integration (forward or backward), distinctive product advantages (e.g., patent
protection), and management strength (e.g., willingness to take risks). These factors may be studied for classifying a given SBU in one of the following competitive positions: dominant, strong, favorable, tenable, or weak.
Exhibit 9-4 summarizes the typical characteristics of firms in different competitive positions. An example of a dominant firm is IBM in the computer field;
its competitors pattern their behavior and strategies on what IBM does. In thebeer industry, Anheuser-Busch exemplifies a strong firm, a firm able to make an
independent move without being punished by the major competitor.

EXHIBIT 9-4
Classification of Competitive Strategic Positions
Dominant••

Controls behavior and/or strategies of other competitors
Can choose from widest range of strategic options, independent of competitor’s actions

Strong•Can take independent stance or action without endangering long-term
positionCan generally maintain long-term position in the face of competitor’s
actions•
Favorable•••

Tenable

•
•
•
•

Weak

•
•
•

Nonviable•

Has strengths that are exploitable with certain strategies if industry conditions are favorable
Has more than average ability to improve position
If in a niche, holds a commanding position relatively secure from attack
Has sufficient potential and/or strengths to warrant continuation inbusiness
May maintain position with tacit consent of dominant company or of theindustry in general but is unlikely to significantly improve position
Tends to be only marginally profitable
If in a niche, is profitable but clearly vulnerable to competitors’ actions
Has currently unsatisfactory performance but has strengths that may
lead to improvement
Has many characteristics of a better position but suffers from past mistakes or current weaknesses
Inherently short-term position; must change (up or out)
Has currently unsatisfactory performance and few, if any, strengths that
may lead to improvement (may take years to die)Strategy Selection

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229

Determining strategic competitive position is one of the most complex elements of business analysis and one of the least researched. With little state-of-theart guidance available, the temptation is to fall back on the single criterion ofmarket share, but the experiences of successful companies make it clear that
determining competitive position is a multifaceted problem embracing, for example, technology, breadth of product line, market share, share movement, and special market relationships. Such factors change in relative importance as industry
maturity changes.
Choice of Strategy

Once the position of an SBU is located on the industry maturity/competitive
position matrix, the guide shown in Exhibit 9-5 may be used to determine whatstrategy the SBU should pursue. Actually, the strategies shown in the exhibit are
guides to strategic thrust rather than strategies per se. They show the normal

EXHIBIT 9-5
Guide to Strategic Thrust Options
Stages of Industry Maturity
Competitive
Position

Embryonic

GrowthMatureAging

Dominant

Grow fast
Start up

Grow fast
Attain cost leadership
Renew
Defend position

Defend position
Focus
Renew
Grow fast

Defend position
Renew
Grow into maturity

StrongStart up
Differentiate
Grow fast

Grow fast
Catch up
Attain cost leadership
Differentiate

Attain cost leadership
Renew, focus
Differentiate
Grow with industry

Find niche
Hold nicheHang in
Grow with industry
HarvestFavorable

Start up
Differentiate
Catch up
Focus
Grow fast

Differentiate, focus
Find niche, hold niche
Grow with industry

Harvest, hang inTurn aroundRenew, turn around
Differentiate, focus
Grow with industry

Retrench

TenableStart up
Grow with industry
Focus

Harvest, catch up
Hold niche, hang in
Find nicheTurn around
Focus
Grow with industry

HarvestTurn around
Find niche
Retrench

DivestRetrench

Weak

Find niche
Catch up
Grow with industry

Turn around
Retrench

Withdraw
DivestWithdraw

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PART 4 Strategy Formulation

strategic path a business unit may adopt, given its industry maturity and competitive position. The Appendix at the end of this chapter further examines thestrategic thrusts identified in Exhibit 9-5. Each strategic thrust is defined, and its
objective, requirements, and expected results are noted.
To bridge the gap between broad guidelines and specific strategies for implementation, further analysis is required. A three-stage process is suggested here.
First, using broad guidelines, the SBU management may be asked to state strategies pursued during previous years. Second, these strategies may be reviewed
by using selected performance ratios to analyze the extent to which strategies
were successfully implemented. Similarly, current strategies may be identified
and their link to past strategies established. Third, having identified and analyzed past and current strategy with the help of strategic guidelines, the management, using the same guidelines, selects the strategy it proposes to pursue inthe future. The future perspective may call for the continuation of current strategies or the development of new ones. Before accepting the future strategic
course, however, it is desirable to measure its cash consequences or internal
deployment (i.e., percentage of funds generated that are reinvested). Exhibit 9-6
illustrates an SBU earning 22 percent on assets with an internal deployment of
80 percent. Such an SBU would normally be considered in the mature stage.
However, if the previous analysis showed that the SBU was in fact operating in
EXHIBIT 9-6
Profitability and Cash Position of a BusinessStrategy Selection

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231

a growth industry, the corporation would need to rethink its investment policy.
All quantitative information pertaining to an SBU may be summarized on one
form, as shown in Exhibit 9-7.
Different product/market plans are reviewed at the SBU level. The purposeof this review is twofold: (a) to consider product/market strategies in finalizing
SBU strategies and (b) to approve product/market strategies. The underlying
criterion for evaluation is a balanced achievement of SBU goals, which may be
specified in terms of profitability and cash consequences. If there is a conflict ofinterest between two product/market groups in the way the strategy is either
articulated or implemented, the conflict should be resolved so that SBU goals are
maximized. Assume that both product/market groups seek additional investments during the next two years. Of these, the first product/market will startdelivering positive cash flow in the third year. The second one is not likely togenerate positive cash flow until the fourth year, but it will provide a higher
overall return on capital. If the SBU’s need for cash is urgent and if it desires
additional cash for its goals during the third year, the first product/market
group will appear more attractive. Thus, despite higher profit expectations fromthe second product/market group, the SBU may approve investment in the first
product/market group with a view to maximizing the realization of its own
goals.
At times, the SBU may require a product/market group to make additionalchanges in its strategic perspective before giving its final approval. On the other
hand, a product/market plan may be totally rejected and the group instructed topursue its current perspective.
Industry maturity and competitive position analysis may also be used in further refining the SBU itself. In other words, after an SBU has been created and isanalyzed for industry maturity and competitive position, it may be found that it
has not been properly constituted. This would require redefining the SBU andundertaking the analysis again. Drawing an example from the car radio industry,
considerable differences in industry maturity may become apparent between car
radios with built-in cassette players and traditional car radios. Differences inindustry maturity or competitive position may also exist with regard to regional
markets, consumer groups, and distribution channels. For example, the market
for cheap car radios sold by discount stores to end users doing their own installations may be growing faster than the market served by specialty retail storesproviding installation services. Such revelations may require further refinement
in formulating SBUs. This may continue until the SBUs represent the highest possible level of aggregation consistent with the need for clear-cut analyses of industry maturity and competitive position.

STRATEGY EVALUATION
The time required to develop resources is so extended, and the timescale ofopportunities is so brief and fleeting, that a company which has not carefully
delineated and appraised its strategy is adrift in white water. This underlines the

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EXHIBIT 9-7
Sources of Competitive Information

Year

Industry
Capacity(A)

Business
Unit’s
Product
Capacity(B)

Business
Unit’sSales(C)

Investment (per $ sales)
Profits
after
Taxes
(D)

New Assets Receivables(E)(F)

Inventories(G)

New
Current
Liabilities(H)

Working
Capital(I)

Other
Assets
(J)

Total
Net
Assets(K)

INVESTMENT
Return (continued)

Funds Generation and Deployment

Cost and Earnings (per $ sales)
Cost ofGoods
Yr. Sold(L)

ResearchandDevelopment
(M)

Sales
and
Marketing(N)

Generaland
Administrative(O)

Source: Arthur D. Little, Inc. Reprinted by permission.

Other
IncomeandExpenses(P)

ProfitbeforeTaxes(Q)

Profit
after
Taxes
(R)

Returnon NetAssets(S)

Operating
Funds
Flow
(T)

(per $ sales)(%)

Changesin
Assets(U)

Internal
Development(U ÷ T)(W)

Net Cash
Flow to
Corporation(V)

Strategy Selection

ReturnIndices of:PART 4 Strategy Formulation

PERFORMANCE

Strategy Selection

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233

importance of strategy evaluation. The adequacy of a strategy may be evaluatedusing the following criteria:13
1. Suitability—Is there a sustainable advantage?
2. Validity—Are the assumptions realistic?
3. Feasibility—Do we have the skills, resources, and commitments?
4. Internal consistency—Does the strategy hang together?
5. Vulnerability—What are the risks and contingencies?
6. Workability—Can we retain our flexibility?
7. Appropriate time horizon.

Suitability

Strategy should offer some sort of competitive advantage. In other words, strategy should lead to a future advantage or an adaptation to forces eroding current
competitive advantage. The following steps may be followed to judge the competitive advantage a strategy may provide: (a) review the potential threats andopportunities to the business, (b) assess each option in light of the capabilities ofthe business, (c) anticipate the likely competitive response to each option, and (d)modify or eliminate unsuitable options.

Validity(Consistent with
the Environment)

Strategy should be consistent with the assumptions about the external product/
market environment. At a time when more and more women are seeking jobs, astrategy assuming traditional roles for women (i.e., raising children and stayinghome) would be inconsistent with the environment.

Feasibility(Appropriateness inLight of Available
Resources)

Money, competence, and physical facilities are the critical resources a manager
should be aware of in finalizing strategy. A resource may be examined in two different ways: as a constraint limiting the achievement of goals and as an opportunity to be exploited as the basis for strategy. It is desirable for a strategist to makecorrect estimates of resources available without being excessively optimistic
about them. Further, even if resources are available in the corporation, a particular product/market group may not be able to lay claim to them. Alternatively,
resources currently available to a product/market group may be transferred toanother group if the SBU strategy deems it necessary.

Internal
Consistency

Strategy should be in tune with the different policies of the corporation, the SBU,
and the product/market arena. For example, if the corporation decided to limit
the government business of any unit to 40 percent of total sales, a product/
market strategy emphasizing greater than 40 percent reliance on the government
market would be internally inconsistent.

Vulnerability(Satisfactory
Degree of Risk)

The degree of risk may be determined on the basis of the perspectives of the strategy and available resources. A pertinent question here is: Will the resources beavailable as planned in appropriate quantities and for as long as it is necessary to
implement the strategy? The overall proportion of resources committed to a venture becomes a factor to be reckoned with: the greater these quantities, the greater
the degree of risk.

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Workability

The workability of a strategy should be realistically evaluated with quantitative
data. Sometimes, however, it may be difficult to undertake such objective analysis. In that case, other indications may be used to assess the contributions of astrategy. One such indication could be the degree of consensus among key executives about the viability of the strategy. Identifying ahead of time alternate
strategies for achieving the goal is another indication of the workability of a strategy. Finally, establishing resource requirements in advance, which eliminates theneed to institute crash programs of cost reduction or to seek reduction in planned
programs, also substantiates the workability of the strategy.

Appropriate Time
HorizonA viable strategy has a time frame for its realization. The time horizon of a strategy should allow implementation without creating havoc in the organization or
missing market availability. For example, in introducing a new product to themarket, enough time should be allotted for market testing, training of salespeople, and so on. But the time frame should not be so long that a competitor canenter the market first and skim the cream off the top.

SUMMARY

This chapter was devoted to strategy formulation for the SBU. A conceptual
framework for developing SBU strategy was outlined. Strategy formulation at the
SBU level requires, among different inputs, the perspectives of product/market
strategies. For this reason, a procedure for developing product/market strategy
was discussed first.
Product/market strategy development requires predicting the momentum of
current operations into the future (assuming constant conditions), modifying the
momentum in the light of environmental changes, and reviewing the adjusted
momentum against goals. If there is no gap between the set goal and the prediction, the present strategy may well be continued. Usually, however, there is a gap
between the goal and expectations from current operations. Thus, the gap mustbe filled.
The following three-step process was suggested for filling the gap: (a) issue
assessment (i.e., raising issues with the status quo vis-à-vis the future), (b) identification of key variables (i.e., isolating the key variables on which success in theindustry depends) and development of alternative strategies, and (c) strategy
selection (i.e., choosing the preferred strategy). The thrust of the preferred strategy is on one or more of the four variables in the marketing mix—product, price,promotion, or distribution. The major emphasis of marketing strategy, the core
strategy, is on this chosen variable. Strategies for the remaining variables are supporting strategies. Usually, the three core marketing strategies are operational
excellence, product leadership, and customer intimacy.
The SBU strategy is based on the three Cs (customer, competition, and company). SBUs were placed on a two-by-two matrix with industry maturity or
attractiveness as one dimension and strategic competitive position as the other.
Stages of industry maturity—embryonic, growth, mature, and aging—wereidentified. Competitive position can be classified as dominant, strong, favorable,

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tenable, or weak. Classification by industry maturity and competitive position
generates 20 different quadrants in the matrix. In each quadrant, an SBU requires
a different strategic perspective. A compendium of strategies was provided tofigure out the appropriate strategy in a particular case.
The chapter concluded with a procedure for evaluating the selected strategy.
This procedure consists of examining the following aspects of the strategy: suitability, validity, feasibility, internal consistency, vulnerability, workability, andappropriateness of time horizon.

DISCUSSIONQUESTIONS

NOTES

1. Describe how a manufacturer of washing machines may measure the momentum of the business for the next five years.
2. List five issues Sears may raise to review its strategy for large appliances.
3. List five key variables on which success in the home construction industry
depends.
4. In what industry state would you position (a) light beer and (b) color television?
5. Based on your knowledge of the company, what would you consider to beMiller’s competitive position in the light beer business and GE’s position in theappliance business?
6. Discuss how strategy evaluation criteria may be employed to review the strategy of an industrial goods manufacturer.

Gary Hamel and C.K. Prahalad, “Strategy as Stretch and Leverage,” Harvard Business
Review (March–April 1993): 75–85.
2 Alistair Hanna, “Evaluating Strategies,” The McKinsey Quarterly 3 (1991): 158–177.
3 Michael E. Porter, “What Is Strategy?” Harvard Business Review (November–December
1996): 61–78.
4 Gary Hamel, “Killer Strategies,” Fortune (23 June 1997): 70.
5 Ian C. MacMillan and Rita Gunther McGrath, “Discovering New Points ofDifferentiation,” Harvard Business Review (July–August 1997): 133–145.
6 Peter R. Dickson and James L. Ginter, “Market Segmentation, Product Differentiation,and Marketing Strategy,” Journal of Marketing 51 (April 1987): 1–10.
7 Jeffrey A. Trachtenberg, “Ikea Furniture Chain Pleases with Its Prices, Not with Its
Service,” The Wall Street Journal (17 September 1991): 1.
8 Michael Norkus, “Soft Drink Wars: A Lot More Than Just Good Taste,” The Wall Street
Journal (8 July 1985): 12.
9 “Tex-Fiber Industries Petroloid Products Division (A),” a case developed by John Craig
under the supervision of Derek F. Abell, copyrighted by the President and Fellows ofHarvard College, 1970, 7.
10 Allan J. Magrath, “Contrarian Marketing,” Across the Board (October 1990): 46–50.
11 Brian O’Reilly, “The Rent-a-Car Jocks who make Enterprise #1,” Fortune (October1996): 125
12 Ibid.
13 See George S. Day, “Tough Questions for Developing Strategies,” Journal of Business(Winter 1986): 60–68.
1

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APPENDIX

Perspectives on Strategic Thrusts

A. Start Up

Definition: Introduction of new product or service with clear, significant technology breakthrough.
Objective: To develop a totally new industry to create and satisfy new demand
where none existed before.
Requirements: Risk-taking attitude of management; capital expenditures; expense.
Expected Results: Negative cash flow; low-to-negative returns; a leadership position in new industry.

B. Grow with
Industry

Definition: To limit efforts to those necessary to maintain market share.
Objective: To free resources to correct market, product, management, or production weaknesses.
Requirements: Management restraint; market intelligence; some capital andexpense investments; time-limited strategy.
Expected Results: Stable market share; profit, cash flow, and RONA not significantly worse than recent history, fluctuating only as do industry averages.

C. Grow Fast

Definition: To pursue aggressively larger share and/or stronger position relative
to competition.
Objective: To grow volume and share faster than competition and faster than general industry growth rate.
Requirements: Available resources for investment and follow-up; risk-taking management attitude; and appropriate investment strategy.
Expected Results: Higher market share; in the short term, perhaps lower returns;
above average returns in the longer term; competitive retaliation.

D. Attain Cost
Leadership

Definition: To achieve lowest delivered costs relative to competition with acceptable quality levels.
Objective: To increase freedom to defend against powerful entries, strong customer blocks, vigorous competitors, or potential substitute products.
Requirements: Relatively high market share; disciplined, persistent management
efforts; favorable access to raw materials; substantial capital expenditures;
aggressive pricing.
Expected Results: In early stages, may result in start-up losses to build share; ultimately, high margins; relatively low capital turnover rates.

E. Differentiate

Definition: To achieve the highest degree of product/quality/service difference(as perceived by customers) in the industry with acceptable costs.
Objective: To insulate the company from switching, substitution, price competition, and strong blocks of customers or suppliers.
Requirements: Willingness to sacrifice high market share; careful target marketing;focused technological and market research; strong brand loyalty.

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Expected Results: Possibly lowered market share; high margins; above-average
earnings; highly defensible position.
F. Focus

Definition: To select a particular segment of the market/product line more narrowin scope than competing firms.
Objective: To serve the strategic target area (geographic, product, or market) more
efficiently, fully, and profitably than it can be served by broad-line competitors.
Requirements: Disciplined management; persistent pursuit of well-defined scopeand mission; premium pricing; careful target selection.
Expected Results: Above-average earnings; may be low-cost producer in its area;
may attain high differentiation.

G. Review

Definition: To restore the competitiveness of a product line in anticipation of
future industry sales.
Objective: To overcome weakness in product/market mix in order to improveshare or to prepare for a new generation of demand, competition, or substitute products.
Requirements: Strong-enough competitive position to generate necessary resources for renewal efforts; capital and expense investments; management capable of taking risk; recognition of potential threats to existing line.
Expected Results: Short-term decline in sales, then sudden or gradual breakout ofold volume/profit patterns.

H. Defend Position

Definition: To ensure that relative competitive position is stable or improved.
Objective: To create barriers that make it difficult, costly, and risky for competitors, suppliers, customer blocks, or new entries to erode your firm’s market
share, profitability, and growth.
Requirements: Establishment of one or more of the following: proprietary technology, strong brand, protected sourcing, favorable locations, economies ofscale, government protection, exclusive distribution, or customer loyalty.
Expected Results: Stable or increasing market share.

I. Harvest

Definition: To convert market share or competitive position into higher returns.
Objective: To bring returns up to industry averages by trading, leasing, or selling
technology, distribution rights, patents, brands, production capacity, locations, or exclusive sources to competitors.
Requirements: A better-than-average market share; rights to entry or mobility barriers that the industry values; alternative investment opportunities.
Expected Results: Sudden surge in profitability and return; a gradual decline ofposition, perhaps leading to withdrawal strategy.

J. Find Niche

Definition: To opt for retaining a small, defensible portion of the available market
rather than withdraw.

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Objective: To define the opportunity so narrowly that large competitors withbroad lines do not find it attractive enough to dislodge you.
Requirements: “Think small” management style; alternative uses for excess production capacity; reliable sources for supplies and materials; superior quality
and/or service with selected sector.
Expected Results: Pronounced decline in volume and share; improved return inmedium to longer term.
K. Hold Niche

Definition: To protect a narrow position in the larger product/market arena fromlarger competitors.
Objective: To create barriers (real or imagined) that make it unattractive for competitors, suppliers, or customer blocks to enter your segment or switch toalternative products.
Requirements: Designing, building, and promoting “switching costs” into yourproduct.
Expected Results: Lower-than-industry average but steady and acceptable returns.

L. Catch Up

Definition: To make up for poor or late entry into an industry by aggressive product/market activities.
Objective: To overcome early gains made by first entrants into the market by careful choice of optimum product, production, distribution, promotion, andmarketing tactics.
Requirements: Management capable of taking risk in flexible environment;
resources to make high investments of capital and expense; corporate understanding of short-term low returns; probably necessary to dislodge weakcompetitors.
Expected Results: Low-to-negative returns in near term; should result in favorable
to strong position by late growth stage of industry.

M. Hang In

Definition: To prolong existence of the unit in anticipation of some specific favorable change in the environment.
Objective: To continue funding a tenable (or better) unit only long enough to takeadvantage of unusual opportunity known to be at hand; this might take theform of patent expiration, management change, government action, technology breakthrough, or socioeconomic shift.
Requirements: Clear view of expected environmental shift; a management willing
and able to sustain poor performance; opportunity and resources to capitalize on new environment; a time limit.
Expected Results: Poorer-than-average performance, perhaps losses; later, substantial growth and high returns.

N. Turn AroundDefinition: To overcome inherent, severe weaknesses in performance in a limitedtime.

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Objective: To halt further declines in share and/or volume; to bring about at leaststability or, preferably, a small improvement in position; to protect the linefrom competitive and substitute products.
Requirements: Fast action to prevent disaster; reductions or redirection to reduce
losses; change in morale.
Expected Results: Stable condition and average performance.
O. Retrench

Definition: To cut back investment in the business and reduce level of risk andexposure to losses.
Objective: To stop unacceptable losses or risks; to prepare the business for divestment or withdrawal; to strip away loss operations in hopes of exposing a“little jewel.”
Requirements: Highly disciplined management system; good communication
with employees to prevent wholesale departures; clear strategic objective andtimetable.
Expected Results: Reduced losses or modestly improved performance.

P. Divest

Definition: To strip the business of some or all of its assets through sale of the
product line, brands, distribution facilities, or production capacity.
Objective: To recover losses sustained through earlier strategic errors; to free up
funds for alternative corporate investments; to abandon part or all of a business to competition.
Requirements: Assets desirable to others competing or desiring to compete in theindustry; a recognition of the futility of further investments.
Expected Results: Increase in cash flow; reduction of asset base; probable reduction in performance levels and/or losses.

Q. Withdraw

Definition: To remove the business from competition.
Objective: To take back from the business whatever corporate assets or expenses
can be recovered through shutdown, sale, auction, or scrapping of operations.
Requirements: A decision to abandon; a caretaker management; a phased timetable; a public relations plan.
Expected Results: Losses and write-offs.

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10Portfolio Analysis
Induce your competitors
not to invest in those
products, markets, andservices where you
expect to invest themost. That is the mostfundamental rule ofstrategy.
BRUCE D. HENDERSONT

he previous chapters dealt with strategy development for individual SBUs.
Different SBU strategies must ultimately be judged from the viewpoint of thetotal organization before being implemented. In today’s environment, most companies operate with a variety of businesses. Even if a company is primarily
involved in a single broad business area, it may actually be operating in multiple
product/market segments. From a strategy angle, different products/markets
may constitute different businesses of a company because they have different
roles to play. This chapter is devoted to the analysis of the different businesses ofan organization so that each may be assigned the unique role for which it issuited, thus maximizing long-term growth and earnings of the company.
Years ago, Peter Drucker suggested classifying products into six categories
that reveal the potential for future sales growth: tomorrow’s breadwinners, today’s
breadwinners, products capable of becoming net contributors if something drastic
is done, yesterday’s breadwinners, the “also rans,” and the failures. Drucker’s classification provides an interesting scheme for determining whether a company isdeveloping enough new products to ensure future growth and profits.
In the past few years, the emphasis has shifted from product to business.
Usually a company discovers that some of its business units are competitively wellplaced, whereas others are not. Because resources, particularly cash resources, arelimited, not all SBUs can be treated alike. In this chapter, three different frameworks are presented to enable management to select the optimum combination ofindividual SBU strategies from a spectrum of possible alternatives and opportunities open to the company, still satisfying the resource limitations within which thecompany must operate. The frameworks may also be used at the SBU level toreview the strategic perspective of its different product/market segments.
The first framework to be discussed, the product life cycle, is a tool manymarketers have traditionally used to formulate marketing strategies for different
products. The second framework was developed by the Boston Consulting Groupand is commonly called the product portfolio approach. The third, the multifactor portfolio approach, owes its development to the General Electric Company.
The chapter concludes with the Porter’s generic strategies framework.

240

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241

PRODUCT LIFE CYCLE
Products tend to go through different stages, each stage being affected by different competitive conditions. These stages require different marketing strategies atdifferent times if sales and profits are to be efficiently realized. The length of a
product’s life cycle is in no way a fixed period of time. It can last from weeks toyears, depending on the type of product. In most texts, the discussion of the product life cycle portrays the sales history of a typical product as following an Sshaped curve. The curve is divided into four stages: introduction, growth,maturity, and decline. (Some authors include a fifth stage, saturation.)
However, not all products follow an S-shaped curve. Marketing scholars
have identified varying product life-cycle patterns. For example, Tellis andCrawford1 identify 17 product life-cycle patterns, while Swan and Rink name 10.2
Exhibit 10-1 conceptualizes a typical product life-cycle curve, which shows therelationship between profits and corresponding sales throughout a product’s life.
Introduction is the period during which initial market acceptance is in
doubt; thus, it is a period of slow growth. Profits are almost nonexistent becauseof high marketing and other expenses. Setbacks in the product’s development,
manufacture, and market introduction exact a heavy toll. Marketing strategy
during this stage is based on different combinations of product, price, promotion, and distribution. For example, price and promotion variables may be combined to generate the following strategy alternatives: (a) high price/highpromotion, (b) high price/low promotion, (c) low price/heavy promotion, and(d) low price/low promotion.
Survivors of the introduction stage enjoy a period of rapid growth. During
this growth period, there is substantial profit improvement. Strategy in this stage

EXHIBIT 10-1
Product Life CyclePortfolio Analysis

242

PART 4 Strategy Formulation

takes the following shape: (a) product improvement, addition of new featuresand models; (b) development of new market segments; (c) addition of new channels; (d) selective demand stimulation; and (e) price reductions to vie for new
customers.
During the next stage, maturity, there is intense rivalry for a mature market.
Efforts may be limited to attracting a new population, leading to a proliferationof sizes, colors, attachments, and other product variants. Battling to retain thecompany’s share, each marketer steps up persuasive advertising, opens newchannels of distribution, and grants price concessions. Unless new competitors
are obstructed by patents or other barriers, entry is easy. Thus, maturity is aperiod when sales growth slows down and profits peak and then start to decline.
Strategy in the maturity stage comprises the following steps: (a) search for
new markets and new and varied uses for the product, (b) improvement of product quality through changes in features and style, and (c) new marketing mix perspectives. For the leader firm, Step c may mean introducing an innovative
product, fortifying the market through multibrand strategy, or engaging in a
price-promotion war against the weaker members of the industry; the nonleader
may seek a differential advantage, finding a niche in the market through either
product or promotional variables.
Finally, there is the decline period. Though sales and profits continue theirdownward trend, the declining product is not necessarily unprofitable. Some of
the competition may have left the market by this stage. Customers who remaincommitted to the product may be willing to use standard models, pay higher
prices, and buy at selected outlets. Promotional expenses can also be reduced.
An important consideration in strategy determination in the decline stage isexit barrier. Even when it appears appropriate to leave the industry, there may be
one or more barriers to prevent easy exit. For example, there may be durable andspecialized assets peculiar to the business that have little value outside the business; the cost of exit may be prohibitive because of labor settlement costs or contingent liabilities for land use; there may be managerial resistance; the businessmay be important in gaining access to financial markets; quitting the business
may have a negative impact on other businesses in the company; or there may be
government pressure to continue in the business, a situation that a multinational
corporation may face, particularly in developing countries.
Overall, in the decline stage, the choice of a specific alternative strategy isbased on the business’s strengths and weaknesses and the attractiveness of theindustry to the company. The following alternative strategies appear appropriate:
1. Increasing the firm’s investment (to dominate or get a good competitive position).
2. Holding the firm’s investment level until the uncertainties about the industry are
resolved.
3. Decreasing the firm’s investment posture selectively by sloughing off unpromising customer groups, while simultaneously strengthening the firm’s investment
posture within the lucrative niches of enduring customer demand.
4. Harvesting (or milking) the firm’s investment to recover cash quickly, regardlessof the resulting investment posture.

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243

5. Divesting the business quickly by disposing of its assets as advantageously as
possible.3

In summary, in the introduction stage, the choices are primarily with what
force to enter the market and whether to target a relatively narrow segment ofcustomers or a broader customer group. In the growth stage, the choices appear
to be to fortify and consolidate previously established market positions or todevelop new primary demand. Developing new primary demand may be accomplished by a variety of means, including developing new applications, extending
geographic coverage, trading down to previously untapped consumer groups, or
adding related products. In the late growth and early maturity stages, the choices
lie among various alternatives for achieving a larger share of the existing market.
This may involve product improvement, product line extension, finer positioningof the product line, a shift from breadth of offering to in-depth focus, invading themarket of a competitor that has invaded one’s own market, or cutting out someof the “frills” associated with the product to appeal better to certain classes of customers. In the maturity stage, market positions have become established and theprimary emphasis is on nose-to-nose competition in various segments of themarket. This type of close competition may take the form of price competition,
minor feature competition, or promotional competition. In the decline stage, thechoices are to continue current product/market perspectives as is, to continue
selectively, or to divest.
Exhibit 10-2 identifies the characteristics, marketing objectives, and marketing strategies of each stage of the S-shaped product life cycle. The characteristics
help locate products on the curve. The objectives and strategies indicate whatmarketing perspective is relevant in each stage. Actual choice of strategies restson the objective set for the product, the nature of the product, and environmental
influences operating at the time. For example, in the introductory stage, if a new
product is launched without any competition and the firm has spent hugeamounts of money on research and development, the firm may pursue a highprice/low promotion strategy (i.e., skim the cream off the top of the market). As
the product becomes established and enters the growth stage, the price may be
cut to bring new segments into the fold—the strategic perspective Texas
Instruments used for its calculators.
On the other hand, if a product is introduced into a market where there isalready a well-established brand, the firm may follow a high price/high promotion strategy. Seiko, for example, introduced its digital watch among well-to-do
buyers with a high price and heavy promotion without any intention of competing against Texas Instruments head on.
Of the four stages, the maturity stage of the life cycle offers the greatest
opportunity to shape the duration of a product’s life cycle. These critical questions must be answered: Why have sales tapered off? Has the product approachedobsolescence because of a superior substitute or because of a fundamental change
in consumer needs? Can obsolescence be attributed to management’s failure to
identify and reach the right consumer needs or has a competitor done a better

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244PART 4 Strategy Formulation

EXHIBIT 10-2
Perspectives of the Product Life Cycle

Introduction

GrowthMaturity

DeclineSales

Low sales

Rapidly rising sales

Peak sales

Declining sales

Costs

High cost per
customer

Average cost per
customerLow cost per
customerLow cost per
customer

Profits

Negative

Rising profits

High profits

Declining profits

Customers

Innovators

Early adopters

Middle majority

Laggards

Competitors

Few

Growing number

Stable number beginning to decline

Declining number

Create a productawareness and trial

Maximize market
share

Maximize profit
while defending
market share

Reduce expenditureand milk the brand

Product

Offer a basic productOffer productextensions, service
warranty

Diversify brands
and models

Phase out weak
items

Price

Use cost-plus

Price to penetrate
marketPrice to match orbeat competitors

Cut price

Distribution

Build selective
distribution

Build intensive
distribution

Build more intensive distribution

Go selective; phaseout unprofitable
outlets

Advertising

Build product awareness among early
adopters and dealers

Build awarenessand interest in themass market

Stress brand differences and benefits

Reduce to levelneeded to retain
hardcore loyals

Sales Promotion

Use heavy sales
promotion to entice
trial

Reduce to takeadvantage of heavy
consumer demand

Increase to encourage brand switching

Reduce to minimal
level

Characteristics

Marketing Objectives

Strategies

Source: Philip Kotler, Marketing Management: Analysis, Planning and Control, 8th Ed., © 1994, p. 373. Reprinted by permission ofPrentice-Hall, Inc., Englewood Cliffs, N.J.

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marketing job? Answers to these questions are crucial if an appropriate strategy
is to be employed to strengthen the product’s position. For example, the productmay be redirected on a growth path through repackaging, physical modification,
repricing, appeals to new users, the addition of new distribution channels, or theuse of some combination of marketing strategy changes. The choice of a rightstrategy at the maturity stage can be extremely beneficial, since a successfully
revitalized product offers a higher return on management time and funds
invested than does a new product.
This point may be illustrated with reference to a Du Pont product, Lycra, asuperstretching polymer invented in its labs in 1959. A little more than 30 years
after its humble start as an ingredient for girdles, demand for Lycra is exploding
so fast that the company must allocate sales of the fiber. The product’s successmay be directly attributed to a shrewd marketing strategy, initiated during thematurity stage, that allowed Lycra’s use to expand steadily, from bathing suits in
the 1970s to cycling pants and aerobic outfits in the 1980s. Teenagers were lured
to it and use it in their everyday fashion wardrobes. Avant-garde designers
picked up on the trend, using Lycra in new, body-hugging designs. Now, this distinctly unnatural fiber is part of the fashion mainstream. Du Pont’s marketingstrategy has paid off well. A recent study showed that consumers would pay 20
percent more for a wool-Lycra skirt than for an all-wool version.4
Product Life-Cycle
Controversy

The product life cycle is a useful concept that may be an important aid in marketing planning and strategy. A concept familiar to most marketers, it is given a
prominent place in every marketing textbook. Its use in practice remains limited,
however, partly because of the lack of normative models available for its application and partly because of the vast amount of data needed for and the level ofsubjectivity involved in its use.
One caution that is in order when using the product life cycle is to keep inmind that not all products follow the typical life-cycle pattern. The same productmay be viewed in different ways: as a brand (Pepsi Light), as a product form (dietcola), and as a product category (cola drink), for example. Among these, the product life-cycle concept is most relevant for product forms.

Locating Productsin Their Life-Cycle

The easiest way to locate a product in its life cycle is to study its past performance,competitive history, and current position and to match this information with thecharacteristics of a particular stage of the life cycle. Analysis of past performanceof the product includes examination of the following:
1. Sales growth progression since introduction.
2. Any design problems and technical bugs that need to be sorted out.
3. Sales and profit history of allied products (those similar in general character orfunction as well as products directly competitive).
4. Number of years the product has been on the market.
5. Casualty history of similar products in the past.

The review of competition focuses on

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1. Profit history.
2. Ease with which other firms can get into the business.
3. Extent of initial investment needed to enter the business.
4. Number of competitors and their strength.
5. Number of competitors that have left the industry.
6. Life cycle of the industry.
7. Critical factors for success in the business.

In addition, current perspectives may be reviewed to gauge whether sales areon the upswing, have leveled out for the last couple of years, or are heading
down; whether any competitive products are moving up to replace the productunder consideration; whether customers are becoming more demanding vis-à-vis
price, service, or special features; whether additional sales efforts are necessary tokeep the sales going up; and whether it is becoming harder to sign up dealers anddistributors.
This information on the product may be related to the characteristics of different stages of the product life cycle as discussed above; the product perspectives
that match the product life cycle indicate the position of the product in its life
cycle. Needless to say, the whole process is highly qualitative in nature, and managerial intuition and judgment bear heavily on the final placement of the productin its life cycle. As a matter of fact, making the appropriate assumptions about thetypes of information described here can be used to construct a model to predict
the industry volume of a newly introduced product through each stage of the
product life cycle.5
A slightly different approach for locating a product in its life cycle is to use
past accounting information for the purpose. Listed below are the steps that may
be followed to position a product in its life cycle:
1. Develop historical trend information for a period of three to five years (longer forsome products). Data included should be unit and dollar sales, profit margins,
total profit contribution, return on invested capital, market share, and prices.
2. Check recent trends in the number and nature of competitors, number andmarket share rankings of competing products and their quality and performanceadvantages, shifts in distribution channels, and relative advantages enjoyed byproducts in each channel.
3. Analyze developments in short-term competitive tactics, such as competitors’
recent announcements of new products or plans for expanding production capacity.
4. Obtain (or update) historical information on the life cycle of similar or related
products.
5. Project sales for the product over the next three to five years, based on all information gathered, and estimate an incremental profit ratio for the product during
each of these years (the ratio of total direct costs—manufacturing, advertising,product development, sales, distribution, etc.—to pretax profits). Expressed as aratio (e.g., 4.8 to 1 or 6.3 to 1), this measure indicates the number of dollars
required to generate each additional dollar of profit. The ratio typically improves(becomes lower) as the product enters its growth period, begins to deteriorate(rise) as the product approaches maturity, and climbs more sharply as it reaches
decline.

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6. Estimate the number of profitable years remaining in the product’s life cycle and,based on all information at hand, fix the product’s position on its life-cycle curve:(a) introduction, (b) early or late growth, (c) early or late maturity, or (d) early orlate decline.

Developing a
Product Life-Cycle
Portfolio

The current positions of different products in the product life cycle may be determined by following the procedure described above, and the net results (i.e., thecash flow and profitability) of these positions may be computed. Similar analyses
may be performed for a future period. The difference between current and future
positions indicates what results management may expect if no strategic changes
are made. These results may be compared with corporate expectations to determine the gap. The gap can be filled either by making strategic changes to extend
the life cycle of a product or by bringing in new products through research anddevelopment or acquisition. This procedure may be put into operation by following these steps:
1. Determine what percentage of the company’s sales and profits fall within eachphase of the product life cycle. These percentages indicate the present life-cycle(sales) profile and the present profit profile of the company’s current line.
2. Calculate changes in life-cycle and profit profiles over the past five years and project these profiles over the next five years.
3. Develop a target life-cycle profile for the company and measure the company’spresent life-cycle profile against it. The target profile, established by marketing
management, specifies the desirable share of company sales that should fallwithin each phase of the product life cycle. It can be determined by industry
obsolescence trends, the pace of new product introductions in the field, the average length of product life cycles in the company’s line, and top management’s
objectives for growth and profitability. As a rule, the target profile for growthminded companies whose life cycles tend to be short calls for a high proportionof sales in introductory and growth phases.

With these steps completed, management can assign priorities to such functions as new product development, acquisition, and product line pruning, basedon the discrepancies between the company’s target profile and its present lifecycle profile. Once corporate effort has been broadly allocated in this way amongproducts at various stages of their life cycles, marketing plans can be detailed forindividual product lines.

PORTFOLIO MATRIX
A good planning system must guide the development of strategic alternatives foreach of the company’s current businesses and new business possibilities. It mustalso provide for management’s review of these strategic alternatives and for corresponding resource allocation decisions. The result is a set of approved businessplans that, taken as a whole, represent the direction of the firm. This process starts
with, and its success is largely determined by, the creation of sound strategic
alternatives.

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The top management of a multibusiness firm cannot generate these strategic
alternatives. It must rely on the managers of its business ventures and on its corporate development personnel. However, top management can and should establish a conceptual framework within which these alternatives can be developed.
One such framework is the portfolio matrix associated with the Boston
Consulting Group (BCG). Briefly, the portfolio matrix is used to establish the best
mix of businesses in order to maximize the long-term earnings growth of the firm.
The portfolio matrix represents a real advance in strategic planning in several
ways:• It encourages top management to evaluate the prospects of each of the company’sbusinesses individually and to set tailored objectives for each business based on
the contribution it can realistically make to corporate goals.
• It stimulates the use of externally focused empirical data to supplement managerial judgment in evaluating the potential of a particular business.
• It explicitly raises the issue of cash flow balancing as management plans for
expansion and growth.
• It gives managers a potent new tool for analyzing competitors and for predicting
competitive responses to strategic moves.
• It provides not just a financial but a strategic context for evaluating acquisitions
and divestitures.6

As a consequence of these benefits, the widespread application of the portfolio matrix approach to corporate planning has sounded the death knell for planning by exhortation, the kind of strategic planning that sets uniform financial
performance goals across an entire company—15 percent growth in earnings or
15 percent return on equity—and then expects each business to meet those goals
year in and year out. The portfolio matrix approach has given top management
the tools to evaluate each business in the context of both its environment and its
unique contribution to the goals of the company as a whole and to weigh theentire array of business opportunities available to the company against the financial resources required to support them.
The portfolio matrix concept addresses the issue of the potential value of aparticular business for the firm. This value has two variables: first, the potential
for generating attractive earnings levels now; second, the potential for growth or,in other words, for significantly increased earnings levels in the future. The portfolio matrix concept holds that these two variables can be quantified. Current
earnings potential is measured by comparing the market position of the businessto that of its competitors. Empirical studies have shown that profitability is
directly determined by relative market share.
Growth potential is measured by the growth rate of the market segment inwhich the business competes. Clearly, if the segment is in the decline stage of its
life cycle, the only way the business can increase its market share is by taking
volume away from competitors. Although this is sometimes possible and economically desirable, it is usually expensive, leads to destructive pricing and erosion of profitability for all competitors, and ultimately results in a market that is
ill served. On the other hand, if a market is in its rapid growth stage, the business

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can gain share by preempting the incremental growth in the market. So if thesetwo dimensions of value are arrayed in matrix form, we have the basis for a business classification scheme. This is essentially what the Boston Consulting Group
portfolio matrix is. Each of the four business categories tends to have specificcharacteristics associated with it. The two quadrants corresponding to highmarket leadership have current earnings potential, and the two corresponding tohigh market growth have growth potential.
Exhibit 10-3 shows a matrix with its two sides labeled product sales growth rate
and relative market share. The area of each circle represents dollar sales. The market
share position of each circle is determined by its horizontal position. Each circle’s
product sales growth rate (corrected for inflation) in the market in which it competes is shown by its vertical position.
With regard to the two axes of the matrix, relative market share is plotted ona logarithmic scale in order to be consistent with the experience curve effect,
which implies that profit margin or rate of cash generation differences between
two competitors tends to be proportionate to the ratio of their competitive positions. A linear axis is used for growth, for which the most generally useful measure is volume growth of the business concerned; in general, rates of cash use
should be directly proportional to growth.

EXHIBIT 10-3
Product Portfolio Matrix

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The lines dividing the matrix into four quadrants are arbitrary. Usually, highgrowth is taken to include all businesses growing in excess of 10 percent annually
in volume. The line separating areas of high and low relative competitive positionis set at 1.0.
The importance of growth variables for strategy development is based on two
factors. First, growth is a major influence in reducing cost because it is easier togain experience or build market share in a growth market than in a low-growthsituation. Second, growth provides opportunity for investment. The relative
market share affects the rate at which a business will generate cash. The stronger
the relative market share position of a product, the higher the margins it will havebecause of the scale effect.
Classification ofBusinesses

Using the two dimensions discussed here in Exhibit 10-4, one can classify businesses and products into four categories. Businesses in each category exhibit different financial characteristics and offer different strategic choices.
Stars. High-growth market leaders are called stars. They generate large
amounts of cash, but the cash they generate from earnings and depreciation is morethan offset by the cash that must be put back in the form of capital expenditures andincreased working capital. Such heavy reinvestment is necessary to fund the capacity increases and inventory and receivable investment that go along with market
share gains. Thus, star products represent probably the best profit opportunity
available to a company, and their competitive position must be maintained. If astar’s share is allowed to slip because the star has been used to provide large
amounts of cash in the short run or because of cutbacks in investment and rising
prices (creating an umbrella for competitors), the star will ultimately become a dog.
EXHIBIT 10-4
Matrix Quadrants

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The ultimate value of any product or service is reflected in the stream of cash
it generates net of its own reinvestment. For a star, this stream of cash lies in the
future—sometimes in the distant future. To obtain real value, the stream of cash
must be discounted back to the present at a rate equal to the return on alternative opportunities. It is the future payoff of the star that counts, not the present
reported profit. For GE, the plastics business is a star in which it keeps investing.
As a matter of fact, the company even acquired Thomson’s plastics operations(a French company) to further strengthen its position in the business.
Cash Cows. Cash cows are characterized by low growth and high market share.
They are net providers of cash. Their high earnings, coupled with their depreciation,
represent high cash inflows, and they need very little in the way of reinvestment.
Thus, these businesses generate large cash surpluses that help to pay dividends andinterest, provide debt capacity, supply funds for research and development, meetoverheads, and also make cash available for investment in other products. Thus,
cash cows are the foundation on which everything else depends. These products
must be protected. Technically speaking, a cash cow has a return on assets thatexceeds its growth rate. Only if this is true will the cash cow generate more cash thanit uses. For NCR Company, the mechanical cash register business is a cash cow. The
company still maintains a dominant share of this business even though growth has
slowed down since the introduction of electronic cash registers. The company uses
the surplus cash from its mechanical cash registers to develop electronic machineswith a view to creating a new star. Likewise, the tire business can be categorized asa cash cow for Goodyear Tire and Rubber Company. The tire industry is characterized by slow market growth, and Goodyear has a major share of the market.
Question Marks. Products in a growth market with a low share are categorized as question marks. Because of growth, these products require more cash thanthey are able to generate on their own. If nothing is done to increase market share,a question mark will simply absorb large amounts of cash in the short run andlater, as the growth slows down, become a dog. Thus, unless something is done
to change its perspective, a question mark remains a cash loser throughout its
existence and ultimately becomes a cash trap.
What can be done to make a question mark more viable? One alternative is togain share increases for it. Because the business is growing, it can be funded todominance. It may then become a star and later, when growth slows down, a cashcow. This strategy is a costly one in the short run. An abundance of cash must be
poured into a question mark in order for it to win a major share of the market, but
in the long run, this strategy is the only way to develop a sound business from thequestion mark stage. Another strategy is to divest the business. Outright sale isthe most desirable alternative. But if this does not work out, a firm decision must
be made not to invest further in the business. The business must simply beallowed to generate whatever cash it can while none is reinvested.
When Joseph E. Seagram and Sons bought Tropicana from Beatrice Co. in
1988, it was a question mark. The product had been trailing behind Coke’s Minute
Maid and was losing ground to Procter & Gamble’s new entry in the field, Citrus

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Hill. Since then, Seagram has invested heavily in Tropicana to develop it into astar product. After just two years, Tropicana has emerged as a leader in the notfrom-concentrate orange juice market, far ahead of Minute Maid, and has been
trying to make inroads into other segments.7
Dogs. Products with low market share positioned in low-growth situations
are called dogs. Their poor competitive position condemns them to poor profits.
Because growth is low, dogs have little potential for gaining sufficient share toachieve viable cost positions. Usually they are net users of cash. Their earnings
are low, and the reinvestment required just to keep the business together eats cash
inflow. The business, therefore, becomes a cash trap that is likely to regularly
absorb cash unless further investment is rigorously avoided. An alternative is toconvert dogs into cash, if there is an opportunity to do so. GE’s consumer electronics business had been in the dog category, maintaining only a small percentage of the available market in a period of slow growth, when the company
decided to unload the business (including the RCA brand acquired in late 1985)
to Thomson, France’s state-owned, leading electronics manufacturer.
Exhibit 10-5 summarizes the investment, earning, and cash flow characteristics of stars, cash cows, question marks, and dogs. Also shown are viable strategy
alternatives for products in each category.
Strategy
Implications

In a typical company, products could be scattered in all four quadrants of theportfolio matrix. The appropriate strategy for products in each cell is given briefly
in Exhibit 10-5. The first goal of a company should be to secure a position with

EXHIBIT 10-5
Characteristics and Strategy Implications of Products in the Strategy Quadrants
Quadrant

Investment
Characteristics

Earning
Cash Flow
Characteristics Characteristics

Strategy
Implication

Stars— Continual expenditures
for capacity expansion— Pipeline filling with cash

Low to high

Negative cash flow(net cash user)

Continue to increase market
share, if necessary at the expense of short-term earnings

Cash cows— Capacity maintenanceexpenditures

High

Positive cash flow(net cash contributor)

Maintain share and leadership
until further investment
becomes marginal

Questionmarks— Heavy initial capacity
expenditures— High research anddevelopment costs

Negative to
low

Negative cash flow(net cash user)

Assess chances of dominating
segment: if good, go after
share; if bad, redefine businessor withdraw

Dogs— Gradually deplete
capacityHigh to low

Positive cash flow(net cash contributor)

Plan an orderly withdrawal so
as to maximize cash flow

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cash cows but to guard against the frequent temptation to reinvest in them excessively. The cash generated from cash cows should first be used to support thosestars that are not self-sustaining. Surplus cash may then be used to financeselected question marks to dominance. Any question mark that cannot be fundedshould be divested. A dog may be restored to a position of viability by shrewdly
segmenting the market; that is, by rationalizing and specializing the business intoa small niche that the product may dominate. If this is not practical, a firm should
manage the dog for cash; it should cut off all investment in the business and liquidate it when an opportunity develops.
Exhibit 10-6 shows the consequences of a correct/incorrect strategic move. If
a question mark is given adequate support, it may become a star and ultimately
a cash cow (success sequence). On the other hand, if a star is not appropriately
funded, it may become a question mark and finally a dog (disaster sequence).
EXHIBIT 10-6
Product Portfolio Matrix: Strategic Consequences

Source: Bruce D. Henderson, “The Product Portfolio” (Boston: The Boston Consulting Group, Inc.,
1970). Perspectives No. 66. Reprinted by permission.

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Top management needs to answer two strategic questions: (a) How promising is the current set of businesses with respect to long-term return and growth?
(b) Which businesses should be developed? maintained as is? liquidated?
Following the portfolio matrix approach, a company needs a cash-balanced portfolio of businesses; that is, it needs cash cows and dogs to throw off sufficient cash
to fund stars and question marks. It needs an ample supply of question marks toensure long-term growth and businesses with return levels appropriate to theirmatrix position. In response to the second question, capital budgeting theory
requires the lining up of capital project proposals, assessment of incremental cash
flows attributable to each project, computation of discounted rate of return on
each, and approval of the project with the highest rate of return until available
funds are exhausted. But the capital budgeting approach misses the strategic content; that is, it ignores questions of how to validate assumptions about volume,
price, cost, and investment and how to eliminate natural biases. This problem issolved by the portfolio matrix approach.
Portfolio Matrix
and Product LifeCycle

The product portfolio matrix approach propounded by the Boston Consulting
Group may be related to the product life cycle by letting the introduction stage
begin in the question mark quadrant; growth starts toward the end of this quadrant and continues well into the star quadrant. Going down from the star to the
cash cow quadrant, the maturity stage begins. Decline is positioned between the
cash cow and the dog quadrants (see Exhibit 10-7). Ideally, a company should
enter the product/market segment in its introduction stage, gain market share in
the growth stage, attain a position of dominance when the product/market segment enters its maturity stage, maintain this dominant position until the product/market segment enters its decline stage, and then determine the optimum
point for liquidation.

Balanced andUnbalanced
Portfolios

Exhibit 10-8 is an example of a balanced portfolio. With three cash cows, this company is well positioned with stars to provide growth and to yield high cash
returns in the future when they mature. The company has four question marks,
two of which present good opportunities to emerge as stars at an investment levelthat the cash cows should be able to support (based on the area of the circles). The
company does have dogs, but they can be managed to avoid drain on cash
resources.
Unbalanced portfolios may be classified into four types:
1. Too many losers (due to inadequate cash flow, inadequate profits, and inadequate
growth).
2. Too many question marks (due to inadequate cash flow and inadequate profits).
3. Too many profit producers (due to inadequate growth and excessive cash flow).
4. Too many developing winners (due to excessive cash demands, excessive
demands on management, and unstable growth and profits).

Exhibit 10-9 illustrates an unbalanced portfolio. The company has just one
cash cow, three question marks, and no stars. Thus, the cash base of the com-

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EXHIBIT 10-7
Relationship between Product Portfolio Matrix and Product Life Cycle

pany is inadequate and cannot support the question marks. The company may
allocate available cash among all question marks in equal proportion. Dogs
may also be given occasional cash nourishment. If the company continues its
current strategy, it may find itself in a dangerous position in five years, particularly when the cash cow moves closer to becoming a dog. To take corrective
action, the company must face the fact that it cannot support all its question
marks. It must choose one or maybe two of its three question marks and fundthem adequately to make them stars. In addition, disbursement of cash in dogs
should be totally prohibited. In brief, the strategic choice for the company, considered in portfolio terms, is obvious. It cannot fund all question marks anddogs equally.
The portfolio matrix focuses on the real fundamentals of businesses and theirrelationships to each other within the portfolio. It is not possible to develop effective strategy in a multiproduct, multimarket company without considering themutual relationships of different businesses.

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EXHIBIT 10-8
Illustration of a Balanced Portfolio

Conclusion

The portfolio matrix approach provides for the simultaneous comparison of different products. It also underlines the importance of cash flow as a strategic variable. Thus, when continuous long-term growth in earnings is the objective, it isnecessary to identify high-growth product/market segments early, develop
businesses, and preempt the growth in these segments. If necessary, short-term
profitability in these segments may be forgone to ensure achievement of thedominant share. Costs must be managed to meet scale-effect standards. The
appropriate point at which to shift from an earnings focus to a cash flow focus
must be determined and a liquidation plan for cash flow maximization established. A cash-balanced mix of businesses should be maintained.
Many companies worldwide have used the portfolio matrix approach in theirstrategic planning. The first companies to use this approach were the Norton
Company, Mead, Borg-Warner, Eaton, and Monsanto. Since then, virtually alllarge corporations have reported following it.
The portfolio matrix approach, however, is not a panacea for strategy development. In reality, many difficulties limit the workability of this approach. Somepotential mistakes associated with the portfolio matrix concept are
1. Overinvesting in low-growth segments (lack of objectivity and “hard” analysis).
2. Underinvesting in high-growth segments (lack of guts).
3. Misjudging the segment growth rate (poor market research).

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EXHIBIT 10-9Illustration of an Unbalanced Portfolio

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4. Not achieving market share (because of improper market strategy, sales capabilities, or promotion).
5. Losing cost effectiveness (lack of operating talent and control system).
6. Not uncovering emerging high-growth segments (lack of corporate development
effort).
7. Unbalanced business mix (lack of planning and financial resources).

Thus, the portfolio matrix approach should be used with great care.

MULTIFACTOR PORTFOLIO MATRIXThe two-factor portfolio matrix discussed above provides a useful approach forreviewing the roles of different products in a company. However, the growth raterelative market share matrix approach leads to many difficulties. At times, factors
other than market share and growth rate bear heavily on cash flow, the mainstayof this approach. Some managers may consider return on investment a more suitable criterion than cash flow for making investment decisions. Further, the twofactor portfolio matrix approach does not address major investment decisions
between dissimilar businesses. These difficulties can lead a company into too
many traps and errors. For this reason, many companies (such as GE and the Shell
Group) have developed the multifactor portfolio approach.
Exhibit 10-10 illustrates the GE matrix. Its two dimensions, industry attractiveness and business strengths, are based on a variety of factors. It is this multifactor characteristic that differentiates this approach from the one discussed in theprevious section. In its early attempts with the portfolio matrix, GE used the criteria and measures shown in Exhibit 10-11 to determine industry attractivenessand business strengths. These criteria and measures are only suggestions; anothercompany may adopt a different list. For example, GE later added cyclicality as acriterion under industry attractiveness. The measure of relative profitability, as
shown in the exhibit, was used for the first time in 1985.
Exhibits 10-12 and 10-13 (pages 261 and 262) illustrate how the factors may beweighed and how a final industry attractiveness and business strengths score
may be computed. Management may establish cutoff points for high, medium,and low industry attractiveness and competitive position scores.
It is worthwhile to mention that the development of a multifactor matrix may
not be as easy as it appears. The actual analysis required may take a considerable
amount of foresight and experience and many, many days of work. The major difficulties lie in identifying relevant factors, relating factors to industry attractiveness and business strengths, and weighing the factors.
Strategy
Development

The overall strategy for a business in a particular position is illustrated in Exhibit
10-10. The area of the circle refers to the business’s sales. Investment priority isgiven to products in the high area (upper left), where a stronger position is supported by the attractiveness of an industry. Along the diagonal, selectivity isdesired to achieve a balanced earnings performance. The businesses in the low
area (lower right) are the candidates for harvesting and divestment.

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EXHIBIT 10-10
Relationship between the Strategic Planning Process and Approaches to Marketing

A company may position its products or businesses on the matrix to study its
present standing. Forecasts may be made to examine the directions different businesses may go in the future, assuming no changes are made in strategy. Future
perspectives may be compared to the corporate mission to identify gaps between
what is desired and what may be expected if no measures are taken now. Filling
the gap requires making strategic moves for different businesses. Once strategic
alternatives for an individual business have been identified, the final choice of astrategy should be based on the scope of the overall corporation vis-à-vis thematrix. For example, the prospects for a business along the diagonal may appear
good, but this business cannot be funded in preference to a business in the highhigh cell. In devising future strategy, a company generally likes to have a few
businesses on the left to provide growth and to furnish potential for investment
and a few on the right to generate cash for investment in the former. The businesses along the diagonal may be selectively supported (based on resources) for
relocation on the left. If this is not feasible, they may be slowly harvested ordivested. Exhibit 10-14 (page 263) summarizes desired strategic perspective in
different cell positions.

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EXHIBIT 10-11
Portfolio Considerations and Measures Used by GE in 1980
Business Strengths

Industry AttractivenessCriterion

MeasureCriterion

Measure1. Market size

• Three-year average served
industry market dollars

1. Market
position

2. Market growth• Ten-year constant dollar average
market growth rate

3. Industry
profitability• Three-year average ROS, SBU
and Big Three competitors:• Nominal• Inflation adjusted• Three-year average market share(total dollars)• Three-year average international
market share• Two-year average relative market
share (SBU/Big Three competitors)

2. Competitive
position

4. Cyclicality• Average annual percent variation of sales from trend

Superior, equal, or inferior to competition in 1980:• Product quality• Technological leadership• Manufacturing/cost leadership• Distribution/marketing leadership

5. Inflation
recovery• Five-year average ratio of combined selling price and productivity change to change in cost
due to inflation

3. Relative
profitability

Three-year average SBU ROS lessaverage ROS, Big Three competitors:• Nominal• Inflation adjusted

6. Importance of• Ten-year average ratio of internon-U.S. markets national to total market
Indicates measure used
for first time in 1980
Source: General Electric Co. Reprinted by permission. The measurements do not reflect current GE practice.

For an individual business, there can be four strategy options: investing tomaintain, investing to grow, investing to regain, and investing to exit. The choiceof a strategy depends on the current position of the business in the matrix (i.e.,
toward the high side, along the diagonal, or toward the low side) and its future
direction, assuming the current strategic perspective continues to be followed. If
the future appears unpromising, a new strategy for the business is called for.
Analysis of present position on the matrix may not pose any problem. At GE,
for example, there was little disagreement on the position of the business.8 The
mapping of future direction, however, may not be easy. A rigorous analysis mustbe performed, taking into account environmental shifts, competitors’ perspectives, and internal strengths and weaknesses.
The four strategy options are shown in Exhibit 10-15 (page 264). Strategy tomaintain the current position (Strategy 1 in the exhibit) may be adopted if, in theabsence of a new strategy, erosion is expected in the future. Investment will besought to hold the position; hence, the name invest-to-maintain strategy. The

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EXHIBIT 10-12
Assessing Industry AttractivenessCriteria

Weights*×Ratings** = Values

Market size
Growth rate
Profit margin
Market diversity
Demand cyclicality
Expert opportunities
Competitive structure
Industry profitability
Inflation vulnerability
Value added
Capital intensity
Raw material availability
Technological role
Energy impact
SocialEnvironmental impact
Legal
Human

.15
.12
.05
.05
.05
.05
.05
.20
.05
.10
GO
GO
.05
.08
GO
GO
GO
. GO .

4
3
3
2
2
5
3
3
2
5
4
4
4
4
4
4
4
. 4 .

.60
.36
.15
.10
.10
.25
.15
.60
.10
.50
—
—
.20
.32
—
—
—
—

1.00

1 to 5

3.43*Some criteria may be of a GO/NO GO type. For example,
many Fortune 500 firms would probably not invest in industries
viewed negatively by society even if it were legal and profitable
to do so.
** “1” denotes very unattractive; “5” denotes very attractive.

second option is the invest-to-grow strategy. Here, the product’s current positionis perceived as less than optimum vis-à-vis industry attractiveness and businessstrengths. In other words, considering the opportunities furnished by the industry and the strengths exhibited by the business, the current position is consideredinadequate. A growth strategy is adopted with the aim of shifting the productposition upward or toward the left. Movement in both directions is an expensive
option with high risk.
The invest-to-regain strategy (Strategy 3 in Exhibit 10-15) is an attempt torebuild the product or business to its previous position. Usually, when the environment (i.e., industry) continues to be relatively attractive but the business position has slipped because of some strategic past mistake (e.g., premature
harvesting), the company may decide to revitalize the business through newinvestments. The fourth and final option, the invest-to-exit strategy, is directedPortfolio Analysis

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PART 4 Strategy Formulation

EXHIBIT 10-13
Assessing Business Strengths
Criteria

Weights*×Ratings** = Values

Market share.10
SBU growth rate
X
Breadth of product line
.05
Sales/distribution effectiveness.20
Proprietary and key
account effectivenessX
Price competitiveness
X
Advertising and promotion effectiveness.05
Facilities location andnewness.05
Capacity and productivity
X
Experience curve effects.15
Value added
X
Investment utilization.05
Raw materials cost
.05
Relative product quality.15
R&D advantage/position.05
Cash throwoff.10
Organizational synergies
X
General image
. X.
1.00

5
3
4

.50
—
.20

4

.80

3
4

—
—

4

.20

5
3
4
4
5
4
4
4
5
5
. 5 .

—
.10
.60
—
.25
.20
.60
.20
.50
—
—

1 to 5

4.30*For any particular industry, there will be some factors that,while important in general, will have little or no effect on therelative competitive position of firms within that industry.
** “1” denotes very weak competitive position; “5” denotes avery strong competitive position.

toward leaving the market through harvesting or divesting. Harvesting amounts
to making very low investments in the business so that in the short run the business will secure positive cash flow and in a few years die out. (With no new investments, the position will continue to deteriorate.) Alternatively, the whole businessmay be divested, that is, sold to another party in a one-time deal. Sometimes small
investments may be made to maintain the viability of business if divestment isdesired but there is no immediate suitor. In this way the business can eventually
be sold at a higher price than would have been possible right away.
Unit of Analysis

The framework discussed here may be applied to either a product/market oran SBU. As a matter of fact, it may be equally applicable to a much higher levelof aggregation in the organization, such as a division or a group. Of course,

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EXHIBIT 10-14
Prescriptive Strategies for Businesses in Different Cells
Competitive Position
StrongMediumWeak

Protect
Position

Invest to
Build

Build
Selectively• Invest to growat maximum
digestible rateHigh
• Concentrateeffort on maintaining strength• Challenge forleadership• Build selectively
on strengths• Reinforce vulnerable areas• Specialize
around limited
strengths• Seek ways to overcome weaknesses• Withdraw if indications of sustainablegrowth are lacking

Build
Selectively

Selectivity/Manage
for Earnings

Limited Expansion
or Harvest• Invest heavily in • Protect existing
most attractive
programsegments• Concentrate• Build up ability
investments in
to counter
segments wherecompetition
profitability is• Emphasize profitgood and risk isability by raising
relatively low
productivity• Look for ways toexpand without highrisk; otherwise, minimize investment andrationalize investment

MarketAttractive- Medium
ness

Protect andRefocus

Low

Manage for
Earnings

Divest• Manage for cur- • Protect position• Sell at time that
rent earnings
in most profitable
will maximize cash
• Concentrate on
segments
value
attractive• Upgrade product • Cut fixed costs andstrengths
line
avoid investment• Defend strengths • Minimize
meanwhile
investment

at the group or division level, it may be very difficult to measure industry
attractiveness and business strengths unless the group or division happens to
be in one business.
In the scheme followed in this book, the analysis may be performed first at
the SBU level to determine the strategic perspective of different products/
markets. Finally, all SBUs may be simultaneously positioned on the matrix todetermine a corporate-wide portfolio.

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EXHIBIT 10-15
Strategy Options
Industry AttractivenessCurrent
Position

Strategy

Industry AttractivenessCurrent
Position

Strategy (tomaintain thisposition)

BusinessStrength

BusinessStrength

Current
Position(a) Invest to Maintain(b) Invest to Grow

Industry AttractivenessIndustry Attractiveness

Strategy
BusinessStrength

BusinessStrength

Current
Position

Strategy

Current
Position(c) Invest to Regain

Directional
Policy Matrix(d) Invest to Exit

A slightly different technique, the directional policy matrix, is popularly used inEurope. It was initially worked out at the Shell Group but later caught the fancy
of many businesses across the Atlantic. Exhibit 10-16 illustrates a directional
policy matrix. The two sides of the matrix are labeled business sector prospects(industry attractiveness) and company’s competitive capabilities (business

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EXHIBIT 10-16
Directional Policy Matrix
Business Sector Prospects
Unattractive
Average
Attractive
Disinvest

Phasedwithdrawal

Doubleor quit

Weak
Proceedwith care
Company’s
Competitive
Capabilities

AveragePhasedwithdrawal

Proceedwith care

Try

Cash
generator

GrowthLeaderStrongLeaderstrengths). Business sector prospects are categorized as unattractive, average, andattractive; and the company’s competitive capabilities are categorized as weak, average, and strong. Within each cell is the overall strategy direction for a businessdepicted by the cell. The consideration of factors used to measure business sector
prospects and a company’s competitive capabilities follows the same logic andanalyses discussed above.

PORTFOLIO MATRIX: CRITICAL ANALYSISIn recent years, a variety of criticisms have been leveled at the portfolio framework. Most of the criticism has centered on the Boston Consulting Group matrix.
1. A question has been raised about the use of market share as the most important
influence on marketing strategy. The BCG matrix is derived from an applicationof the learning curve to manufacturing and other costs. It was observed that, as afirm’s product output (and thus market share) increases, total cost declines by afixed percentage. This may be true for commodities; however, in mostproduct/market situations, products are differentiated, new products and brands
are continually introduced, and the pace of technological changes keeps increasing. As a result, one may move from learning curve to learning curve or
encounter a discontinuity. More concrete evidence is needed before the validity ofmarket share as a dimension in strategy formulation is established or rejected.
2. Another criticism, closely related to the first, is how product/market boundaries
are defined. Market share varies depending on the definition of the corresponding

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product/market. Hence, a product may be classified in different cells, dependingon the market boundaries used.
3. The stability of product life cycles is implicitly assumed in some portfolio models.
However, as in the case of the learning curve, it is possible for the product life
cycle to change during the life of the product. For example, recycling can extend
the life cycle of a product, sparking a second growth stage after maturity. A
related subissue concerns the assumption that investment is more desirable inhigh-growth markets than in low-growth ones. There is insufficient evidence tosupport this proposition.9 This overall issue becomes more problematic for international firms because a given product may be in different stages of its life cycle
in different countries.
4. The BCG portfolio framework was developed for balancing cash flows. It ignores
the existence of capital markets. Cash balancing is not always an important consideration.
5. The portfolio framework assumes that investments in all products/markets areequally risky, but this is not the case. In fact, financial portfolio management
theory does take risk into account. The more risky an investment, the higher the
return expected of it. The portfolio matrix does not consider the risk factor.
6. The BCG portfolio model assumes that there is no interdependency between
products/markets. This assumption can be questioned on various grounds. For
instance, different products/markets might share technology or costs.10 These
interdependencies should be accounted for in a portfolio framework.
7. There is no consensus on the level at which portfolio models are appropriately
used. Five levels can be identified: product, product line, market segment, SBU,
and business sector. The most frequent application has been at the SBU level;
however, it has been suggested that the framework is equally applicable at otherlevels. Because it is unlikely that any one model could have such wide application, the suggestion that it does casts doubt on the model itself.
8. Most portfolio approaches are retrospective and overly dependent on conventional wisdom in the way in which they treat both market attractiveness andbusiness strengths.11 For example, despite evidence to the contrary, conventional
wisdom suggests the following:a. Dominant market share endows companies with sufficient power to maintain
price above a competitive level or to obtain massive cost advantages througheconomies of scale and the experience curve. However, the returns for suchcompanies as Goodyear and Maytag show that this is not always the case.
MarketSituation

Conventional
WisdomDominant
marketMarket leader gains— Premium prices— Cost advantages
due to scale andexperience curve

ExamplesGoodyear:
40% of U.S. tire market; market leader
Maytag:5% of U.S. applianceindustry; niche
competitor

Return on Total
Capital Employed
1975–79
7.0%

26.7%

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b. High market growth means that rivals can expand output and show profits
without having to take demand out of each other’s plants and provoking
price warfare. But the experience of industries as different as the European
tungsten carbide industry and the U.S. airline industry suggests that it is notalways true.
MarketSituation

Conventional
WisdomHigh
marketgrowthHigh market growthallows companies toexpand output without provoking pricecompetition andleads to higher profits

ExamplesEuropean tungsten
carbide industry:
1% annual growth
U.S. airline industry:
13.6% annual growth

Return on Total
Capital Employed
1975–79
15.0%

5.7%

c. High barriers to entry allow existing competitors to keep prices high and earnhigh profits. But the experience of the U.S. brewing industry seems to refuteconventional wisdom.
MarketSituation

Conventional
WisdomHighbarriers
to entry

High barriers prevent new entrants
from competingaway previously
excess profits

ExamplesU.S. brewing industry is highly concentrated with very highbarriers to entry

Return on Total
Capital Employed
1975–79
8.6%

9. There are also issues of measurement and weighting. Different measures havebeen proposed and used for the dimensions of portfolio models; however, a product’s position on a matrix may vary depending on the measures used.12 In addition, the weights used for models having composite dimensions may impact theresults, and the position of a business on the matrix may change with the weighting scheme used.
10. Portfolio models ignore the impact of both the external and internal environments of a company. Because a firm’s strategic decisions are made within its environments, their potential impact must be taken into account. Day highlights a few
situational factors that might affect a firm’s strategic plan. As examples of internal
factors, he cites rate of capacity utilization, union pressures, barriers to entry, andextent of captive business. GNP, interest rates, and social, legal, and regulatoryenvironment are cited as examples of external factors.13 No systematic treatment
has been accorded to such environmental influences in the portfolio models.
These influences are always unique to a company, so the importance of customizing a portfolio approach becomes clear.
11. The relevance of a particular strategy for a business depends on its correct categorization on the matrix. If a mistake is made in locating a business in a particularcell of the matrix, the failure of the prescribed strategy cannot be blamed on theframework. In other words, superficial and uncritical application of the portfolio
framework can misdirect a business’s strategy. As Gluck has observed:

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Portfolio approaches have their limitations, of course. First, it’s just not all thateasy to define the businesses or product/market units appropriately before
you begin to analyze them. Second, some attractive strategic opportunities canbe overlooked if management treats its businesses as independent entities
when there may be real advantages in their sharing resources at the researchor manufacturing or distribution level. And third, like more sophisticatedmodels, when it’s used uncritically the portfolio can give its users the illusionthat they’re being rigorous and scientific when in fact they’ve fallen prey tothe old garbage-in, garbage-out syndrome.14
12. Most portfolio approaches suggest standard or generic strategies based on theportfolio position of individual SBUs. But these kinds of responses can often
result in lost opportunities, turn out to be impractical or unrealistic, and stifle creativity. For example, the standard strategy for managing dogs (SBUs that have a
low share of a mature market) is to treat them as candidates for divestment or liquidation. New evidence demonstrates, however, that, with proper management,
dogs can be assets to a diversified corporation. One recent study of the performance of more than a thousand industrial-product businesses slotted into thefour cells of the BCG matrix found that the average dog had a positive cash floweven greater than the cash needs of the average question mark. Moreover, in aslow-growth economy, more than half of a company’s businesses might qualify as
dogs. Disposing of them all would be neither feasible nor desirable. Yet the portfolio approach provides no help in suggesting how to improve the performanceof such businesses.15
13. Portfolio models fail to answer such questions as (a) how a company may determine whether its strategic goals are consistent with its financial objectives, (b)how a company may relate strategic goals to its affordable growth, and (c) how
relevant the designated strategies are vis-à-vis competition from overseas companies. In addition, many marketers have raised other questions about the viabilityof portfolio approaches as a strategy development tool. For example, it has been
claimed that the BCG matrix approach is relevant only for positioning existing
businesses and fails to prescribe how a question mark may be reared to emerge asa star, how new stars can be located, and so on. Empirical support for the limitations of portfolio planning methods come from the work of Armstrong andBrodie. According to them, the limitations are so serious that portfolio matrices
are detrimental since they produce poorer decisions.16
In response to these criticisms, it should be pointed out that the BCG portfolio
framework was developed as an aid in formulating business strategies in complex environments. Its aim was not to prescribe strategy, though many executives
and academicians have misused it in this way. As one writer has noted:
No simple, monolithic set of rules or strategy imperatives will point automatically to the right course. No planning system guarantees the development of
successful strategies. Nor does any technique. The Business Portfolio (thegrowth/share matrix) made a major contribution to strategic thought. Today it
is misused and overexposed. It can be a helpful tool, but it can also be misleading or, worse, a straitjacket.17

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A NEW PRODUCT PORTFOLIO APPROACH: PORTER’SGENERIC STRATEGIES FRAMEWORK
Porter has identified three generic strategies: (a) overall cost leadership (i.e.,making units of a fairly standardized product and underpricing everybody else);(b) differentiation (i.e., turning out something customers perceive as unique—anitem whose quality, design, brand name, or reputation for service commands
higher-than-average prices); and (c) focus (i.e., concentrating on a particulargroup of customers, geographic market, channel of distribution, or distinct segment of the product line).18
Porter’s choice of strategy is based on two factors: the strategic target atwhich the business aims and the strategic advantage that the business has inaiming at that target. According to Porter, forging successful strategy begins with
understanding of what is happening in one’s industry and deciding which of theavailable competitive niches one should attempt to dominate. For example, a firm
may discover that the largest competitor in an industry is aggressively pursuingcost leadership, that others are trying the differentiation route, and that no one is
attempting to focus on some small specialty market. On the basis of this information, the firm might sharpen its efforts to distinguish its product from others or
switch to a focus game plan. As Porter says, the idea is to position the firm “so it
won’t be slugging it out with everybody else in the industry; if it does it right, it
won’t be directly toe-to-toe with anyone.” The objective is to mark out a defensible competitive position—defensible not just against rival companies but also
against the forces driving industry competition (discussed in Chapter 4).
What it means is that the give-and-take between firms already in the business
represents only one such force. Others are the bargaining power of suppliers, thebargaining power of buyers, the threat of substitute products or services, and thethreat of new entrants. In conclusion, Porter’s framework emphasizes not onlythat certain characteristics of the industry must be considered in choosing ageneric strategy, but that they in fact dictate the proper choice.

PORTFOLIO ANALYSIS CONCLUSION
Portfolio approaches provide a useful tool for strategists. Granted, theseapproaches have limitations, but all these limitations can be overcome with a little
imagination and foresight. The real concern about the portfolio approach is thatits elegant simplicity often tempts managers to believe that it can solve all problems of corporate choices and resource allocation. The truth is that it addresses
only half of the problem: the back half. The portfolio approach is a powerful toolfor helping the strategist select from a menu of available opportunities, but it does
not put the menu into his or her hands. That is the front half of the problem. The
other critical dimension in making strategic choices is the need to generate a richarray of business options from which to choose. No simple tool is available that

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can provide this option-generating capability. Here only creative thinking about
one’s environment, one’s business, one’s customers, and one’s competitors canhelp.
For a successful introduction of the portfolio framework, the strategist should
heed the following advice:
1. Once introduced, move quickly to establish the legitimacy of portfolio analysis.
2. Educate line managers in its relevance and use.
3. Redefine SBUs explicitly because their definition is the “genesis and nemesis” ofadequately using the portfolio framework.
4. Use the portfolio framework to seek the strategic direction for different businesses without haggling over the fancy labels by which to call them.
5. Make top management acknowledge SBUs as portfolios to be managed.
6. Seek top management time for reviewing different businesses using the portfolio framework.
7. Rely on a flexible, informal management process to differentiate influence patterns at the SBU level.
8. Tie resource allocation to the business plan.
9. Consider strategic expenses and human resources as explicitly as capital investment.
10. Plan explicitly for new business development.
11. Make a clear strategic commitment to a few selected technologies or markets
early.

SUMMARY

A diversified organization needs to examine its widely different businesses at thecorporate level to see how each business fits within the overall corporate purpose
and to come to grips with the resource allocation problem. The portfolio
approaches described in this chapter help management determine the role thateach business plays in the corporation and allocate resources accordingly.
Three portfolio approaches were introduced: product life cycle, growth raterelative market share matrix, and multifactor portfolio matrix. The product lifecycle approach determines the life status of different products and whether thecompany has enough viable products to provide desired growth in the future. If
the company lacks new products with which to generate growth in coming years,
investments may be made in new products. If growth is hurt by the early maturity of promising products, the strategic effort may be directed toward extensionof their life cycles.
The second approach, the growth rate-relative market share matrix, suggests
locating products or businesses on a matrix with relative market share andgrowth rate as its dimensions. The four cells in the matrix, whose positions are
based on whether growth is high or low and whether relative market share ishigh or low, are labeled stars, cash cows, question marks, and dogs. The strategy
for a product or business in each cell, which is primarily based on the business’s
cash flow implications, was outlined.
The third approach, the multifactor portfolio matrix, again uses two variables(industry attractiveness and business strengths), but these two variables are

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based on a variety of factors. Here, again, a desired strategy for a product/business in each cell was recommended. The focus of the multifactor matrix approachis on the return-on-investment implications of strategy alternatives rather than on
cash flow, as in the growth rate-relative market share matrix approach.
Various portfolio approaches were critically examined. The criticisms relate
mainly to operational definitions of dimensions used, weighting of variables, andproduct/market boundary determination. The chapter concluded with a discussion of Porter’s generic strategies framework.

DISCUSSIONQUESTIONS

1. What purpose may a product portfolio serve in the context of marketing strategy?
2. How can the position of a product in its life cycle be located?
3. What is the strategic significance of products in the maturity stage of the product life cycle?
4. What is the meaning of relative market share?
5. What sequence should products follow for success? What may management
do to ensure this sequence?
6. What factors may a company consider when measuring industry attractiveness and business strengths? Should these factors vary from one business toanother in a company?
7. What is the basic difference between the growth rate-relative market sharematrix approach and the multifactor portfolio matrix approach?
8. What major problems with portfolio approaches have critics identified?
9. What generic strategies does Porter recommend? Discuss.

NOTES

1 Gerald J. Tellis and C. Merle Crawford, “An Evolutionary Approach to Product Growth

Theory,” Journal of Marketing (Fall 1981): 125–34.
2 John E. Swan and David R. Rink, “Fitting Market Strategy to Varying Product Life

Cycles,” Business Horizons (January–February 1982): 72–76; and Yoram J. Wind,
Product Policy: Concepts, Methods, and Strategy (Reading, MA: Addison-Wesley
Publishing Co., 1982).
3 Kathryn Rudie Harrigan, “Strategies for Declining Industries,” Journal of Business
Strategy (Fall 1980): 27.
4 “How Du Pont Keeps Them Coming Back for More,” Business Week (20 August 1990):
80.
5 Stephen G. Harrell and Elmer D. Taylor, “Modeling the Product Life Cycle forConsumer Durables,” Journal of Marketing (Fall 1981): 68–75.
6 See Philippe Haspeslagh, “Portfolio Planning: Uses and Limits,” Harvard Business
Review (January–February 1982): 60, 73.
7 “They’re All Juiced Up at Tropicana,” Business Week (13 May 1991). Information
updated through company sources.
8 Organizing and Managing the Planning Function (Fairfield, CT: GE Company, n.d.).
9 Robin Wensley, “Strategic Marketing: Betas, Boxes, or Basics,” Journal of Marketing(Summer 1981): 173–182.
10 Michael E. Porter, Competitive Strategy (New York: The Free Press, 1981).

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11 Fred Gluck, “A Fresh Look at Strategic Management,” Journal of Business Strategy (Fall1985): 23.
12 Yoram Wind, Vijay Mahajan, and Donald J. Swire, “An Empirical Comparison ofStandardized Portfolio Models,” Journal of Marketing (Spring 1983): 89–99.
13 George Day, “Diagnosing the Product Portfolio,” Journal of Marketing (April 1977):

29–38.
14 Frederick W. Gluck, “Strategic Choice and Resource Allocation,” McKinsey Quarterly(Winter 1980): 24.
15 Donald Hambrick and Ian MacMillan, “The Product Portfolio and Man’s Best Friend,”

California Management Review (Fall 1982): 16–23.
16 J. Scott Armstrong and Roderick J. Brodie, “Effects of Portfolio Planning Methods on

Decision Making: Experimental Results,” International Journal of Research in Marketing
11 (1994): 73–84.
17 The Boston Consulting Group Annual Perspective (Boston: Boston Consulting Group,1981).
18 Porter, Competitive Strategy.

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Organizational Structure
Whatever action is
performed by a greatman, common men follow
in his footsteps, andwhatever standards hesets by exemplary acts,
all the world pursues.
BHAGAVAD GITA

A

strategic planning system should provide answers to two basic questions:what to do and how to do it. The first question refers to selection of a strategy; the second, to organizational arrangements. An organization must have not
only a winning strategy to pursue but also a matching structure to facilitate its
implementation. The emphasis in the preceding chapters has been on strategy
formulation. This chapter is devoted to building a viable organizational structure
to administer the strategy.
As we enter the next century, principles of strategic analysis and planning havebeen fully integrated into corporate decision making at all levels. Yet, althoughthese precepts now enjoy global acceptance, the need to translate strategic guidelines into long-term results and adapt them to rapidly changing market conditions
continues to rank among the major challenges confronting today’s companies.
Essentially, there are three aspects of implementation that, if properly organized,
can lead to superior corporate performance and competitive advantage: organization planning, management systems, and executive reward programs.
Fitting these aspects to the underlying strategy requires strategic reorganization. There is no magic formula to ensure successful reorganization and, generally, no “perfect” prototype to follow. Reorganization is a delicate process thatabove all requires a finely tuned management sense.
The discussion in this chapter focuses on five dimensions: (a) the creation ofmarket-responsive organizations, (b) the role of systems in implementing strategy,(c) executive reward systems, (d) leadership style (i.e., the establishment of aninternal environment conducive to strategy implementation), and (e) the measurement of strategic performance (i.e., the development of a network of control
and communication to monitor and evaluate progress in achieving strategic goals).
In addition, the impact of strategic planning on marketing organization is studied.

THE TRADITIONAL ORGANIZATION
Corporations have traditionally been organized with a strong emphasis on pursuingand achieving established objectives. Such organizations adapt well to growing
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internal complexities and provide adequate incentive mechanisms and systems ofaccountability to support objectives. However, they fail to provide a congenial environment for strategic planning. For example, one of the organizational capabilities
needed for strategic planning is that of modifying, or redefining, the objectives
themselves so that the corporation is prepared to meet future competition. The traditional organizational structure, based on “command and control” principles,
resists change, which is why a new type of structure is needed for strategic planning:
The forces shaping organization today are dramatically different from those facing
Frederick Taylor and Alfred Sloan. End-use markets are fragmenting, requiring fasterand more targeted responses. Advances in the ability to capture, manipulate, andtransmit information electronically make it possible to distribute decision making(“command”) without losing “control.” Gone is the abundant, primarily male, bluecollar workforce. Workers today are better educated, in short supply, and demanding
greater participation and variety in their jobs.
Individually all these changes are dramatic; collectively they shape a new era inorganization and strategy. Strategies are increasingly shifting from cost- and volumebased sources of competitive advantage to those focusing on increased value to thecustomer. Competitive strength is derived from the skills, speed, specificity, and service levels provided to customers. The Command and Control organization is understrain. Indeed, many businesses are finding that C&C principles now result in competitive disadvantage.1

Exhibit 11-1 differentiates the characteristics of command and control structure (i.e., traditional organization with emphasis on the achievement of establishedobjectives) and strategic planning. By and large, command and control structure
works in known territory and is concerned with immediate issues. Strategic planning stresses unfamiliar perspectives and is oriented toward the future.2

CREATING MARKET-RESPONSIVE ORGANIZATIONS
As markets and technologies change more and more rapidly, organizations must
respond quickly and frequently to strategic moves if they are to sustain competitive advantage. Although corporations have learned to make changes in strategy
quickly, their organizations may lack parallel market responsiveness. One major
reason for this failure is the conflict between scale economics, which is geared tothe expansion and aggregation of resources, and the economics of vertical integration, which links differentiated functions and resources for maximum efficiency in responding to market changes.
The opposing pressures fueling this conflict are both subtle and complex. On
one side of the equation are all the forces contributing to the need to reap maximum scale advantage. On the other side of the equation, the accelerated pace ofchange—environmental, competitive, and technological—drives corporations
toward increased flexibility, high levels of internal integration, and smaller operating units.
Although scale advantage has traditionally held high ground, evidence ismounting that highly integrated organizations can increase productive capacity
through the efficient coordination of functions and resources while remainingOrganizational Structure

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EXHIBIT 11-1
Organizational Characteristics
Command and Control Structure

Strategic Planning

1. Concerned with goals derived fromestablished objectives.
2. Goals usually have been validated
through extensive experience.
3. Goals are reduced to specific subgoals
for functional units.
4. Managers tend to identify with functions or professions and to be preoccupied with means.
5. Managers obtain relatively prompt
evidence of their performance against
goals.
6. Incentives, formal and social, are tied
to operating goals.
7. The “rules of the game” become wellunderstood. Experienced individuals
feel competent and secure.
8. The issues are immediate, concrete,
and familiar.

1. Concerned with the identification andevaluation of new objectives andstrategies.
2. New objectives and strategies can behighly debatable; experience within
the organization or in other companies may be minimal.
3. Objectives usually are evaluated primarily for corporate significance.
4. Managers need a corporate point ofview oriented to the environment.
5. Evidence of the merit of new objectives or strategies is often available
only after several years.
6. Incentives are at best only loosely
associated with planning.
7. New fields of endeavor may be considered. Past experience may not provide competence in a “new game.”
8. Issues are abstract, deferrable (tosome extent), and may be unfamiliar.

highly adaptive and market sensitive. Such organizations respond to the strategicneed for change more quickly, smoothly, and successfully than centralized, largeunit organizations oriented toward scale aggregation.3
Management has basically three options for resolving the conflict between
scale and integration. First, a company can choose to centralize its functions inorder to achieve scale at the expense of market responsiveness. Second, it can
opt for market responsiveness over scale; that is, it can emphasize small, independent units. Third, it can adopt another, more difficult approach, exploiting
the strengths associated with both large and small organizational units toachieve benefits of scale and market responsiveness simultaneously. The key
to sustainable competitive advantage lies in successful pursuit of the third
alternative.
Exploiting the benefits of both large and small organizational structures
involves creating market-responsive units within a framework of shared resources.
Such units can combine the strengths of a small company (lean, entrepreneurial
management; sharp focus on the business; immediacy of the relationship with thecustomer; dedication to growth; and action-oriented viewpoint) with those of thelarge company (extensive financial information and resources; availability of multiple technologies; recognition as an established business; people with diverse
skills to draw on; and an intimate knowledge of markets and functions).

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The creation of such units demands that planners determine, as precisely as
possible, in what form and to what degree resources must be integrated to ensure
the level of market responsiveness dictated by their business strategy. This
process can be successful only when it is undertaken in the context of a rigorous
analytical framework that links strategy to organization.
Procedure forCreating a MarketResponsive
Organization

To create a market-responsive organization, management can use a three-phaseprocess: (a) determine corporate strategic boundaries, (b) balance the demands ofscale and market responsiveness, and (c) organize for strategic effectiveness.
Determine Corporate Strategic Boundaries. How successfully a corporationaligns its structure with its strategic objectives depends on its success in making
a number of key decisions: determining the stage of the value-added process at
which it will compete, identifying those activities in which it has a competitiveedge, selecting the functions it should execute internally, and developing a planof action for integrating those functions most productively. These decisions
determine how resources should be allocated and how external and internalboundaries should be drawn. They define the company’s business—its products,
services, customers, and markets—and determine both long- and short-term
strategic potential. How well the company exploits its assets and the degree towhich each division’s performance supports strategic objectives determine how
close it will come to achieving that potential.
How strategic boundary setting reflects the trade-offs between scale and integration becomes clearer when one considers the case of an assembler facing a typical make-or-buy decision for components. As long as the components
manufacturer is able to produce common components for several customers, theassembler among them, the components manufacturer enjoys scale advantage. As
the products ordered by the assembler become more specialized in response tomarket demands or increased competitive pressures, however, the benefits thecomponents manufacturer gains from scale begin to decline. At the same time, thecost of integrating operations with those of the assembler increases as technicalspecifications become more complex and as manufacturing operations become
more interdependent. To continue their relationship and sustain their respective
advantages, the components manufacturer and the assembler are required tomake additional investments: the components manufacturer in capital equipment
outlays and product design; the assembler in negotiating terms, research anddevelopment planning, quality control, and related areas. As a result, a substantial “disruption cost” is incurred if the components manufacturer and the assembler decide to end their business relationship. Both parties attempt to guard
against this potential loss through longer-term contracts, whether explicit or
implicit. As interdependence increases, prices and contract negotiations become
cumbersome and unresponsive. At some point, the economies of scale may
decline enough and the integration costs climb high enough that the assembler
finds it more cost effective to produce components internally—to bring that particular function inside the assembler’s corporate boundaries.

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In this classic make-or-buy example, economic trade-offs between scale andintegration costs are direct and relatively clear-cut. As we move from simple makeor-buy decisions to issues of full-scale vertical integration, the economic impact
can be far more subtle and far-reaching. Scale advantage is not expressed solely interms of lower unit manufacturing costs but may also flow from the critical massof skills gained or from the transferability of new product or process technologies.
Valuable integration benefits, on the other hand, may be gained from the willingness to undertake more profitable research and development investments because
vertical integration ensures a “market” in downstream operations.
Balance the Demands of Scale and Market Responsiveness. The balancing ofscale and market responsiveness demands may be illustrated with reference to alarge insurance company. The company faced a complex set of internal andmarket-based organizational trade-offs in its core business—property and casualty insurance. Lagging market growth, increased price sensitivity, new forms of
product distribution, new information technology, and escalating competition
were all placing enormous pressures on the company’s traditional mode of operation. Top management realized that fundamental changes in organization wereneeded in both its home office and in its field network if the company was toremain competitive and meet aggressive new growth and profit goals.
In responding to these pressures, the company found itself facing a familiar
dilemma. On the one hand, it was vital that its organizational structure become
more responsive to local market demand, particularly in terms of regional product pricing and agent deployment. This need pointed to decentralization as thelogical method for restructuring operations, with the field divided into smaller
sales and marketing regions and more responsibility assigned to local management. On the other hand, however, management was determined to reduce thecosts of transaction processing. Meeting this need for administrative streamlining
appeared to require that field offices around the country be reorganized intolarger regional centers to exploit fully the scale economies offered by improvements in automated processing capacity.
Initially, these strategic requirements seemed to set large centers against
locally responsive marketing and sales units. Yet, by carefully analyzing and“rewiring” its structure, the company was able to resolve the apparent conflictcost-effectively and efficiently. Here is the approach it pursued. The company’s
field operations consisted of essentially self-sufficient regional centers; each center included all functional departments under its umbrella, ranging from sales,
claims, and underwriting to operations and personnel. Two of these functions
dominated field operations: customer interaction through sales and marketingand transaction processing. Originally, the field organization was designed
around exploiting administrative scale in the processing function and balancing
the need to locate sales and marketing functions to serve the customer base effectively. The underlying basis for the organizational design was the need to coordinate sales and processing functions because of the high volume of transactions
and interactions between them. A layer of management between the home officeand the regional centers coordinated programs and enforced company policies.

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In line with its new strategic objectives (greater market responsiveness andincreased productivity), the company instituted major organizational changes.
First, the layer of management between the home office and regional centers waseliminated to improve communications and to facilitate more market-responsive
decision making. Second, to achieve scale economies and contain costs, thereporting relationships of the processing centers were shifted from the regional
level directly to the home office. New information technology allowed the company to “unhook” processing centers from sales functions and still remain adequately integrated. As a result, the number of regions of independent saleorganizations was no longer tied to the number of processing centers. The number of processing centers was reduced as information-technology innovations
allowed additional processing capacity, whereas the number of marketing andsales regions was increased as market requirements demanded, allowing theentire sales organization to move closer to its local client base. The needs for bothmarket responsiveness and scale economies in processing was fully satisfied.
Organize for Strategic Effectiveness. To organize for strategic effectiveness, it
is important to recognize that the ultimate goal of a business organization is competitive advantage, and the drive for competitive advantage must be expressed ineconomic terms and pursued through the use of economic tools. Only by placingorganizational decisions in an economic context can the value of alternative formsof structure, incentive, and management process be determined.4 It is only in thelight of these assessments that the steps needed to strike the proper balance
between scale and market responsiveness can be taken. Needless complexity,
excessive layers of management, and nonessential integration of channels mustall be eliminated. The design phase is easy when compared to the difficulties ofexecution (i.e., implementing organizational change). It requires strong leadership, consistent signals and actions, and strategically driven incentive programs.
Managing aMarket-Responsive
Organization

Designing and managing a market-responsive organization requires overturning
old assumptions. First, the linearity from strategy to structure and on to systems,
staff, etc., cannot be reasoned. The process is instead iterative: a team is formed tomeet a strategic need; it sizes up the situation, develops a specific strategy, and reorganizes itself as necessary. What’s more, the structure is temporary. The organizationneeds to be ready to change its configuration quickly to respond to new needs andcircumstances. Second, the organization’s purpose is not to control from the top; it is
to empower a group of people to get a job done. Management occurs through training, incentives, and strongly articulated goals, strategies, and standards.
Market-responsive organizations are found most often in businesses that are
driven by product development and customer service—electronics and software
companies, for example—and are often smaller, younger organizations where traditional boundaries are weaker. Some large-scale models include parts of Honda
and Panasonic, 3M, and also, in some ways, GE, which has developed extraordinary flexibility in recent years in reshaping its organization and pushing authority down to frontline managers.

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Market-responsive organizations have obvious drawbacks: they lack tightcontrols, they are ill-suited to exploit scale or to accomplish massive tasks, andthey depend on capable and motivated people at the working level. However,companies that cannot use the full market-responsive model can appropriate
aspects of it—new product development teams, for instance.
Some large companies, such as IBM, Microsoft, and Dow Chemical, with theneed for both innovation and coordination of resources among markets, productlines, and technologies, often use the concept in modified form. They frequently
change the focus of resources and control by reshuffling product groups—shifting power among parts of the organization or by using ad hoc teams.
Experience suggests that people are quite willing and able to change as longas they have a clear understanding of what’s expected of them, know why it isimportant to change, and have latitude in designing the new organization. Five
key elements that companies should carefully consider in seeking strategic effectiveness are discussed below:5
1. Forge a clear link between strategy and skills—A company’s strategy, whichshould embody the value it proposes to deliver to its customers, determines the
skills it needs. Many companies, however, are not sufficiently clear or rigorous
about this linkage. Because Frank Perdue promises to deliver more tender chickens, his organization must excel at the breeding and logistics skills necessary todeliver them. Because Volvo promises to deliver more reliable, tougher, and safer
cars, it must be skilled in designing and manufacturing them. Because Domino’s
Pizza says it will deliver fresh pizza hot to your door within 30 minutes, each of its
5,000 outlets needs to be skilled at making a good pizza quickly and at customer
order processing and delivery. Strategy drives skills, but if this linkage is missed, acompany may end up doing some things right but not the right things right.
2. Be specific and selective about core skills—Managers often describe the coreskills their companies need in terms that are too general. Saying that you need tobe first rate at customer service or marketing is not good enough. For example,
the employees of a department store committed to being better at customer service will not know what to do differently because the term customer service doesn’t paint a specific enough picture of the behavior desired of them. In fact, a
department store needs to be good in at least three different types of customer
services: with hard goods such as refrigerators or furniture, customer service
must have a high component of product and technical knowledge; with fineapparel, what counts is expertise in fashion counseling; with basics and sundries,
the need is for friendly, efficient self-service. Each of these service goals translates
into a different set of day-to-day behaviors expected of employees. Unless thesebehaviors are precisely defined, even willing employees won’t change their
behavior very much because they won’t know how.
3. Clarify the implications for pivotal jobs—Consider the department store again.
The definition of different types of customer services drives through to the identification of several specific jobs whose performance determines whether customers think the store is good at customer service: the product salesperson forrefrigerators, the fashion counselor for fine apparel, and the cashier for sundries.
Pushing the skill definition to these specific jobs, which may be called pivotal jobs,
allows the company to describe in specific terms what the holders of these jobs

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should do or not do, which kind of people to hire, which kind of training andcoaching to give them, which rewards motivate them, and which kind of information they need. For example, at Nordstrom, the excellent Seattle-based fashion specialty retailer, the pivotal job is the frontline sales associate. Because Nordstrom isclear about the type of person it wants for this job—someone interested in a career,
not just a summer position—it looks more for a service orientation than priorexperience. It pays better than the industry average and offers incentives thatallow top sales associates to make over $80,000 a year. Nordstrom stresses customer service above all else. The company philosophy is to offer the customer, in
this order, “the best service, selection, quality, and value.”
This clarity about priorities helps sales associates determine appropriate service behavior. So does the excellent product and service training they receive.
And so does the customer information system that provides sales associates with
up-to-date sales and service records on their customers. Nordstrom recognizes
that its business success depends on the success of pivotal jobholders in delivering value to customers, and the company has geared its entire organization to
support these frontline associates.
4. Provide leadership from the top—The key ingredients that have been foundworkable in this task include• Appeal to the pride of the organization. Most people want to do a superiorjob, especially for a company that expresses its mission with an idea bigger
than just making money. Providing them with a single noble purpose—be it“quality, service, cleanliness, value” or “innovation”—will unleash energy but
keep it focused.
• Clarify the importance and value of building core skills. Provide the organization with a good economic understanding of the value as well as a clear picture of the consequences of not paying attention to core skills.
• Be willing to do the tough things that break bottlenecks and establish credibility for the belief that “this change is for real.” Usually, the toughest things
involve replacing people who are change blockers, committing key managers
to the skill-building effort, and spending money on it.
• Treat the program to build skills as something special, not as business as
usual. Reflect this in the leader’s own time allocation, in the questions he or
she asks subordinates, in the special assignments he or she gives people, in the
choice of the special measurements he or she looks at, and so on.
• Over-communicate to superiors, subordinates, customers, and especially topivotal jobholders. Talk and write incessantly about the skill-building program—about the skills the company is trying to build and about why they are
critical; about early wins, heroes, and lessons learned from failures; about
milestones achieved.
5. Empower the organization to learn—Organizations, like individuals, learn bestby doing. Building new core skills is preeminently a learning process. Sketch out
for employees the boundaries of their playing field by defining the strategy, theskills the company is trying to build, the pivotal job behaviors required, and theconvictions they must hold about what is right. But within these boundaries, givethem a lot of room to run—to try things, succeed, fail and to learn for themselves
exactly what works and what doesn’t. They will figure out for themselves details
that could never be prescribed from above.6

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To illustrate the point, take, for example, the 10,000 route salespeople of FritoLay. Michael Jordan, the company’s president, says that these people with their“store to door service” control the destiny of Frito-Lay. Wayne Calloway,
PepsiCo’s former president and past CEO of Frito-Lay, describes this pivotal job
as follows: “Our sales people are entrepreneurs of the first order. Over 100,000
times a day they encounter customers who are making buying decisions on the
spot. How in the world could an old-fashioned sort of management deal withthose kinds of conditions? Our approach is to find good people and to give themas much responsibility as possible because they’re closest to the customer, theyknow what’s going on.”7

ROLE OF SYSTEMS IN IMPLEMENTING STRATEGY
The term systems refers to management systems, which include any of the formally organized procedures that pervade a business. Three types of systems may
be distinguished: execution systems, monitoring systems, and control systems.
1. Execution systems focus directly on the basic processes for conducting the firm’s
business. They include systems that enable products to be designed, supplies tobe ordered, production to be scheduled, goods to be shipped, cash to be applied,and employees to be paid.
2. Monitoring systems are any procedures that measure and assess basic processes.
They can be designed to gather information in different ways to serve a numberof internal or external reporting purposes: to meet SEC or other regulatory
requirements, to control budgets, to pay taxes, and to serve the strategic andorganizational intent of the company.
3. Control systems are the means through which processes are made to conform or
are kept within tolerable limits. At the broadest level, they include separation ofduties, authority limits, product inspection, and plan submittals.

As can be seen from this brief description, systems pervade the conduct ofbusiness. For that very reason, systems provide ample opportunity for strategies
to fail. In most companies, the major emphasis is on execution systems. But creating systems that support strategies and organizational intent requires top management to include monitoring and control systems in addition to executing
systems in strategic thinking and to focus on systems in strategy implementation.
It means, as part of the strategic planning, answering such key questions as: What
are the critical success factors? How do they translate into operational performance? How should that operational performance be measured and motivated?
How should information about financial performance be derived? What businesscycles are important? How should systems support them? What is the role offinancial controls and measures? Where should control of information reside?
How should strategic objectives and organizational performance be monitored
and modified? How should internal and external information be linked?
In short, integrating all systems with strategy requires great vision—the ability to see the firm as an organic whole. Unfortunately, too many systems managers lack vision or clout and too many executives lack the understanding or the
inclination to make this integration happen.

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Techniques for
Systems Design283

To create systems that support strategic and organizational intent, top management must include systems in strategic thinking and focus on systems in strategy
implementation. Once critical success factors have been identified and translated
into operational measurements, good systems design techniques are needed toensure that those factors and measurements are appropriately accommodated by
all systems. Following are some guidelines for good systems design:
1. Design an effective information-capturing procedure—Data should be captured
close to the source, and source documents should be linked. For example, at one
company, data processing personnel collected information on raw materials fromreceiving reports two days after delivery and entered that information into purchasing control and inventory management systems. Two days later, accounting
gathered information on the same delivery from invoices, this time entering it
into accounting systems. The failure to link source documents led to apparent
inventory discrepancies. Purchasing and inventory processes focused on inventory codes and quantities; accounting processes dealt with accounting codes andmonetary amounts, which were available only at the end of the month.
These problems required a three-part solution: placing terminals at the receiving dock, where receiving clerks could enter operating information; using internallinks to accounting codes; and creating a reconciliation proof on which quantities
and amounts were entered as invoices were received.
2. Manage commonly used data elements for firm-wide accessibility andcontrol—If a multidivisional firm allows each unit to code inventory discretely,stock that is commonly used cannot be traded and rebalanced. Traditionally, auto
dealers maintained independent inventory controls. By contrast, Ford Motor
Company has worked to keep its inventory records consistent and thus accessible
to dealers so that imbalances at one lead to opportunities for another.
3. Decide which applications are common and which tolerate distributed processing—Typical considerations here include pinpointing the need to share data,
determining the availability of hardware and software offerings that make a distributed approach feasible, and investigating the effect of geographical distance.
Once a particular application or function is judged appropriate for a distributed
approach, it must be integrated into an information network.
4. Manage information, not reports—Systems are often developed with end reports
in mind, focusing on output, not content. If needs change or if developers andusers misunderstand each other, the results can lead to frustration at best or theinability to modify output at worst. When the development focus is on content,
on information that has been strategically identified as critical to success, users
can tailor the presentation of output to their purposes. For example, in one company with a well-constructed receivables database, one manager chose to compare cash collections to target amounts, another used days outstanding, and athird used turnover ratios.
5. Examine cost-effectiveness—Questioning the value of a system and of the workrequired to support it is healthy. But such questioning must be handled properly. As
an example, to escape merely chipping away at existing processes through cost
reduction, Procter & Gamble developed its elimination approach, which is based on
the key “if” question: If it were not for this [reason], this [cost] would be eliminated.8
Designing and maintaining systems that focus on strategic intent and that assess
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lack of integration between systems and strategy is an important reason why soundstrategic and organizational concepts get bogged down in implementation and do
not achieve the results their creators intended. Soundly designed and managed systems do not happen casually: they emerge only with top management involvement
and with a clear vision of the importance of systems to strategic outcomes.

EXECUTIVE REWARD SYSTEMS
Executive compensation and strategy are mutually dependent and reinforcing. A
good reward system should have three characteristics:9 (a) it should optimize
value to all key stakeholders, including both shareholders and management alike(the so-called agency problem); (b) it should properly measure and recapture
value; and (c) it should integrate compensation signals with those implicit instrategy and structure. Although these issues are generally addressed from theperspective of plan implementation, they also have an important but rarely noted
strategic dimension. And that strategic dimension actually has a make-or-break
impact on plan effectiveness.
The Agency
Problem

The agency problem refers to the potential conflict of interest between shareholders and their agents, the executives charged with implementing corporate strategy. The executives of a corporation serve as agents of the corporation’sshareholders. Yet, though both executives and shareholders are stakeholders in a
corporation, their interests do not coincide. In fact, they naturally diverge on three
counts: risk position (e.g., shareholders stand last in line among claimants to theresources of the corporation, whereas executives have the right to payment ofsalaries and benefits before the claims of shareholders are met); ability to redeploy (e.g., shareholders can freely redeploy their investments; the executives’
human capital invested in the course of a career may not be easily redeployableat full value); time horizon (e.g., shareholders embrace long time horizons to earncompetitive returns; time horizons of executives are usually shorter). These differences lead to differences in the ways each group measures the risks andrewards of any corporate action. In general, the differences in risk evaluation
make a company’s executives more averse to risk than are its shareholders.
Resolving the agency problem requires bridging the gap between the inherently divergent interests of shareholders and the executives entrusted with the
responsibility of safeguarding and increasing shareholder investments. Though
executive compensation plans can and should help resolve this problem, theyoften compound it. Most incentive plans, for example, are based on improvements in short-term earnings; therefore, they actually inhibit the very risk decisions required to provide highly competitive returns to shareholders.
New and creative ways of compensating executives must be developed tosynchronize their interests with those of shareholders.

The Value Problem

From the company’s viewpoint, the value issue is twofold. One aspect revolves
around the need to reward executive performance in a way that is systematically

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related to the market value of the corporation. The other is the need to create
incentive plans for managers of individual business units.
In this book, our major concern is with creating incentive plans for managers
of individual business units. Compensation planning for individual business units
is illustrated with reference to a hypothetical company, Hellenic Corporation.10
Hellenic Corporation consists of four businesses: Alpha, Beta, Gamma, andDelta. Alpha operates in a promising market but needs to increase market share
rapidly. Beta is an efficient, well-run business that already has the largest shareof a mature market. Gamma, once a top performer, has suffered recently fromserious management mistakes; nevertheless, it has the potential to be a winner
again. Delta is a mediocre performer in a mediocre market; moreover, its business is largely unrelated to the other businesses of the corporation.
Hellenic’s strategic plan calls for Alpha to grow rapidly, for Beta to capitalize
on its well-established position, for Gamma to turn itself around, and for Delta to
be divested. This plan maximizes the value of the corporation as a whole. Eachdivision is vital to the corporation’s success; however, the management objectivesof the chiefs at Alpha, Beta, Gamma, and Delta differ from one another and influence the market value of the firm in distinct ways. This conflict, however, does notmean that shareholder value is an impractical standard for determining executive
reward. Even when a manager’s performance is related only indirectly to shareholder value, increasing shareholder value need not be abandoned as the aim of
executive compensation planning. The challenge is to craft a plan that links performance to value in a way that is consistent with the corporation’s long-term
strategy. To do this requires tailoring a specific compensation package for the
manager of each business unit. The determinants of compensation at Alpha must
be different from those at Beta, which again must be different from those at
Gamma and at Delta.
This overall plan can be created by analyzing how risk and time horizons inexecutive pay plans suit the strategic objectives of each business unit. For example, the top manager at Alpha is engaged in a very long-term project. Exceptional
growth and profitability are planned, and the risks incurred in executing the plan
are considerable. These circumstances call for a pay package geared to the entrepreneurial challenges facing Alpha. Accordingly, the time horizon is very longand the risk posture is high. At Beta, where the prime objective is to maximize
returns from a well-established market position, the time horizon and risk posture are moderate. At Gamma, the turnaround candidate, the time horizon isshort and the risk posture is very high. At Delta, being managed for window
dressing, the time horizon is short and the risk posture is low. In addition, otherspecial sell-off compensation arrangements (e.g., a percentage of the sale price)
may be needed.
The Signaling
Problem

A signal is simply an inducement to action. Because pay is clearly a powerful
inducement to action, compensation systems are powerful signaling devices.
Other signaling devices include financial controls, the planning process, and the
top management succession plan. All these factors convey messages about what

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a corporation expects and what it values. Collectively, these signals shape the corporation’s culture and determine the actions it takes in given situations.
When management sends consistent signals through all channels, it adheres
to a clear strategic track. Unfortunately, conflicting internal signals are common,and compensation is frequently the area of greatest dissonance. Companies must
tackle the signaling problem directly. Winners should be paid like winners, andpoor performers must not be rewarded. Briefly, executive compensation plans
require more risk taking based on real value.
Incentive plans should be designed to induce risk taking. They should makeexecutives think like owners. That is, the plan must bring the interests of executives in line with the interests of shareholders. By resolving the problems of agency
and value, by ensuring that high levels of risk taking reap commensurate rewards,
and by eliminating conflicting signals, companies can put in place the kinds of
incentives required to create exceptional value for owners and agents alike.

LEADERSHIP STYLE
However strategic plans are arrived at, only one person, the CEO, can ensure thatenergies and efforts throughout the organization are orchestrated to attain
desired objectives. What the Chinese general and philosopher Sun-tzu said in 514
B.C. is still true today: “Weak leadership can wreck the soundest strategy; forcefulexecution of even a poor plan can often bring victory.” This section examines the
key role of the CEO in shaping the organization for strategy implementation. Also
discussed is the role of the strategic planner, whose activities also have a major
impact on the organization and its attitude toward strategic change.
Role of the CEO

The CEO of a company is the chief strategist. He or she communicates the importance of strategic planning to the organization. Personal commitment on the partof the CEO to the significance of planning must not only be highly visible—it
must also be consistent with all other decisions that the CEO makes to influence
the work of the organization.11 To be accepted within the organization, the strategic planning process needs the CEO’s support. People accustomed to a short-termorientation may resist the strategic planning process, which requires different
methods. But the CEO can set an example for them by adhering to the planning
process. Essentially, the CEO is responsible for creating a corporate climate conducive to strategic planning. The CEO can also set a future perspective for theorganization. One CEO remarked:
My people cannot plan or work beyond the distance of my own vision. If I focus on
next year, I’ll force them to become preoccupied with next year. If I can try to look fiveto ten years ahead, at least I’ll make it possible for the rest of the organization to raise
their eyes off the ground immediately in front of them.12

The CEO should focus attention on the corporate purpose and approvestrategic decisions accordingly. To perform these tasks well, the CEO should support the staff work and analysis upon which his or her decisions are based. Along

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the same lines, the CEO should ensure the establishment of a noise-free communications network in the organization. Communications should flow downward
from the CEO with respect to organizational goals and aspirations and the valuesof top management. Similarly, information about risks, results, plans, concepts,
capabilities, competition, and the environment should flow upward. The CEOshould avoid seeking false uniformity, trying to eliminate risk, trusting tradition,
dominating discussion, and delegating strategy development.13 A CEO who does
these things could inadvertently discourage strategy implementation.
Concern for the future may require a change in organizational perspectives,
as discussed above. The CEO should not only perceive the need for a change but
should also be instrumental in making it happen. Change is not easy, however,
because past success provides a strong motive for preserving the status quo. As
long as the environment and competitive behavior do not change, past perspectives are fine. However, as the environment shifts, changes in policies and attitudes become essential. The CEO must rise to the occasion and not only initiatechange but encourage others to accept it and adapt to it.14 The timing of a change
may be more important than the change itself. The need for change must be realized before the optimum time for it has passed so that competitive advantage andflexibility are not lost. Exhibit 11-2 summarizes the qualities and attributes of achief strategist.
Zaleznink makes a distinction between the CEO who is a manager and the
CEO who is a leader. Managers keep things running smoothly; leaders provide

EXHIBIT 11-2
Qualities and Attributes of a Chief Strategist
1.

2.

3.

4.

5.

Trustworthiness. Trustworthiness is one of the most important qualities required byany leader. In other words, anyone seeking to be a leader should always tell thetruth, if for no other reason than it is simpler.
Fairness. Americans will forgive much, but seldom unfairness. Unfairness in a chief
executive (or for that matter in any executive) is particularly serious, because he or
she sets the example for everyone else. In fact, to be called an unfair leader is damning, and even implies a flawed character.
Unassuming behavior. Arrogance, haughtiness, and egotism are poisonous to leadership. Having a “servant” leadership viewpoint helps any CEO focus on company
performance and on the needs of constituents rather than on his or her own performance or image. Successful leaders are as unassuming in the surroundings they create—or tolerate—as they are in their behavior.
Leaders listen. Active listening helps assure the other person that he or she is being
heard and understood. Unfortunately, of all the skills of leadership, listening is oneof the most valuable; yet one of the least understood.
Open-mindedness. Any leader with an open mind makes better judgements, learns
more of what he or she needs to know, and establishes more positive relations withsubordinates and constituents. In such an environment, people in the organization
can be more productive.

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EXHIBIT 11-2
Qualities and Attributes of a Chief Strategist (continued)
6.

7.

8.

9.
10.

11.
12.

13.
14.

Sensitivity to people. A leader cannot motivate or persuade constituents or others
effectively without having some sense of what is on their minds. Sensitivity to people also means that leaders are sensitive to their feelings. Leaders are polite, considerate, understanding, and careful that what they say to someone is not dispiriting
unless criticism is intended.
Sensitivity to situations. Situations are created by people and must be dealt with bypeople. Any company leader who is called on to resolve a dispute or disagreement
must combine a careful analysis of the facts with an acute sensitivity to the feelings
and attitudes of the people involved.
Leaders take initiative. Initiative is one of the most important attributes of any
leader. Just think a bit, use judgment, and act. Nothing happens except at the initiative of a single person.
Good judgment. Judgment is the ability to combine hard data, questionable data,and intuitive guesses to arrive at a conclusion that events prove to be correct.
Broad-mindedness. Broad-mindedness refers to tolerance of varied views and willingness to condone minor departures from conventional behavior. This attribute isclosely related to being open-minded, adaptable, and flexible. Other aspects ofbroad-mindedness are being undisturbed by little things, willing to overlook small
errors, and easy to talk with.
Flexibility and adaptability. The leader should be ready to consider change and be
willing to make changes when most agree they are needed.
Capacity to make sound and timely decisions. All decisions will be of higher quality where subordinates are free to speak up and disagree. The leader should recognize that the speed as well as the quality of his or her decisions will set an example
for others to follow in the organization.
Capacity to motivate. A leader should have the capacity to move people to action,
to communicate persuasively, and to strengthen the confidence of followers.
Sense of urgency. A sense of urgency should underlie everything that the leader
does—for example, bring new products out on time, deliver orders promptly, or get
things done faster than competitors. When a sense of urgency has spread through a
company, it can make a substantial difference in both effectiveness and efficiency,
making it easier to speed up activities further when necessary.

Source: See Marvin Bower, The Will To Lead (Boston, MA: Harvard Business School Press, 1997).

longer-term direction and thrust.15 Successful strategic planning requires that the
CEO be a good leader. In this capacity, the CEO should
1. Gain complete and willing acceptance of his or her leadership.
2. Determine those business goals, objectives, and standards of behavior that are as
ambitious as the potential abilities of the organization will permit.
3. Introduce these objectives and motivate the organization to accept them as theirown. The rate of introduction should be the maximum that is consistent with continued acceptance of the CEO’s leadership. Because of this need for acceptance,
the new manager must always go slowly, except in emergencies. In emergencies,
the boss must not go slowly if he or she is to maintain leadership.

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4. Change the organizational relationships internally as necessary to facilitate boththe acceptance and attainment of the new objectives.

A coordinated program of change in pursuit of a sound and relevant strategy
under the active direction of the chief executive and the chief planner can lead tosignificant progress. Although this may only begin a long-term program, it
should yield benefits far beyond the time and effort invested. Although pace andeffectiveness of strategic change cannot be judged in quantitative terms, there areuseful criteria by which they may be assessed. Some of the more important hallmarks of progress are listed here:• Strategies are principally developed by line managers, with direct, constructive
support by the staff.
• Real strategic alternatives are openly discussed at all levels within the corporation.
• Corporate priorities are relatively clear to senior management, but they permit
flexible response to new opportunities and threats.
• Corporate resources are allocated based on these priorities and in view of future
potential as well as historical performance.
• The strategic roles of business units are clearly differentiated as are the performance measures applied to their managers.
• Realistic responses to likely future events are worked out well in advance.
• The corporate staff adds real value to the consideration of strategic issues andreceives cooperation from most divisions.

Role of theStrategic Planner

A strategic planner is a staff person who helps line executives in their planning
efforts. Thus, there may be a corporate strategic planner working closely with theCEO. A strategic planner may also be attached to an SBU. This section examines
the role of a strategic planner at the SBU level.
The planner conceptualizes the planning process and helps translate it forline executives who actually do the planning. As part of this function, the planner
works out a planning schedule and may develop a planning manual. He or she
may also design a variety of forms, charts, and tables that may be used to collect,analyze, and communicate planning-oriented information. The planner may also
serve as a trainer in orienting line managers to strategic planning.
The planner generates innovative ways of performing difficult tasks and educates line managers in new techniques and tools needed for an efficient job ofstrategic planning. The planner also coordinates the efforts of other specialists(i.e., marketing researchers, systems persons, econometricians, environmental
monitors, and management scientists) with those of line management. In this role,
the planner exposes managers to the newest and most sophisticated concepts andtechniques in planning.
The planner serves as an adviser to the head of the SBU. In matters of concern, the SBU head may ask the planner to undertake a study. For example, the
SBU head may seek the advice of the SBU strategic planner in deciding whether
private branding should be accepted so as to increase market share or whether itshould be rejected for eroding the quality image of the brand.

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Another key role the planner plays is that of evaluator of strategic plans. For
example, strategic plans relative to various products/markets are submitted to
the SBU head. The latter may ask the planner to develop an evaluation system forproducts/markets. In addition, the planner may also be asked to express an opinion on strategic issues.
The planner may be involved in integrating different plans. For example, theplanner may integrate different product/market plans into an SBU strategic plan.
Similarly, an SBU’s plans may be integrated by the corporate strategic planner fromthe perspectives of the entire corporation. For example, if a company uses the growthrate-relative market share matrix (see Exhibit 10-4) to judge plans submitted by different businesses, the planner may be asked not only to establish the position of thesebusinesses on the matrix but also to furnish a recommendation on such matters as
which of two question marks (businesses in the high-growth-rate, low-market-sharequadrant of the matrix) should be selected for additional funding. The planner’s recommendation on such strategic issues helps crystallize executive thinking.
Matters of a nonroutine nature may be assigned to the planner for study andrecommendation. For example, the planner may head a committee to recommend
structural changes in the organization.
Obviously, the job of strategic planner is not an easy one. The strategic planner must
1. Be well versed in theoretical frameworks relevant to planning and, at the sametime, realize their limitations as far as practical applications are concerned.
2. Be capable of making a point with conviction and firmness and, at the same time,
be a practical politician who can avoid creating conflict in the organization.
3. Maintain a working alliance with other units in the organization.
4. Command the respect of other executives and managers.
5. Be a salesperson who can help managers accept new and difficult tools andtechniques.

In short, a planner needs to be a jack-of-all-trades.

MEASURING STRATEGIC PERFORMANCE
Tracking strategy, or evaluating progress toward established objectives, is an
important task in strategy implementation. There are three basic considerations in
putting together a performance measurement system: (a) selecting performancemeasures, (b) setting performance standards, and (c) designing reports. A strategic
performance measurement system requires reporting not by profit center or costcenter but by SBU. It may require allocation or restatement of financial results basedon the new type of reporting center. Most management reporting is geared to SEC(Security and Exchange Commission) and FASB (Financial Accounting Standards
Board) requirements and focuses on the bottom line. For many business units, however, profit is not the pertinent measure of a unit’s strategic performance.
In selecting performance measures, only those measures that are relevant to thestrategies adopted by each SBU should be chosen. For example, brand building,

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advertising, and many public relations activities are commonly designed to build
long-term value for the brand and the organization. In reality, most marketing
expenses are investments. They are investments in customers. A marketing investment that makes certain customers more loyal can deliver a return by persuadingthese customers to buy and pay more, by costing less in sales and service, and byreferring new customers through existing customers’ visible use of the product orservice and their advocacy. Ford estimates that each percentage point gained in carowner loyalty is worth $100 million in profit every year. 16
Further, when setting performance standards, the targets, or expected values,
should be established so that they are consistent with both the strategic positionof business units and the strategies selected. Finally, reports should focus management attention on key performance measures. Exhibit 11-3 summarizes significant issues in measuring strategic performance.

ACHIEVING STRATEGIC PLANNING EFFECTIVENESS
As mentioned above, most companies have made significant progress in the last
10 to 15 years in improving their strategic planning capabilities. Clear, concise
methods have been developed for analyzing and evaluating market segments,
business performance, and pricing and cost structures. Creative, even elegant,methods have been devised for displaying the results of these strategic analyses
to top management.
Few today would argue the value—in theory at least—of the strategic
approach to business planning. RJR Nabisco’s former CEO, Lou Gerstner (nowCEO at IBM), describes that value in the following words: “It is my absolute conviction that you can out-manage your competition by having brilliant strategies.”17 Unfortunately, RJR Nabisco’s successful experience appears to be more
the exception than the rule. Much more typical are reports of dissatisfaction withthe results of strategic planning.
Why the achievement gap between strategic planning and strategic performance? Reasons undoubtedly will vary from corporation to corporation, but certain ones appear to be critical. First, many companies have found that top-down
strategic planning produces resistance on the part of operating managers. Second,
strategic planning efforts have failed to encourage innovative ideas and techniques to implement the strategy. Third, even in companies known for excellencein strategic planning, lack of adequate emphasis on marketing has led to poor
implementation of strategic plans.
Strategy
Implementationand Management
Behavior

Strategic planning as currently practiced has produced resistance on the part ofoperating managers. One observer has identified three types of resistance: measurement myopia (i.e., managers behave in ways that show good short-term performance), measurement invalidation (i.e., managers supply top managementwith distorted or selected biased data), and measurement justification (i.e., managers justify their behavior excessively and become excessively cautious about
specific factors identified as critical cash flow or ROI determinants).18

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EXHIBIT 11-3
Strategic Performance Measurements
1.

2.

To be effective, strategic performance measures must be tailored to the particular
strategy of each individual business unit. While there is a basket of generic strategic
measurement tools, selection and application is highly dependent on detailed understanding of the particular business strategy and situation.
Strategic performance measurements have two dimensions:• Monitoring key program implementation to ensure that the necessary elementsof strategy are being provided.
• Monitoring results to ensure that the programs are having the desired effects.

3.

Strategy performance necessarily involves trade-offs—costs and benefits. Both must
be recognized in any useful strategic performance measurement system:• Objectives— assessing progress toward primary goals.
• Constraints— monitoring other dimensions of performance that may be sacrificed,
to some degree and for some period, in order to achieve strategic objectives.

4.

5.

6.

Strategic performance measurements do not replace, but rather supplement, shortterm financial measurements. They do provide management with a view of longterm progress in contrast to short-term performance. They may indicate that
fundamental objectives are being met in spite of short-term problems, and thatstrategic programs should be sustained despite adversity. They may also show that
fundamentals are not being met although short-term performance is satisfactory,
and, therefore, strategy needs to be changed.
Strategic performance measurement is linked to competitive analysis. Performancemeasurements should be stated in competitive terms (share, relative profitability, relative growth). While quantitative goals must be established, evaluating performanceagainst them should include an assessment of what competition has been able to attain.
Strategic performance measurement is linked to environmental monitoring.
Reasonable goals cannot always be met by dint of effort if the external world turns
against us. Strategic performance measurement systems must attempt to filter
uncontrollable from controllable performance, and provide signals when the measures themselves may be the problem, rather than performance against them.

Source: Rochelle O’Connor, Tracking the Strategic Plan (New York: The Conference Board, Inc., nodate): 11. Reprinted by permission of the publisher.

To solve this resistance problem, it is important to remember that, althoughsophisticated management tools and the up-to-the-minute techniques of businessschools may help identify a desirable strategic course, implementation of a strategy requires time-honored simple and straightforward approaches. As a matter offact, the latter are still vital prerequisites for success. Experience shows the following specific steps are helpful in effective implementation.19• Benchmark using world standards. Find the world champions in every process
you measure, from inventory turns to customer service, and try to exceed them.
• Use process mapping. Break down your organization’s activities to their component parts. Identify the inefficiencies, then redesign each process as if from scratch.

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For each step, ask whether customers would pay for it if they knew about it.
• Communicate with employees to encourage them to focus on external reality—
customers and competitors. Define a clear vision that creates a sense of urgency.
Help them understand the impact of their own behavior.
• Distinguish what needs to be done from how hard it is to do it. The difficulty of
doing is irrelevant; real emphasis should be on what is to be done.
• Set stretch targets. There is nothing wrong with asking employees to perform as
well as the best in the world. But don’t tell them how to do it. They will come out
with ideas to accomplish what has to be done.
• Never stop. When you get ahead of the pack, don’t relax. That is just when yourcompetitors are getting energized by benchmarking against you.

Effective Innovative
Planning

Effective strategic planning should eliminate organizational restraints, not multiply
them; it should contribute to innovation, not inhibit it. In the coming years, strategic planners face a unique challenge because innovation and new product development must be stimulated within the structure of large, multinational corporate
enterprises. A number of companies have proved that innovation and entrepreneurial drive can be institutionalized and fostered by a responsive organizational
structure. 3M and IBM, for example, have established technology review boards toensure that promising product ideas and new technologies receive adequate startup support. Adopting another approach, Dow Chemical has instituted an “innovation department” to streamline technology commercialization.
To encourage perpetuation of new ideas and innovation, management
should:20
1. Focus attention on the goals of strategic planning rather than on process; that is,concentrate on substance, not form.
2. Integrate into its business strategy the analysis of emerging technologies andtechnology management, consumer trends and demographic shifts, regulatory
impact, and global economics.
3. Design totally new planning processes and review standards and acceptance criteria for technological advances and new business “thrusts” that may not conform completely to the current corporate base.
4. Adopt a longer planning horizon to ensure that a promising business or technological development will not be cut off prematurely.
5. Ensure that overly stringent financial requirements aren’t imposed during thestart-up phase of a promising project.
6. Create special organizational “satellites,” such as new venture groups, whose
mission is to pursue new ideas free from the pressures of day-to-day operations.
7. Institute financial and career reward systems that encourage bold, innovative
development programs.

STRATEGIC PLANNING AND MARKETING ORGANIZATION
Strategic planning deals with the relationship of the organization to its environment and thus relates to all areas of a business. Among all these areas, however, marketing is the most susceptible to outside influences. Thus, marketingOrganizational Structure

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concerns are pivotal to strategic planning. Initially, however, the role of marketing in the organization declined with the advent of strategic planning. As
Kotler noted in 1978:
Strategic planning threatens to demote marketing from a strategic to an operational
function. Instead of marketing being in the driver’s seat, strategic planning has moved
into the driver’s seat. Marketing has moved into the passenger seat and in some companies into the back seat.21

It has generally been believed that the only marketing decision that has
strategic content is the one concerned with product/market perspectives. As far
as other marketing decisions are concerned, they are mainly operational innature; that is, they deal with short-term performance, although they may occasionally have strategic marketing significance. Product/market decisions, however, being the most far-reaching in nature as far as strategy is concerned, arefrequently made by top management; the marketing organization is relegated tomaking operating decisions. In brief, the inroads of strategic planning havetended to lower marketing’s status in the organization.
Many marketers have opined that marketing would continue to be important, but mainly for day-to-day operations. For example, Kotler predicted that
1. The marketer’s job would be harder than ever in the 1980s because of the toughenvironment.
2. The strategic planner would provide the directive force to the company’s growth,
not the marketer.
3. The marketer would be relied on to contribute a great deal of data and appraisal of
corporate purposes, objectives and goals, growth decisions, and portfolio decisions.
4. The marketer would assume more of an operational and less of a strategic role inthe company.
5. The marketer would still need to champion the customer concept because companies tend to forget it.22

Experience has shown, however, that marketing definitely has an important
strategic role to play. How neglect of marketing can affect strategy implementation and performance can be illustrated by Atari’s problems. This company had
been a pioneer in developing video games. Because of negligence in marketing,however, Atari failed to realize how quickly the market for video games would
mature. Atari based earnings projections on the assumption that demand wouldgrow at the same rate as in the past and that the company would hold its share of
the market. But its assumption proved to be wrong. The market for video games
grew at a much lower rate than anticipated.
Continuous close contact with the marketplace is an important prerequisite toexcellent performance that no firm can ignore:
Stay close to the customer. No company, high tech or low, can afford to ignore it.
Successful companies always ask what the customer needs. Even if they have strong
technology, they do their marketing homework.23

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More businesses today than during the establishment years of strategic planning are making organizational arrangements to bring in marketing perspectives—
an understandable development because, with the emergence of strategic planning(particularly in organizations that have adopted the SBU concept), marketing has
become a more pervasive function. Thus, although marketing positions at the corporate level may have vanished, the marketing function still plays a key strategicrole at the SBU level.
Businesses, by and large, have recognized that an important link is missing intheir strategic planning processes: inadequate attention to marketing. Without
properly relating the strategic planning effort to marketing, the whole process
tends to become static. Business exists in a dynamic setting. It is only throughmarketing inputs that perspectives of changing social, economic, political, andtechnological environments can be brought into the strategic planning process.
Overall, marketing is once again assuming prominence. Businesses are finding that marketing is not just an operations function relevant to day-to-day decision making. It has strategic content as well.
As has been mentioned before, strategic planning emerged largely as an outgrowth of the budgeting and financial planning process, which demoted marketing to a secondary role. However, things are different now. In some companies, ofcourse, concern with broad strategy considerations has long forced routine, highlevel attention to issues closely related to markets and marketing. There is abundant evidence, however, of renewed emphasis on such issues on the part of senior
management and hence of staff planners in a growing number of other companies
as well. Moreover, both marketers and planners are drawing increasingly fromthe same growing body of analytical techniques for futurist studies, market forecasts, competitive appraisals, and the like. Such overlapping in orientation,
resources, and methods no doubt helps to reinstate the crucial importance of marketing in the strategic planning effort.
Accumulating forces have caused most firms to reassess their marketing perspectives at both the corporate and the SBU level. Although initially marketing
got lost in the midst of the emphasis on strategic planning, now the role of marketing is better understood and is reemerging in the form of strategic marketing.24
The decade of the 1990s will indeed be considered as a period of marketing
renaissance.

SUMMARY

The chapter examined five dimensions of strategy implementation and control:creation of a market-responsive organization, the role of systems in implementing
strategy, executive reward systems, leadership style, and measurement of strategic performance. It is not enough for an organization to develop a sound strategy.
It must, at the same time, structure the organization in a manner that ensures theimplementation of the strategy. This chapter examined how to accomplish thistask, that is, to match organizational structure to strategy.

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Inasmuch as strategic planning is a recent activity in most corporations, nobasic principles have been developed on the subject. As a matter of fact, limited
academic research has been reported in this area. However, it is clear that one
fundamental aspect that deeply impacts strategy implementation is the proper
linking of organization, systems, and compensation. This chapter examined
how to ensure maximum market responsiveness, how to fully exploit management systems as a strategic tool, and how to tie the reward system to the strategic mission.
Strategy implementation requires establishing an appropriate climate in theorganization. The CEO plays a key role in adapting the organization for strategicplanning. Also examined was the role of the strategic planner in the context ofstrategic planning and its implementation.
Many companies have not been satisfied with their strategic planning experiences. Three reasons were given for the gap between strategic planning andstrategic performance: (a) resistance on the part of operating managers, (b) lack ofemphasis on innovations, and (c) neglect of marketing. Suggestions were madefor eliminating dysfunctional behavior among managers and for improving innovation planning.
As far as the strategic role of marketing is concerned, with the advent ofstrategic planning, marketing appears to have lost ground. Lately, however, marketing is reemerging as an important force in strategy formulation and implementation.

DISCUSSIONQUESTIONS

NOTES

1. What is the meaning of scale integration in the context of creating a marketresponsive organization?
2. Discuss the three broad principles of establishing a market-responsive organization.
3. Define the term systems. Discuss the three categories of systems examined inthis chapter.
4. Discuss the three problems that affect the establishment of a sound executive
reward system.
5. What is the significance of the office of the CEO in strategic planning?
6. How does the role of a strategic planner at the corporate level differ from therole of a planner within the SBU?

Steven F. Dichter, “The Organization of the ‘90s,” McKinsey Quarterly (Fall 1991):
146–147.
2 “Paradigms for Postmodern Managers,” Business Week, Reinventing America Issue(1992): 62.
3 Michael Treacy and Fred Wiersema, “How Market Leaders Keep Their Edge,” Fortune(6 February 1995): 88.
4 Rahul Jacob, “The Struggle To Create An Organization,” Fortune (3 April 1995): 90.
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See Robert A. Irwin and Edward G. Michaels III, “Core Skills: Doing the Right Things
Right,” McKinsey Quarterly (Summer 1989): 4–19.
6 Nigel Freedman, “Operation Centurion: Managing Transformation at Philips,” Long
Range Planning 29, no. 5, (1997): 607–615.
7 Ron Zemke and Dick Schaaf, The Service Edge (New York: New American Library, 1989): 342.
8 “The New Breed of Strategic Planner,” Business Week (17 September 1984): 62.
9 Paul F. Anderson, “Integrating Strategy and Executive Rewards: Solving the Agency,
Value and Signaling Problems” (Speech delivered at the Strategic Financial Planning
Seminar at Northwestern University, Evanston, IL, March 1985).
10 Louis J. Brindisi, Jr., “Paying for Strategic Performance: A New Executive
Compensation Imperative,” Strategic Management (1981): 31–39. See also Joel A.
Bleeke, “Peak Strategies,” McKinsey Quarterly (Spring 1989): 19–27.
11 See Frank J. Sulloway, Born to Rebel: Birth Order, Family Dynamics, and Creative Lives(New York: Pantheon, 1998).
12 Frederick G. Hilmer, “Real Jobs for Real Managers,” McKinsey Quarterly (Summer1989): 24.
13 Sumantra Ghoshal and Christopher A. Bartlett, “Changing the Role of Top
Management: Beyond Structure to Process,” Harvard Business Review(January–February 1995): 86–96.
14 Charles M. Farkas and Suzy Wetlaufer, “The Ways Chief Executive Officers Lead,”
Harvard Business Review (May–June 1996): 110–122.
15 See Abraham Zaleznink, “Managers and Leaders: Are They Different?” Harvard
Business Review (May–June 1977): 67–68.
16 Don E. Schultz and Anders Cronstedt, “Making Marcom an Investment,” Marketing
Management (Fall 1977): 41–49.
17 Irwin and Michaels, “Core Skills,” 5.
18 Thomas V. Bonoma and Victoria L. Crittenden, “Managing Marketing
Implementation,” Sloan Management Review (Winter 1988): 7–14.
19 Stratford Sherman, “Are You As Good As the Best in the World,” Fortune (13December 1993): 95. Also see “What Is So Effective About Stephen Covey,” Fortune(12 December 1994): 116.
20 See Ray Stata, “Organizational Learning: The Key to Management Innovation,” Sloan
Management Review (Spring 1989): 63–74.
21 Philip Kotler, “The Future Marketing Manager,” in Marketing Expansion in a Shrinking
World: 1978 Business Proceedings, ed. Betsy D. Gelb (Chicago: American Marketing
Association, 1978): 3.
22 Kotler, “The Future Marketing Manager,” 5.
23 Susan Fraker, “High-Speed Management for the High-Tech Age,” Fortune (5 March
1984): 62.
24 Ravi S. Achrol, “Evolution of the Marketing Organization: New Forms for Turbulent
Environments,” Journal of Marketing (October 1991): 77–93.
5

C H A P T E R T W E LV E

12Strategic Tools
The Red Queen said:“Now, here, it takes
all the running you
can do to keep in thesame place. If you wantto get somewhere else,
you must run twice as
fast as that.”
LEWIS CARROLL(ALICE IN WONDERLAND)

S

trategy development is by no means an easy job. Not only must decision makers review a variety of inside factors, they must also incorporate the impact ofenvironmental changes in order to design viable strategies. Strategists havebecome increasingly aware that the old way of “muddling through” is not adequate when confronted by the complexities involved in designing a future for a
corporation.
Economic uncertainty, leveling off of productivity, international competition,and environmental problems pose new challenges with which corporations must
cope when planning their strategies. There is, therefore, a need for systematic procedures for formulating strategy. This chapter discusses selected tools and models that serve as aids in strategy development.
A model may be defined as an instrument that serves as an aid in searching,screening, analyzing, selecting, and implementing a course of action. Because
marketing strategy interfaces with and affects the perspectives of an entire corporation, the tools and models of the entire science of management can be considered relevant here. In this chapter, however, we deal with eight models thatexhibit direct application to marketing strategies: the experience curve concept,
PIMS model, value-based planning, game theory, the delphi technique, trendimpact analysis, cross-impact analysis, and scenario building. In addition, a variety of new tools that are commonly used by strategic planners are summarily
listed.

EXPERIENCE CURVE CONCEPT
Experience shows that practice makes perfect. It is common knowledge thatbeginners are slow and clumsy and that with practice they generally improve tothe point where they reach their own permanent level of skill. Anyone with business experience knows that the initial period of a new venture or expansion into
a new area is frequently not immediately profitable. Many factors, such as making a product name known to potential customers, are often cited as reasons forthis nonprofitability. In brief, even the most unsophisticated businessperson
acknowledges that experience and learning lead to improvement. Unfortunately,
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the significance of experience is realized only in abstract terms. For example,
managers in a new and unprofitable situation tend to think of experience invague terms without ever analyzing it in terms of cost. This statement applies toall functions of a business where cost improvements are commonly sought—
except for production management.
As growth continues, we anticipate greater efficiency and more productive
output. But how much improvement can one reasonably expect? Generally, management makes an arbitrary decision to ascertain what level of output reflects the
optimum level. Obviously, in the great majority of situations, this decision is primarily based on pure conjecture. Ideally, however, one should be able to use historical data to predict cost/volume relationships and learning patterns. Manycompanies have, in fact, developed their own learning curves—but only in theareas of production or manufacturing where tangible data are readily available
and most variables can be quantified.
Several years ago the Boston Consulting Group observed that the concept ofexperience is not limited to production alone. The experience curve concept
embraces almost all cost areas of business.
Unlike the well-known “learning curve” and “progress function,” the experiencecurve effect is observed to encompass all costs—capital, administrative, research andmarketing—and to have transferred impact from technological displacements andproduct evolution.1

Historical
Perspective

The experience effect was first observed in the aircraft industry. Because theexpense incurred in building the first unit is exceptionally high in this industry,
any reduction in the cost of manufacturing succeeding units is readily apparent
and becomes extremely pertinent in any management decision regarding future
production. For example, it has been observed that an “80 percent air frame
curve” could be developed for the manufacture of airplanes. This curve depicts a
20 percent improvement every time production doubles (i.e., to produce thefourth unit requires 80 percent of the time needed to produce the second unit, andso on).2 Studies of the aircraft industry suggest that this rate of improvement
seems to prevail consistently over the range of production under study; hence,
the label experience is applied to the curve.

Implications

Although the significance of the experience curve concept is corporate-wide, it
bears most heavily on the setting of marketing objectives and the pricing decision. As already mentioned, according to the experience curve concept, all costs
go down as experience increases. Thus, if a company acquired a higher market
share, its costs would decline, enabling it to reduce prices. The lowering of prices
would enable the company to acquire a still higher market share. This process isunending as long as the market continues to grow. But as a matter of strategy,
while aiming at a dominant position in the industry, the company may be wise
to stop short of raising the eyebrows of the Antitrust Division of the U.S.
Department of Justice.

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During the growth phase, a company keeps making the desired level ofprofit, but in order to provide for its growth, a company needs to reinvest profits.
In fact, further resources might need to be diverted from elsewhere to support
such growth. Once the growth comes to an end, the product makes available huge
cash throw-offs that can be invested in a new product.
The Boston Consulting Group claims that, in the case of a second product, theaccumulated experience of the first product should provide an extra advantage tothe firm in reducing costs. However, experience is transferable only imperfectly.
There is a transfer effect between identical products in different locations, but thetransfer effect between different products occurs only if the products are somewhat the same (i.e., in the same family). This is true, for instance, in the case of themarketing cost component of two products distributed through the same tradechannel. Even in this case, however, the loss of buyer “franchise” can result insome lack of experience transferability. Exhibit 12-1 is a diagram of the implications of the experience curve concept.
Some of the Boston Consulting Group’s claims about the experience effect are
hard to substantiate. In fact, until enough empirical studies have been done on thesubject, many claims may even be disputed.3 For example, conventional wisdom
holds that market share drives profitability. Certainly, in some industries, such as
chemicals, paper, and steel, market share and profitability are inextricably linked.
But the profitability of premium brands—brands that sell for 25% to 30% morethan private-label brands—in 40 categories of consumer goods, the market sharealone did not drive profitability.
Instead, both market share and the nature of the category, or product market,
in which the brand competes, drive a brand’s profitability. A brand’s relative market share has a different impact on profitability depending on whether the overall category is dominated by premium brands or by value brands. If a category iscomposed largely of premium brands, then most of the brands in the category
are—or should be—quite profitable. If the category is composed mostly of value
and private-label brands, then returns will be lower across the board.4
To summarize, the experience curve concept leads to the conclusion that all
producers must achieve and maintain the full cost-reduction potential of theirexperience gains if they hope to survive. Furthermore, the experience framework
has implications for strategy development, as shown in Exhibit 12-2. The appendix at the end of this chapter describes construction of experience curves, showing how the relationship between costs and accumulated experience can be
empirically developed.
Application toMarketing

The application of the experience curve concept to marketing requires sorting out
various marketing costs and projecting their behavior for different sales volumes.
It is hoped that the analyses will show a close relationship between increases incumulative sales volume and declines in costs. The widening gap between volume and costs establishes the company’s flexibility in cutting prices in order togain higher market share.

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EXHIBIT 12-1
Schematic Presentation of Implications of the Experience Concept*An assumption is made here that Product B is closely related to Product A.

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EXHIBIT 12-2
Experience Curves Strategy Implications
Market Power
High

Low

High

Continue to invest
increased market share up
to “target” level

Assess competition; theneither invest heavily inincreased share, segment
market, or withdraw

Low

Obtain highest possible
earnings consistent withmaintaining market share

Assess competition; theneither challenge, segment
market, or withdraw

Industry
GrowthRate

Declines in costs are logical and occur for reasons such as the following:
1. Economies of scale (e.g., lower advertising media costs).
2. Increase in efficiency across the board (e.g., ability of salespersons to reduce time
per call).
3. Technological advances.

Conceivably, four different techniques could be used to project costs at different levels of volume: regression, simulation, analogy, and intuition. Because
historical information on growing products may be lacking, the regression technique may not work. Simulation is a possibility, but it continues to be rarely practiced because it is strenuous. Drawing an analogy between the subject productand the one that has matured perhaps provides the most feasible means of projecting various marketing costs as a function of cumulative sales. But analogy
alone may not suffice. As with any other managerial decision, analogy may need
to be combined with intuition.
The cost characteristics of experience curves can be observed in all types ofcosts: labor costs, advertising costs, overhead costs, distribution costs, development costs, or manufacturing costs. Thus, marketing costs as well as those for
production, research and development, accounting, service, etc., should be combined to see how total cost varies with volume. Further, total costs over different
ranges of volume should be projected while considering the company’s ability tofinance an increased volume of business, to undertake an increased level of risk,
and to maintain cordial relations with the Antitrust Division.
Each element of cost included in total cost may have a different slope on agraph. The aggregation of these elements does not necessarily produce a straightline on logarithmic coordinates. Thus, the relationship between cost and volume

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is necessarily an approximation of a trend line. Also, the cost derivatives of thecurve are not based on accounting costs but on accumulated cash input divided
by accumulated end-product output. The cost decline of the experience curve isthe rate of change in that ratio.
Management should establish a market share objective that projects well into
the future. Estimates should be made of the timing of price cuts in order toachieve designated market share. If at any time a competitor happens to challenge
a firm’s market share position, the firm should go all out to protect its market
share and never surrender it without an awareness of its value. Needless to say,the perspective of the entire corporation must change if the gains expected froma particular market share strategy are to become reality. Thus, proper coordination among different functions becomes essential for the timely implementationof related tasks.
Although the experience effect is independent of the life cycle, of growth rate,
and of initial market share, as a matter of strategy it is safer to base one’s actions
on experience when the following conditions are operating: (a) the product is in
the early stages of growth in its life cycle, (b) no one competitor holds a dominantposition in the market, and (c) the product is not amenable to nonprice competition (e.g., emotional appeals, packaging). Because the concept demands undertaking a big offensive in a battle that might last many years, a well-drawn
long-range plan should be in existence. Top management should be capable ofundertaking risks and going through the initial period of fast activity involved insudden moves to enlarge the company’s operations; the company should also
have enough resources to support the enlargement of operations.
The experience effect has been widely accepted as a basis for strategy in a
number of industries, the aircraft, petroleum, consumer electronics, and a varietyof durable and maintenance-related industries among them. The application ofthis concept to marketing has been minimal for the following reasons:
1. Skepticism that improvement can continue.
2. Difficulty with the exact quantification of different relationships in marketing.
3. Inability to recognize experience patterns even though they are already occurring.
4. Lack of awareness that the improvement pattern can be subjectively approximated and that the concept can apply to groups of employees as well as to individual performance across the board in different functions of the business.
5. Inability to predict the effect of future technological advances, which can badly
distort any historical data.
6. Accounting practices that may make it difficult to segregate costs adequately.

Despite these obstacles, the concept adds new importance to the market sharestrategy.

PROFIT IMPACT OF MARKETING STRATEGY (PIMS)
In 1960, the vice president of marketing services at GE authorized a large-scale
project (called PROM, for profitability optimization model) to examine the profit
impact of marketing strategies. Several years of effort produced a computer-based

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model that identified the major factors responsible for a great deal of the variationin return on investment. Because the data used to support the model came fromdiverse markets and industries, the PROM model is often referred to as a crosssectional model. Even today, cross-sectional models are popularly used at GE.
In 1972, the PROM program, henceforth called PIMS, was moved to theMarketing Science Institute, a nonprofit organization associated with the Harvard
Business School. The scope of the PIMS program has increased so much and its
popularity has gained such momentum that a few years ago its administration
moved to the Strategic Planning Institute, a new organization established for
PIMS.
The PIMS program is based on the experience of more than 500 companies innearly 3,800 “businesses” for periods that range from two to twelve years.
“Business” is synonymous with “SBU” and is defined as an operative unit thatsells a distinct set of products to an identifiable group of customers in competition with a well-defined set of competitors. Essentially, PIMS is a cross-sectional
study of the strategic experience of profit organizations. The information gathered from participating businesses is supplied to the PIMS program in a standardized format in the form of about 200 pieces of data. The PIMS database
covers large and small companies; markets in North America, Europe, and elsewhere; and a wide variety of products and services, ranging from candy to heavy
capital goods to financial services. The information deals with such items as• A description of the market conditions in which the business operates, including
such things as the distribution channels used by the SBU, the number and size of
its customers, and rates of market growth and inflation.
• The business unit’s competitive position in its marketplace, including market
share, relative quality, prices and costs relative to the competition, and degree ofvertical integration relative to the competition.
• Annual measures of the SBU’s financial and operating performance over periods
ranging from two to twelve years.

Overall Results

The PIMS project indicated that the profitability of a business is affected by 37
basic factors, explaining the more than 80 percent profitability variation among
businesses studied. Of the 37 basic factors, seven proved to be of primary importance (see Exhibit 12-3).
Based on analysis of information available in the PIMS database, Buzzell andGale have hypothesized the following strategy principles, or links between strategy and performance:
1. In the long run, the most important single factor affecting a business unit’s performance is the quality of its products and services relative to those of competitors. A quality edge boosts performance in two ways. In the short run, superior
quality yields increased profits via premium prices. In the longer term, superior
or improving relative quality is the more effective way for a business to grow,leading to both market expansion and gains in market share.
2. Market share and profitability are strongly related. Business units with very large
shares—over 50 percent of their served markets—enjoy rates of return more than

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EXHIBIT 12-3
Return on Investment and Key Profit Issues
Return on Investment (ROI):
The ratio of net pretax operating income to average investment. Operating income iswhat is available after deduction of allocated corporate overhead expenses but before
deduction of any financial charges on assets employed. “Investment” equals equity plus
long-term debt, or, equivalently, total assets employed minus current liabilities attributed
to the business.
Market Share:
The ratio of dollar sales by a business, in a given time period, to total sales by all competitors in the same market. The “market” includes all of the products or services, customer types, and geographic areas that are directly related to the activities of thebusiness. For example, it includes all products and services that are competitive withthose sold by the business.
Product (Service) Quality:
The quality of each participating company’s offerings, appraised in the following terms:
What was the percentage of sales of products or services from each business in each yearthat were superior to those of competitors? What was the percentage of equivalent products? Inferior products?
Marketing Expenditures:
Total costs for sales force, advertising, sales promotion, marketing research, and marketing administration. The figures do not include costs of physical distribution.
R&D Expenditures:
Total costs of product development and process improvement, including those costs
incurred by corporate-level units that can be directly attributed to the individual business.
Investment Intensity:
Ratio of total investment to sales.
Corporate Diversity:
An index that reflects (1) the number of different 4-digit Standard Industrial
Classification industries in which a corporation operates, (2) the percentage of total corporate employment in each industry, and (3) the degree of similarity or difference among
the industries in which it participates.
Source: Reprinted by permission of the Harvard Business Review. Exhibit from “Impact of Strategic
Planning on Profit Performance” by Sidney Schoeffler, Robert D. Buzzell, and Donald F. Heany(March–April 1974): 140. Copyright © 1974 by the President and Fellows of Harvard College, allrights reserved.

three times greater than small-share SBUs (those that serve under 10 percent of
their markets). The primary reason for the market share-profitability link, apartfrom the connection with relative quality, is that large-share businesses benefit
from scale economies. They simply have lower per-unit costs than their smaller
competitors.

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3. High-investment intensity acts as a powerful drag on profitability. Investmentintensive businesses are those that employ a great deal of capital per dollar ofsales, per dollar of value added, or per employee.
4. Many so-called “dog” and “question mark” businesses generate cash, while
many “cash cows” are dry. The guiding principle of the growth-share matrix
approach to planning (see Chapter 10) is that cash flows largely depend on market growth and competitive position (your share relative to that of your largest
competitor). However, the PIMS-based research shows that, while market growth
and relative share are linked to cash flows, many other factors also influence thisdimension of performance. As a result, forecasts of cash flow based solely on thegrowth-share matrix are often misleading.
5. Vertical integration is a profitable strategy for some kinds of businesses, but notfor others. Whether increased vertical integration helps or hurts depends on thesituation, quite apart from the question of the cost of achieving it.
6. Most of the strategic factors that boost ROI also contribute to long-term value.5

These principles are derived from the premise that business performance
depends on three major kinds of factors: the characteristics of the market (i.e.,market differentiation, market growth rate, entry conditions, unionization, capital intensity, and purchase amount), the business’s competitive position in thatmarket (i.e., relative perceived quality, relative market share, relative capitalintensity, and relative cost), and the strategy it follows (i.e., pricing, researchand development spending, new product introductions, change in relative quality, variety of products/services, marketing expenses, distribution channels,
and relative vertical integration). Performance refers to such measures as profitability (ROS, ROI, etc.), growth, cash flow, value enhancement, and stock
prices.
Managerial
Applications

The PIMS approach is to gather data on as many actual business experiences as
possible and to search for relationships that appear to have the most significant
effect on performance. A model of these relationships is then developed so that an
estimate of a business’s return on investment can be made from the structuralcompetitive/strategy factors associated with the business. Obviously, the PIMS
conceptual framework must be modified on occasion. For example, repositioning
structural factors may be impossible and the costs of doing so prohibitive.
Besides, actual performance may reflect some element of luck or some unusual
event.6 In addition, results may be influenced by the transitional effect of a conscious change in strategic direction.7 Despite these reservations, the PIMS framework can be beneficial in the following ways:
1. It provides a realistic and consistent method for establishing potential returnlevels for individual businesses.
2. It stimulates managerial thinking on the reasons for deviations from parperformance.
3. It provides insight into strategic moves that will improve the par return on
investment.
4. It encourages a more discerning appraisal of business unit performance.

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Since the mid-1970s, the PIMS database has been used by managers and planning specialists in many ways. Applications include developing business plans,evaluating forecasts submitted by divisional managers, and appraising possible
strategies. The data suggests that8• For followers, current profitability is adversely affected by a high level of productinnovation, measured either by the ratio of new product sales to total sales or byresearch and development spending. The penalty paid for innovation is especially heavy for businesses ranked fourth or lower in their served markets. The
market leader’s profitability, on the other hand, is not hurt by new product activity or research and development spending.
• High rates of marketing expenditure depress return on investment for followers,
not for leaders.
• Low-ranking market followers benefit from high inflation. For businesses ranked
first, second, and third, inflation has no relation to return on investment.

MEASURING THE VALUE OF MARKETING STRATEGIESIn the last few years, a new yardstick for measuring the worth of marketingstrategies has been suggested. This new approach, called value-based planning,
judges marketing strategies by their ability to enhance shareholders’ value. It
emphasizes the impact a strategic move has on the value investors place on theequity portion of a firm’s assets.9 The principal feature of value-based planning isthat managers should be evaluated on their ability to make strategic investmentsthat produce returns greater than their cost of capital.
Value-based planning draws ideas from contemporary financial theory. For
example, a company’s primary obligation is to maximize returns from capital
appreciation. Similarly, the market value of a stock depends on investors’ expectations of the ability of each business unit in the firm to generate cash.10
Value is created when the financial benefits of a strategic activity exceed costs.
To account for differences in the timing and riskiness of the costs and benefits,
value-based planning estimates overall value by discounting all relevant cash
flows.
A company that has been using the value-based approach for some time is theConnecticut-based Dexter Corporation. Its value-based planning uses four subsystems:11• The Dexter financial decision support system (DSS), which provides strategic
business segments (SBS) with financial data. The DSS provides a monthly profit
and loss and balance sheet statement of each strategic business segment. All divisional expenses, assets, and current liabilities are allocated to the SBSs.
• A microcomputer-based system, which transforms this data for use in the two following subsystems: corporate financial reports system and value planner system.
The financial data generated by DSS must be transformed to fit the input specifications of these two subsystems.
• The corporate financial reports system estimates the cost of capital of an SBS. For
estimating cost of capital, Dexter uses two models. The first is the bond-rating

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simulation model. This model is used to estimate the capital structure appropriate to each of its SBSs, given its six-year financial history. Each SBS is assigned thehighest debt-to-total capital ratio that would allow it to receive an A bond rating.
The second model, which is used to compute cost of capital, is the business risk
index estimation model. This model allows cost of equity to be estimated forbusiness segments that are not publicly traded.
• The value planner system estimates a business’s future cash flows. The basic
premise of the value planner system is that business decisions should be based ona rigorous consideration of expected future cash flows. Dexter uses the 12 mostrecent quarters of SBS data to produce a first-cut projection of future cash flows.
As information on a new quarter becomes available, the oldest quarter in themodel is deleted. These historical trends are used for projecting financial ratios
into the future. The following assumptions are made to compute future cash
flows:
Sales growth—Based on the expectation that each SBS will maintain market
share.
Net plant investment—Based on the growth rate in unit volume deemed necessary to maintain Dexter’s market share.
Unallocated divisional expenses—Projected for each SBS using the same percentage of sales used for the division as a whole.
The appropriate time horizon for cash flow projections—Based on the
expected number of years that a business can reinvest at an expected rate of
return.

These assumptions are controversial because they do not allow cash flow projections to be tailored to each SBS. Dexter management terms its historical forecast anaive projection and uses it to challenge its managers to explain why the future
will be different from the recent past.
The next step in the value-based planning process is to compute the value of
projected future cash flows and to discount them by the cost of capital for an SBS.
If the estimated value of an SBS is in excess of its book value, the SBS contributes
positively to the wealth of Dexter’s stockholders, which means it makes sense to
reinvest in it.
The major strengths of Dexter’s SBS value planner system have been articulated as follows:• Its emphasis on being intelligible to line managers—A value-based planningmodel can indicate which SBSs are not creating value for the firm’s stockholders.
However, it is the SBS manager who must initiate action to rectify problems thatthe analysis uncovers.
• Its degree of accuracy—The real dilemma in designing models for value-basedplanning is to make them easy to use while improving the accuracy with which
they reflect or predict the firm’s market value.
• Its integration with existing systems and databases—By developing a systemthat works with existing systems, costs are reduced and upgrades are easier toimplement. Also, it is easier to gain the acceptance of line managers if the valuebased planning system is presented as an extension of the decision support system they are currently using.

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In the seven years that Dexter has used the value-based approach, it has madeimportant contributions to the decision-making process. Using this approach,
Dexter managers made the following decisions:• Not to invest further in an SBS with high-growth prospects until its valuation,
based on actual performance, increases significantly.
• To harvest and downsize an SBS with a negative value.
• To sell an SBS with negative value to its employees for book value.
• To sell an SBS with a value higher than book value but for which an offer wasreceived that was significantly greater than any valuation that could be reasonably modeled in Dexter’s hands.

The interesting characteristic of these decisions is that they can run somewhat
counter to the prescriptions that flow out of a typical portfolio-planningapproach. The first decision, for example, refers to a star business, presumably
worthy of further investment. Unlike portfolio planning, in which growth isdesirable in and of itself, under value-based planning, growth is healthy only if
the business is creating value.
Dexter uses value-based planning as a guideline for decision making, not as
an absolute rule. The approach is, in general, understood and accepted, but many
managers question its relevance. They now know whether their divisions create
value for the company, but they do not understand how they can use that information to make or change important business decisions. Top management understands that value-added planning needs more time before it is completely
accepted.

GAME THEORY
Game theory is a useful technique for companies to rapidly respond to changes
in products, technologies, and prices. It helps companies pay attention to interactions with competitors, customers, and suppliers, and induces companies to focus
on the end-game so that their near-term actions promote their long-term interest
by influencing what these players do.
The theory is reasonably straightforward to use. There are two competitors,
Ace and Smith. Ace expects Smith to enter the market and is trying to understandSmith’s likely pricing strategy. To do so, Ace uses something called a payoff matrix(see Exhibit 12-4). Each quadrant in the matrix contains the payoffs—or financial
impact—to each player for each possible strategy. If both players maintain prices
at current levels, they will both be better off: Ace will earn $100 million and Smith
will earn $60 million (Quadrant A). Unfortunately for both Ace and Smith, however, they have perverse incentives to cut prices.
Ace calculates that if he maintains prices, Smith will cut prices to increase
earnings to $70 million from $60 million. (See the arrow moving from Quadrant
A to Quadrant B.) Smith makes a similar calculation that if she maintains prices,
Ace will cut. The logic eventually drives them both to Quadrant D, with both cutting prices and both earning lower returns than they would with current prices inStrategic Tools

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EXHIBIT 12-4
Game Theory: An Illustration of the Pricing Game

place. This equilibrium is unattractive for both parties. If each party perceives
this, then there is some prospect that each will separately determine to try to compete largely on other factors, such as product features, service levels, sales force
deployment, or advertising.
But it is necessary to have in-depth knowledge of the industry before gametheory is truly valuable. Whether the goal is to implement by fully quantifying
the outcomes of a payoff matrix or by more qualitatively assessing the outcomeof the matrix, it is necessary to understand entry costs, exit costs, demand functions, revenue structures, cost curves, etc. Without that understanding, the gametheory may not provide correct answers.
The following are the rules to observe to make the best use of the theory:• Examine the number, concentration, and size distribution of the players.
Industries with four or fewer significant competitors have the greatest potential
for using game theory to gain an edge because (a) the competitors will usually belarge enough to benefit more from an improvement in general industry conditions than they would from improving their position at the expense of others, and(b) with smaller numbers of competitors it is possible for managers to think
through the different combinations of moves and countermoves. Similarly, thenumber of customers, suppliers, etc., affects the usefulness of game theory.
• Keep an eye out for strategies inherent in one’s market share. Small players canuse “judo economics” to take advantage of larger companies that may be moreconcerned with maintaining the status quo than with retaliating against a small
entrant. In 1992, for instance, Kiwi Airlines got away with undercutting Delta’s

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•

•

•

311

and Continental’s prices between Atlanta and Newark by as much as 75 percent.
The reason: When Kiwi first entered the market it represented less then 7 percentof that route’s capacity, and the cost of a significant pricing response by theincumbents would have likely exceeded the benefits.12 Conversely, large players
can create economies of scale or scope. Companies such as United and American
have used frequent-flier programs to create switching barriers, whereas mostsmall airlines would not have the route structure required to make their frequentflier programs very attractive.
Understand the nature of the buying decision. If there are only a few deals
signed in an industry each year, it will be hard to avoid aggressive competition.
In the jet engine industry, for example, three manufacturers (GE, Pratt & Whitney,
and Rolls Royce) compete ruthlessly for scarce orders. If a producer loses several
large bids in a row, layoffs will be likely, and it might even go out of business. In
this kind of situation, the challenge for game theory is to improve the bidding
process to shift the power balance between the industry and its customers.
Scrutinize the competitors’ cost and revenue structures. Industries wherecompetitors have a high proportion of fixed-to-variable cost will probably
behave more aggressively than those where production costs are more variable. In the paper, steel, and refining industries, for example, high profit contributions on extra volume give most producers strong incentives to cut prices
to get volume.
Examine the similarity of firms. Industries where competitors have similar costand revenue structures often exhibit independently determined but similar
behavior. Consider the U.S. cellular telephone industry: The two providers ineach market share similar technologies, and have similar cost structures. Given
their similar economic incentives, the challenge is to find prices that create thelargest markets and then to compete largely on factors such as distribution andservice quality.
Analyze the nature of demand. The best chances to create value with less aggressive strategies are in markets where demand is stable or growing at a moderate
rate. For example, even in oil-field services in the early 1980s after drilling activity had plummeted, declining demand did not lead to lower prices in all sectors.
In those more-technology-demanding parts of the industry where there were only
a limited number of competitors (e.g. open-hole logging and well-pressure control), prices were more stable than in other sectors.

Done right, game theory can turn conventional strategies on their heads anddramatically improve a company’s ability to create economic value. Sometimes it
can increase the size of the pie; on other occasions it can make a company’s sliceof the pie bigger, and it may even help do both.

DELPHI TECHNIQUE
The delphi technique, named after Apollo’s oracle at Delphi, is a method of making forecasts based on expert opinion. Traditionally, expert opinions were pooledin committee. The delphi technique was developed to overcome the weaknessesof the committee method. Some of the problems that occur when issues are discussed in committee include:Strategic Tools

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1. The influence of a dominant individual.
2. The introduction of a lot of redundant or irrelevant material into committee
workings.
3. Group pressure that places a premium on compromise.
4. Reaching decisions is slow, expensive, and sometimes painful.
5. Holding members accountable for the actions of a group.

All of these factors provide certain psychological drawbacks to people inface-to-face communication. Because people often feel pressure to conform, themost popular solution, instead of the best one, prevails. With the delphi technique, a staff coordinator questions selected individuals on various issues. The
following is a sample of questions asked:
1. What is the probability of a future event occurring? For example, by what year do
you think there will be widespread use of robot services for refuse collection, as
household slaves, as sewer inspectors, etc.?
a. 2000
b. 2010c. 2020
d. 2030
2. How desirable is the event in Question 1?
a. needed desperately
b. desirablec. undesirable but possible
3. What is the feasibility of the event in Question 1?
a. highly feasible
b. likelyc. unlikely but possible
4. What is your familiarity with the material in Question 1?
a. fairb. goodc. excellent

The coordinator compiles the responses, splitting them into three groups:
lower, upper, and inner. The division into groups may vary from one investigation to another. Frequently, however, the lower and upper groups each represent
10 percent, whereas the inner group takes the remaining 80 percent. When a person makes a response in either the upper or lower group, it is customary to ask
about the reasons for his or her extreme opinion.
In the next round, the respondents are given the same questionnaire, alongwith a summary of the results from the first round. The data feedback includes
the consensus and the minority opinion. During the second round, the respondents are asked to specify by what year the particular product or service will
come to exist with 50 percent probability and with 90 percent probability. Results

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are once again compiled and fed back. This process of repeating rounds can becontinued indefinitely; however, rarely has any research been conducted past thesixth round. In recent years, the delphi technique has been refined by the use ofinteractive computer programs to obtain inputs from experts, to present summary estimates, and to store revised judgments in data files that are retrievable atuser terminals.
The delphi technique is gradually becoming important for predicting future
events objectively. Most large corporations use this technique for long-range forecasting. Some of the advantages of the delphi technique are listed below:
1. It is a rapid and efficient way to gain objective information from a group of
experts.
2. It involves less effort for a respondent to answer a well-designed questionnairethan to participate in a conference or write a paper.
3. It can be highly motivating for a group of experts to see the responses of knowledgeable persons.
4. The use of systematic procedures applies an air of objectivity to the outcomes.
5. The results of delphi exercises are subject to greater acceptance on the part of thegroup than are the consequences arrived at by more direct forms of interaction.

Delphi Application

Change is an accepted phenomenon in the modern world. Change coupled withcompetition forces a corporation to pick up the trends in the environment and to
determine their significance for company operations. In light of the changing
environment, the corporation must evaluate and define strategic posture to beable to face the future boldly. Two types of changes can be distinguished: cyclicaland developmental. A cyclical change is repetitive in nature; managers usuallydevelop routine procedures to meet cyclical changes. A developmental change isinnovative and irregular; having no use for the “good” old ways, managers abandon them. Developmental change appears on the horizon so slowly that it may
go unrecognized or be ignored until it becomes an accomplished fact with drastic consequences. It is this latter category of change that assumes importance inthe context of strategy development. The delphi technique can be fruitfully used
to analyze developmental changes. Functionally, a change may fall into one of thefollowing categories: social, economic, political, regulatory, or technological. The
delphi technique has been used by organizations to study emerging perspectives
in all these areas.
One drawback of the delphi technique is that each trend is given unilateralconsideration on its own merits. Thus, one may end up with conflicting forecasts;
that is, one trend may suggest that something will happen, whereas another may
lead in the opposite direction. To resolve this problem, another forecasting technique, the cross-impact matrix (discussed later) has been used by someresearchers. With this technique, the effect of potential interactions among items
in a forecasted set of occurrences can be investigated. If the behavior of an individual item is predictable (i.e., if it varies positively or negatively with the occurrence or nonoccurrence of other items), the cross-impact effect is present. It is thus
possible to determine whether a predicted event will have an enhancing orStrategic Tools

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inhibiting influence upon each of the other events under study by using a crossimpact matrix.
Recent research shows that the use of the delphi technique has undergone
quite a change. The salient features of the revised delphi technique are (a) identifying recognized experts in the field of interest; (b) seeking their cooperationand sending them a summary paper on the topic being examined (based on a literature search); and (c) conducting personal interviews with each expert basedon a structured questionnaire, usually by two interviewers. Feedback andrepeated rounds of responding to written questionnaires are no longer considered necessary.

TREND-IMPACT ANALYSIS
Trend-impact analysis is a technique for projecting future trends from information gathered on past behavior. The uniqueness of this method lies in its combination of statistical method and human judgment. If predictions are based on
quantitative data alone, they will fail to reflect the impact of unprecedented
future events. On the other hand, human judgment provides only subjective
insights into the future. Therefore, because both human judgment and statisticalextrapolation have their shortcomings, both should be taken into consideration
when predicting future trends.
In trend-impact analysis (TIA), past history is first extrapolated with the helpof a computer. Then the judgment of experts is sought (usually by means of thedelphi technique) to specify a set of unique future events that may have a bearing
on the phenomenon under study and to indicate how the trend extrapolation may
be affected by the occurrence of each of these events. The computer then uses
these judgments to modify its trend extrapolation. Finally, the experts review theadjusted extrapolation and modify the inputs in those cases in which an input
appears unreasonable.
To illustrate TIA methods, let us consider the case of the average price of a newprescription drug to the year 2005. As shown in Exhibit 12-5, statistical extrapolation of historical data shows that price will rise to $13 by the year 2000 and to$14.23 by the year 2005. The events considered relevant include (a) generic dispensing, which increases 20 percent of all prescriptions filled; (b) Medicaid andMedicare prescription reimbursement, which is based on a fixed monthly fee per
covered patient (“capitation plan”); and (c) a 50 percent decrease in the averagerate of growth in prescription size. Consider the first event, i.e., 20 percent increasein generic dispensing. Expert judgment may show that this event has a 75 percent
chance of occurring by 1997. If this event does occur, it is expected that its first
impact on the average price of a new prescription will begin right away. The maximum impact, a 3 percent reduction in the average price, will occur after five years.
The combination of these events, probabilities, and impacts with the baseline
extrapolation leads to a forecast markedly different from the baseline extrapolation (see Exhibit 12-5). The curve even begins to taper off in the year 2005. The
level of uncertainty is indicated by quartiles above and below the mean forecast.

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EXHIBIT 12-5
Average Retail Price of a New Prescription

Forecast
Historical Data
1962
1964
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978

2.17
2.41
2.78
2.92
2.99
3.15
3.22
3.27
3.26
3.35
3.42
3.48
3.56
3.63
3.70

1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992

3.86
4.02
4.19
4.32
4.45
4.70
5.20
5.60
5.98
6.44
7.03
7.66
8.63
10.37

1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005

Lower
Quartile

Mean

Upper
Quartile

10.65
10.92
11.21
11.54
11.83
12.08
12.30
12.52
12.74
12.95
13.17
13.39
13.60

10.70
11.03
11.40
11.79
12.15
12.45
12.74
13.00
13.25
13.50
13.75
13.99
14.23

10.75
11.14
11.61
12.10
12.54
12.92
13.25
13.55
13.83
14.10
14.38
14.64
14.90

(The quartiles indicate the middle 50 percent of future values of the curve, with
25 percent lying on each side of the forecast curve.) The uncertainty shown by
these quartiles results from the fact that many of the events that have large
impacts also have relatively low probabilities.

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At this juncture, it is desirable to determine the sensitivity of these results tothe individual estimates upon which they are based. For example, one might raise
valid questions about the estimates of event probability, the magnitude of the
impacts used, and the lag time associated with these impacts. Having preparedthese data in a disaggregated fashion, one can very easily vary such estimates andview the change in results. It may also be observed that intervention policies,
whether they are institutional (such as lobbying, advertising, or new marketing
approaches) or technological (such as increased research and development expenditures), can be viewed as a means of influencing event probabilities or impacts.
TIA can be used not only to improve forecasts of time series variables but also
to study the sensitivity of these forecasts to policy. Of course, any policy underconsideration should attempt to influence as many events as possible rather thanone, as in this example. Corporate actions often have both beneficial and detrimental effects because they may increase both desirable and undesirable possibilities. The use of TIA can make such uncertainties more clearly visible than can
traditional methods.

CROSS-IMPACT ANALYSIS
Cross-impact analysis, as mentioned earlier, is a technique used for examining
the impacts of potential future events upon each other. It indicates the relative
importance of specific events, identifies groups of reinforcing or inhibiting events,
and reveals relationships between events that appear unrelated. In brief, crossimpact analysis provides a future forecast, making due allowance for the effect ofinteracting forces on the shape of things to come.
Essentially, this technique consists of selecting a group of five to ten project
participants who are asked to specify critical events having any relationship withthe subject of the analysis. For example, in an analysis of a marketing project,
events may fall into any of the following categories:
1. Corporate objectives and goals.
2. Corporate strategy.
3. Markets or customers (potential volume, market share, possible strategies of key
customers, etc.).
4. Competitors (product, price, promotion, and distribution strategies).
5. Overall competitive strategic posture, whether aggressive or defensive.
6. Internally or externally developed strategies that might affect the project.
7. Legal or regulatory activities having favorable or unfavorable effects.
8. Other social, demographic, or economic events.

The initial attempt at specifying critical events presumably will generate along list of alternatives that should be consolidated into a manageable size (e.g.,
25 to 30 events) by means of group discussion, concentrated thinking, eliminationof duplications, and refinement of the problem. It is desirable for each event tocontain one and only one variable, thus avoiding double counting. Selected
events are represented in an n × n matrix for developing the estimated impact of

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each event on every other event. This is done by assuming that each specific event
has already occurred and that it will have an enhancing, an inhibiting, or no effecton other events. If desired, impacts may be weighted. The project coordinator
seeks impact estimates from each project participant individually and consolidates the estimates in the matrix form. Individual results, in summary form, arepresented to the group. Project participants vote on the impact of each event. If
the spread of votes is too wide, the coordinator asks those persons voting at theextremes to justify their positions. The participants are encouraged to discuss differences in the hope of clarifying problems. Another round of voting takes place.
During this second round, opinions usually converge, and the median value ofthe votes is entered in the appropriate cell in the matrix. This procedure isrepeated until the entire matrix is complete.
In the process of completing the matrix, a review of occurrences and interactions identifies events that are strong actors and significant reactors and provides
a subjective opinion of their relative strengths. This information then serves as animportant input in formulating strategy.
The use of cross-impact analysis may be illustrated with reference to a study
concerning the future of U.S. automobile component suppliers. The following
events were set forth in the study:
1. Motor vehicle safety standards that come into effect between 1992 and 1996 will
result in an additional 150 pounds of weight for the average-sized U.S. car.
2. The 1993 NOX emissions regulations will be relaxed by the EPA.
3. The retail price of gasoline (regular grade) will be $2 per gallon.
4. U.S. automakers will introduce passenger cars that will achieve at least 40 mpg
under average summer driving conditions.

These events are arranged in matrix form in Exhibit 12-6. The arrows show
the direction of the analysis. For example, the occurrence of Event A would be
likely to bring more pressure to bear upon regulatory officials; consequently,
Event B would be more likely to occur. An enhancing arrow is therefore placed in
the cell where Row A and Column B intersect. Moving to Column C, it is notexpected that the occurrence of Event A will have any effect on Event C, so a horizontal line is placed in this cell. It is judged that the occurrence of Event A would
make Event D less likely to occur, and an inhibiting arrow is placed in this cell. If
Event B were to occur, the consensus is that Event A would be more likely; hence
the enhancing arrow. Event B is not expected to affect Event C but would make
Event D more likely. Cells are completed in accordance with these judgments.
Similar analyses for Events C and D complete the matrix.
The completed matrix shows the direction of the impact of rows (actors)
upon columns (reactors). An analysis of the matrix at this point reveals that
Reactor C has only one actor (Event D) because there is only one reaction in
Column C. If interest is primarily focused on Event D, Column D should be studied for actor events. Then each actor should be examined to determine what
degree of influence, if any, it is likely to have on other actors in order to bringabout Event D.

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EXHIBIT 12-6
Basic Format for Cross-Impact Matrix

Next, impacts should be quantified to show linkage strengths (i.e., to determine how strongly the occurrence or nonoccurrence of one event would influence
the occurrence of every other event). To assist in quantifying interactions, a subjective rating scale, such as the one shown on page 307, may be used.
Voting
Scale
+8
+6
+4
+2
0
–2
–4
–6
–8

Subjective Scale
Critical: essential for success
Major: major item for successSignificant: positive and helpful but not essential
Slight: noticeable enhancing effectNo effect
Slight: noticeable inhibiting effectSignificant: retarding effect
Major: major obstacle to successCritical: almost insurmountable hurdle

Enhancing

Inhibiting

Consider the impact of Event A upon Event B. It is felt that the occurrence ofEvent A would significantly improve the likelihood of the occurrence of Event B.
Both the direction and the degree of enhancing impact are shown in Exhibit 12-7
by the +4 rating in the appropriate cell. Event A’s occurrence would make Event
D less likely; therefore, the consensus rating is –4. This process continues until all
interactions have been evaluated and the matrix is complete.
There are a number of variations for quantifying interactions. For example,
the subjective scale could be 0 to 10 rather than –8 to +8, as shown in the example
above.

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EXHIBIT 12-7
Cross-Impact Matrix Showing Degrees of Impact

Another technique for quantifying interactions involves the use of probabilities. If the probability of the occurrence of each event is assessed before the construction of the matrix, then the change in that probability can be assessed foreach interaction. As shown in Exhibit 12-8, the probabilities of occurrence can beentered in a column preceding the matrix, and the matrix is constructed in theconventional manner. Consider the impact of Event A on the probable occurrenceof Event B. It is judged to be an enhancing effect, and the consensus is that theprobability of Event B occurring will change from 0.8 to 0.9. The new probability
is therefore entered in the appropriate cell. Event A is judged to have no effectupon Event C; therefore, the original probability, 0.5, is unchanged. Event D is
inhibited by the occurrence of Event A, and the resulting probability of occurrence is lowered from 0.5 to 0.4. The occurrence of Event B increases the probability of Event A occurring from 0.7 to 0.8. Event B has no impact upon Event C(0.5, unchanged) and increases the probability of Event D to 0.7. This procedure
is followed until all cells are completed.
An examination of the matrix at this stage reveals several important relationships. For example, if we wanted Event D to occur, then the most likely actors are
Events B and C. We would then examine Columns B and C to determine what
actors might be influenced. Influences that bring about desired results at a critical
moment are often secondary, tertiary, or beyond. In many instances, the degree of
impact is not the only important information to be gathered from a considerationof interactions. Time relationships are often very important and can be shown ina number of ways. For example, in Exhibit 12-8 information about time has been
added in parentheses. It shows that if Event A were to occur, it would have an
enhancing effect upon Event B, raising B’s probability of occurrence from 0.8 to
0.9, and that this enhancement would occur immediately. If Event B were to occur,
it would raise the probability of the occurrence of Event D from 0.5 to 0.7. It
would also take two years to reach the probable time of occurrence of Event D.

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EXHIBIT 12-8
Cross-Impact Matrix Showing Interactive Probabilities of Occurrence

SCENARIO BUILDING
Plans for the future were traditionally developed on a single set of assumptions.
Restricting one’s assumptions may have been acceptable during times of relative
stability, but as we enter the new century experience has shown that it may not bedesirable to commit an organization to the most probable future alone. It isequally important to make allowances for unexpected or less probable future
trends that may seriously jeopardize strategy. One way to focus on different
future outcomes within the planning process is to develop scenarios and todesign strategy so that it has enough flexibility to accommodate whatever outcome occurs. In other words, by developing multiple scenarios of the shape ofthings to come, a company can make a better strategic response to the future environment. Scenario building in this sense is a synopsis that depicts potential
actions and events in a likely order of development, beginning with a set of conditions that describe a current situation or set of circumstances. In addition, scenarios depict a possible course of evolution in a given field. Identification ofchanges and evolution of programs are two stages in scenario building.
Changes in the environment can be grouped into two classes: (a) scientificand technological changes and (b) socioeconomic-political changes. Chapter 6
dealt with environmental scanning and the identification of these changes.
Identification should take into consideration the total environment and its possibilities: What changes are taking place? What shape will change take in the
future? How are other areas related to environmental change? What effect willchange have on other related fields? What opportunities and threats are likely?13
A scenario should be developed without any intention of predicting thefuture. It should be a time-ordered sequence of events that reflects logical cause-

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and-effect relationships among events. The objective of a scenario building
should be to clarify certain phenomena or to study the key points in a series ofdevelopments in order to evolve new programs. One can follow an inductive ora deductive approach in building a scenario. The deductive approach, which ispredictive in nature, studies broad changes, analyzes the impact of each change
on a company’s existing lines, and at the same time generates ideas about new
areas of potential exploitation. Under the inductive approach, the future of eachproduct line is simulated by exposing its current environment to various foreseenchanges. Through a process of elimination, those changes that have relevance for
one’s business can be studied more deeply for possible action. Both approaches
have their merits and limitations. The deductive approach is much more demanding, however, because it calls for proceeding from the unknown to the specific.
Exhibit 12-9 summarizes how scenarios may be constructed. Scenarios are nota set of random thoughts: They are logical conclusions based on past behaviors,
future expectations, and the likely interactions of the two. As a matter of fact, avariety of analytical techniques (e.g., the delphi technique, trend impact analysis,
and cross-impact analysis) may be used to formulate scenarios.
The following procedure may be utilized to analyze the scenarios:• Identify and make explicit your company’s mission, basic objective, and policies.
• Determine how far into the future you wish to plan.
• Develop a good understanding of your company’s points of leverage and vulnerability.
• Determine factors that you think will definitely occur within your planning timeframe.
• Make a list of key variables that will have make-or-break consequences for yourcompany.
• Assign reasonable values to each key variable.
• Build scenarios in which your company may operate.
• Develop a strategy for each scenario that will most likely achieve your company’s
objectives.
• Check the flexibility of each strategy in each scenario by testing its effectivenessin the other scenarios.
• Select or develop an “optimum response” strategy.

OTHER TOOLS
Traditionally, tool usage was in favor of cost-reduction techniques. In recent
years, the tool preferences are shifting toward models for retaining customers,
outsmarting competitors, motivating employees, and accelerating innovation.
Here is a listing of select new tools that are commonly used by strategists.
Benchmarking. This process measures a company against the standards andpractices of other companies. The use of benchmarking is growing quickly amongsmall companies, as it becomes easier to do due to the vast amount of information accessible through the web and availability of special software for benchmarking. Benchmarking falls into two main categories: (a) comparison ofStrategic Tools

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EXHIBIT 12-9
Scenario-Building Method at GE

financial measures, (b) qualitative and systematic search to identify the best practices of a relevant industry.
Core competencies. Core competencies are the capabilities of a firm or its
product that are important in the eyes of customers and at the same time difficult
to replicate by competition. In other words, a core competence has three traits:
1. It makes a contribution to perceived customer benefits.
2. It is difficult for competitors to imitate.
3. It can be leveraged to a wide variety of markets.

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It is important to know that core competencies do change over time; thus
companies must be proactive in developing new ones in response to market
needs. Another trend that can be observed is that external relationship competencies are becoming more important than internal technological and processcompetencies.
Customer satisfaction measurement. Customer satisfaction measurement
follows the perspectives of the marketing concept, i.e., first, firms need to be able
to identify and understand customer needs; second, they need to be able to satisfy those needs. The customer satisfaction measurement is critical in evaluating
how well the needs have been satisfied. A well-designed customer satisfaction
measurement system has a direct and indirect impact in meeting many common
business requirements: (a) design and development of a market-driven business
plan; (b) design, analysis, and use of essential performance indicators; (c) productdesign and development; (d) assessment of the effectiveness of servicing; (e) continuous improvement; and (f) benchmarking.
There are 15 steps in the creation of an effective customer satisfaction measurement system. They include
1. Define the scope and purpose of the survey.
2. Determine the data collection method.
3. Determine how the data should be segmented by market, titles, etc.
4. Determine the appropriate sample sizes.
5. Determine the drivers of satisfaction.
6. Design the instrument to assess the relative importance of the drivers of customer
satisfaction.
7. Develop a method to verify the buying criteria.
8. Develop open-ended questions.
9. Structure the competitive analysis section.
10. Develop the scale.
11. Test the instrument.
12. Pre-notify customers.
13. Administer the survey.
14. Develop the report.
15. Use the results and do it again.

Pay for performance. This system of compensation is tied to performance, as
the name indicates. Although it may sound like a very straightforward system,
the main challenge for compensation managers here is to tie the right rewards to
the right outcomes. Issues that need to be taken under consideration in designing
pay-for-performance plans are
1. Specific outcomes that should be measured
2. Competency-based pay programs for senior management compensation
3. Accounting and tax issues for stock and executive compensation programs
4. Retirement planning

Reengineering. Reengineering is a strategy of radically redesigning businessprocesses to increase productivity. Specifically, reengineering often deals with

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reassigning job tasks and downsizing. Some authors suggest that empowerment
should be an important aspect of reengineering, while others argue that empowerment does not really increase performance because people have difficulty withdefining their own jobs.
Strategic alliances. Many businesses today realize that they “can’t go italone.” Thus, they form business partnerships with their customers, suppliers,
or even competitors. Such alliances are not only present in the domestic market but also in the international arena (joint ventures). The main issue here is:
Are alliances a successful method of conducting business? Many of them fail—this brings up a challenge of identifying the success and failure factors in such
ventures.
Total Quality Management. Total Quality Management (TMQ) is a management technique that focuses on continuous improvement of business operations
and practices to eliminate errors (thus improve quality and cut costs) and
improve quality of customer satisfaction. Several success factors have been identified for TQM, among others:
1. Process focus (improving how things should be done to make them better)
2. Systematic and continuous improvement
3. Company-wide emphasis
4. Customer focus (e.g., quality defined from the customer perspective)
5. Employee involvement and development
6. Cross-functional management
7. Supplier relationships
8. Recognition of TQM as a critical competitive strategy

SUMMARY

This chapter presented a variety of tools and techniques that are helpful in different aspects of strategy formulation and implementation. These tools and techniques include experience curves, the PIMS model, a model for measuring thevalue of marketing strategies, game theory, the delphi technique, trend-impact
analysis, cross-impact analysis, and scenario building. Most of these techniques
require data inputs both from within the organization and from outside. Each toolor technique was examined for its application and usefulness. In some cases, procedural details for using a technique were illustrated with examples from the field.

DISCUSSIONQUESTIONS

1. Explain the relevance of experience curves in formulating pricing strategy.
2. Discuss how the delphi technique may be used to generate innovative ideas for
new types of distribution channels for automobiles.
3. Explain how PIMS judgments can be useful in developing marketing strategy.
4. Experience curves and the PIMS model both seem to imply that market shareis an essential ingredient of a winning strategy. Does that mean that a company
with a low market share has no way of running a profitable business?

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5. One of the PIMS principles states that quality is the most important single factor affecting an SBU’s performance. Comment on the link between quality andbusiness performance.

NOTES

APPENDIX

Perspective on Experience (Boston: Boston Consulting Group, 1970): 1. See also James
Aley, “The Theory That Made Microsoft,” Fortune (29 April 1996): 65.
2 See John Dutton and Annie Thomas, ”Treating Progress Functions as a Managerial
Opportunity,” Academy of Management Review (April 1984).
3 See Richard Minter, “The Myth Of Market Share,” The Wall Street Journal (15 June 1998):
A17. See also William W. Alberts, “The Experience Curve Doctrine Reconsidered,”
Journal of Marketing (July 1989): 36–49; and Robert Jacobson, “Distinguishing among
Competing Theories of the Market Share Effect,” Journal of Marketing (October 1988):
68–80.
4 Vijay Vishwahath and Jonathon Mark, “Your Brand’s Best Strategy,” Harvard Business
Review (May–June, 1997): 123–131.
5 Robert D. Buzzell and Robert T. Gale, The PIMS Principles: Linking Strategy to
Performance (New York: The Free Press, 1987): 2.
6 Robert Jacobson and David A. Aaker, “Is Market Share All It’s Cracked Up to Be?”
Journal of Marketing (Fall 1985): 11–22. See also John E. Prescott, Ajay K. Kohli, and N.
Venkatraman, “The Market Share-Profitability Relationship: An Empirical
Assessment of Major Assertions and Contradictions,” Strategic Management Journal 7(1986): 377–394.
7 See Cheri T. Marshall and Robert D. Buzzell, “PIMS and the FTC Line-of-Business
Data: A Comparison,” Strategic Management Journal 11 (1990): 269–282.
8 Buzzell and Gale, PIMS Principles, 192–193. Also see V. Ramanujan and N.
Venkatraman, “An Inventory and Critique of Strategy Research Using the PIMS
Data Base,” Academy of Management Review (January 1984): 138–151.
9 George S. Day and Liam Fahey, “Valuing Market Strategies,” Journal of Marketing (July
1988): 45–57.
10 Sharon Tully, “The Real Key to Creating Wealth,” Fortune (20 September 1993): 38. Also
see Laura Walbert, “America’s Best Wealth Creators,” Fortune (27 December 1993):
64.
11 See Bala Chakravarthy and Worth Loomis, “Dexter Corporation’s Value-Based
Strategic Planning System,” Planning Review (January–February 1988): 34–41.
12 F. William Barnett, “Making Game Theory Work in Practice,” The Wall Street Journal(13 February 1995): B8.
13 Frank Rutolo, “Scenarios: Moving Beyond Survival Toward Prosperity,” Outlook(November 1994).
1

Experience Curve Construction
The experience curve concept can be used as an aid in developing marketingstrategy. The procedure for constructing curves discussed below describes how
the relationship between costs and accumulated experience can be empiricallydeveloped.

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The first step in the process of constructing the experience curve is to compute experience and accumulated cost information. Experience for a particular
year is the accumulation of all volume up to and including that year. It is computed by adding the year’s volume to the experience of previous years.
Accumulated cost (constant dollars) is the total of all constant costs incurred forthe product up to and including that year. It is computed by adding the year’s
constant dollar cost to the accumulated costs of previous years. A year’s constantdollar cost is the real dollar cost for that year, corrected by inflation. It is computed by dividing cost (actual dollars) by the appropriate deflator.
The second step is to plot the initial and annual experience/accumulated cost(constant dollars) data on log-log graph paper (see Exhibit 12-A). It is importantthat the experience axis of this graph be calibrated so that its point of intersection
with the accumulated cost axis is at one unit of experience. The accumulated cost
axis may be calibrated in any convenient manner.
The next step is to fit a straight line to the points on the graph, which may be
accomplished by using the least-squares method (Exhibit 12-A).
It is useful at this point to stop and analyze the accumulated cost diagram. In
general, the closer the data points are to the accumulated cost curve, the stronger
the evidence that the experience effect is present. Deviations of the data points
from the curve, however, do not necessarily disprove the presence of the experience effect. If the deviations can be attributed to heavy investment in plant, equipment, etc. (as is common in very capital-intensive industries), the experience
effect still holds, but only in the long run because, in the long run, the fluctuations
are averaged out. If, on the other hand, significant deviations from the line cannot be explained as necessary periodic changes in the rate of investment, then thepresence of the experience effect, or at least its consistency, is open to question. In
Exhibit 12-B (page 328) there is one deviation (see Point X) that stands out as significant. If this can be ascribed to heavy investment (in plant, equipment, etc.), theexperience effect is still viable here.
The next step in the process of constructing the experience curve is to calculate
the intensity of the product’s experience effect. Intensity is the percentage in unit
cost reduction achieved each time the product’s experience is doubled. As such, it
determines the slope of the experience curve. To compute the intensity from theaccumulated cost curve, arbitrarily select an experience level on the experience axis
(e.g., Point E1 in Exhibit 12-C). Draw a line vertically up from E1 until it intersects
the accumulated cost curve. From that point on the curve, draw a horizontal line left
until it intersects the accumulated cost axis. Read the corresponding accumulated
cost (A1) from the scale. Follow the same procedure for experience level E2, whereE2 equals E1 × 2, to obtain A2. Divide A2 by A1, divide the result by 2, and subtract
the second result from the number 1. The final answer is the product’s intensity.
With the information given in Exhibit 12-C, the intensity equals 16.7 percent:
When the intensity has been computed, the slope of the experience curve isdetermined. However, as shown in Exhibit 12-D (page 329), this information in
itself is not sufficient for constructing the curve. Because all of the lines in Exhibit
12-D are parallel, they have the same slope and represent the same intensity. To

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EXHIBIT 12-A
Accumulated Cost Diagram

construct the experience curve, it is necessary to find a point (C1) on the unit costaxis. This can be achieved in the following manner: Find the intensity multiplier corresponding to the product’s intensity from the table specially prepared for the purpose (Exhibit 12-E, page 330). If the intensity falls between two values in Exhibit
12-E, the appropriate intensity multiplier should be determined by implementation and control interpolation. Read the value on the accumulated cost axis where
the curve intersects that axis. Multiply this value by the intensity multiplier. The
result is C1.

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EXHIBIT 12-B
Interpretation of Deviations from Accumulated Cost Curve

EXHIBIT 12-C
Product Intensity Computation

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EXHIBIT 12-D
Slopes of Parallel Lines

The intensity was calculated above as 16.7 percent. By using Exhibit 12-E, thecorresponding intensity multiplier can be interpolated as approximately 0.736. As
shown in Exhibit 12-A, the accumulated cost at the point of intersection can beread as approximately $260. Multiplying $260 by 0.736 yields a C1 of $191. The
experience curve can now be plotted on log-log graph paper. Position C1 on theunit cost axis. Multiply C1 by the quantity (1 – intensity) to obtain C2:$191 × (1 – 0.167) = $159
Locate C2 on the unit cost axis. Find the point of intersection (y) of a line
drawn vertically up from 2 on the experience axis and a line drawn horizontallyright from C2 on the unit cost axis. Draw a straight line through the points C1 andy. The result is the product’s experience curve (Exhibit 12-F, page 331).
The application of the experience curve concept to marketing strategy
requires the forecasting of costs. This can be achieved by using the curve.
Determine the current cumulative experience of the product. Add to this value
the planned cumulative volume from the present to the future time point. The
result is the planned experience level at that point. Locate the planned experience level on the experience axis of the graph. Move vertically up from that point
until the line extension of the experience curve is reached. Move horizontally leftfrom the line to the unit cost axis. Read the estimated unit cost value from theStrategic Tools

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EXHIBIT 12-E
Intensity Multipliers
Intensity

Intensity
Multiplier

Intensity

Intensity
Multiplier

5.0%
5.5
6.0
6.5
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
11.0
11.5
12.0
12.5
13.0
13.5
14.0
14.5
15.0
15.5
16.0
16.5
17.0
17.5
18.0
18.5
19.0
19.5
20.0

.926
.918
.911
.903
.895
.888
.880
.872
.864
.856
.848
.840
.832
.824
.816
.807
.799
.791
.782
.774
.766
.757
.748
.740
.731
.722
.714
.705
.696
.687
.678

20.5%
21.0
21.5
22.0
22.5
23.0
23.5
24.0
24.5
25.0
25.5
26.0
26.5
27.0
27.5
28.0
28.5
29.0
29.5
30.0
30.5
31.0
31.5
32.0
32.5
33.0
33.5
34.0
34.5
35.0
35.5

.669
.660
.651
.642
.632
.623
.614
.604
.595
.585
.575
.566
.556
.546
.536
.526
.516
.506
.496
.485
.475
.465
.454
.444
.433
.422
.411
.401
.390
.379
.367

scale. The unit cost obtained is expressed in constant dollars, but it can be converted to an actual dollar cost by multiplying it by the projected inflator for the
future year.
Cost forecasts can also be used to determine the minimum rate of volume
growth necessary to offset an assumed rate of inflation. For example, with anassumed inflation rate of 3.8 percent, a producer having an intensity of 20 percent must realize a volume growth of approximately 13 percent per year just to
maintain unit cost in real dollars. Should growth be slower or should full costreduction potential not be realized, the producer’s unit cost would rise.

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EXHIBIT 12-F
Experience Curve Estimation

Competitor cost is one of the most fundamental yet elusive information needsof the producer attempting to develop marketing strategy. The experience curve
concept provides a sound basis for estimating the cost positions of competitors as
well. With certain assumptions, competitors’ curves can be estimated.

13
CHAPTER THIRTEEN

Market Strategies
In the final analysis, all business strategies must be justified by the availability of
a viable market. When there is no viable market, even the best strategy will flop.
In addition, the development of marketing strategies for each business should be
realistically tied to the target market. Because the market should be the focus of
successful marketing, strategies aligned to the market point the way for each present business, serve as underpinnings for overall corporate-wide strategy, and provide direction for programming key activities and projects in all functional areas.
When corporate resources are scarce and corporate strengths are limited, it isfatal to spread them across too many markets. Rather, these critical resources
should be concentrated on those key markets (key in terms of type of market, geographic location, time of entry, and commitment) that are decisive for the business’s success. Merely allocating resources in the same way that other firms doyields no competitive differential. If, however, it can be discovered which markets
really hold potential, the business will be able to lever itself into a position of relative competitive superiority.
This chapter will identify different aspects of market strategies that companies
commonly pursue and will analyze their impact on performance vis-à-vis SBU
objectives. The use of these strategies will be illustrated with examples from themarketing literature. The appendix at the end of this chapter will summarize eachstrategy in terms of definition, objectives, requirements, and expected results.

Three women anda goose makea marketplace.
ITALIAN PROVERBDIMENSIONS OF MARKET STRATEGIESMarket strategies deal with the perspectives of markets to be served. These perspectives can be determined in different ways. For example, a company may
serve an entire market or dissect it into key segments on which to concentrate its
major effort. Thus, market scope is one aspect of market strategy. The geographic
dimensions of a market constitute another aspect: a company may focus on a
local, regional, national, or international market. Another strategic variable is thetime of entry into a market. A company may be the first, among the first few, oramong the last to enter a market. Commitment to a market is still another aspectof market strategy. This commitment can be to achieve market dominance, tobecome a major factor in the market, or merely to play a minor role in it. Finally,a company may intentionally decide to dilute a part of its market as a matter ofstrategy. Briefly, then, the following constitute the major market strategies that acompany may pursue:
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•
•
•
•
•

Market-scope strategy
Market-geography strategy
Market-entry strategy
Market-commitment strategy
Market-dilution strategy

MARKET-SCOPE STRATEGY
Market-scope strategy deals with the coverage of the market. A business unit
may serve an entire market or concentrate on one or more of its parts. Three majoralternatives in market-scope strategy are single-market strategy, multimarket
strategy, and total-market strategy.
Single-Market
Strategy

A variety of reasons may lead a company to concentrate its efforts on a single segment of a market. For example, in order to avoid confrontation with large competitors, a small company may find a unique niche in a market and devote its
energies to serving this niche. Design and Manufacturing Corporation (D&M) is
a classic example of a successful single-market strategy. In the late 1950s, Samuel
Regenstrief studied the dishwasher market and found (a) high growth potential;(b) market domination by GE; and (c) absence of a manufacturer to supply large
retailers, such as Sears, with their own private brand. These conclusions led him
to enter the dishwasher market and to concentrate his efforts on a single segment:
national retailers. The company has emerged as the largest producer of dishwashers in the world with over 25 percent of the U.S. market. A D&M executive
describes the company’s strategy in the following words: “Sam knew precisely
what segment of the market he was going after; he hit it at exactly the right time;and he has set up a tightly run organization to take full advantage of these opportunities.”1
The story of Tampax also illustrates the success of the single-market strategy.
Tampax had a minimal share of a market dominated by Kimberly-Clark’s Kotex
and Personal Product’s Modess. Tampax (in 1997 Procter & Gamble purchased
this business) could not afford to compete head-on with these major brands. To
sell its different concept of sanitary protection—internal protection—the company found that newer, younger users were more open-minded and very brandloyal. Starting from a premise that had great appeal for the young user, that internal protection offers greater freedom of action, Tampax concentrated on reaching
young women. Its single-market strategy has proved to be highly beneficial.2
Even today the company’s advertising is scarcely distinguishable from the firm’s
first efforts.
In the competitive field of cosmetics, Noxell Corporation (a division ofProcter & Gamble), marketer of the popular Noxzema and Cover Girl brands of
makeup and skin cream, found success in a single segment of the $15-billion cosmetics industry that its rivals disdain: the mass market. Noxell’s products
are aimed primarily at teenagers and evoke the image of fresh-faced natural
beauty. Widely distributed and heavily advertised, Noxell’s brands are easily

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recognizable by their low price. Content to sell its products in chains such as
Kmart and Wal-Mart, the company avoids more prestigious, but cutthroat,
department and specialty store businesses. The determination to sell exclusively
through mass merchandisers is based on Noxell’s belief that distribution throughdepartment stores is unattractive: it requires leasing counter space, keeping large
inventories on hand, and paying commissions to salespeople. Noxell’s continued
sales growth and healthy profit performance attest to the viability of concentrating on a single segment of the market.3
There is no magic formula for choosing a segment. A business should analyze
the market carefully to find a segment that is currently being ignored or served
inadequately. Then it should concentrate on the chosen segment wholeheartedly,
despite initial difficulties, and avoid competition from the established firms.
New market segments often emerge as a result of changes in the environment. For example, the women’s movement motivated Smith and Wesson Corp.
to launch Lady Smith in 1989, a line of guns specifically designed for women. The
result: sales to women jumped from 5 percent of the company’s total to nearly 20
percent.4 Despite the cutthroat competition from mass merchandisers such as
Toys “R” Us, FAO Schwartz continues to successfully operate by targeting
upscale children.
The single-market strategy consists of seeking out a market segment thatlarger competitors consider too small, too risky, or just plain unappealing. The
strategy will not work in areas where the market power of big companies isimportant in realizing economies of scale, as in the extractive and process industries, for example. Companies concentrating on a single market have the advantage of being able to make quick responses to market opportunities and threats
through appropriate changes in policies. The single-market, or niche, strategy isoften born of necessity. Lacking the resources to fight head-to-head battles acrossthe board with larger entrenched competitors, winners typically seek out niches
that are too small to interest the giants or that can be captured and protected bysheer perseverance and by serving customers surpassingly well.
As far as the impact of the single-market strategy is concerned, it affects profitability in a positive direction. When effort is concentrated on a single market,
particularly when competition is minimal, it is feasible to keep costs down while
prices are kept high, thus earning substantially higher profits. Although its
growth objective may not be achieved when this strategy is followed, a company
may be able to increase its market share if the chosen segment is large enough visà-vis the overall market.
Multimarket
Strategy

Instead of limiting business to one segment and thus putting all its eggs in one
basket, a company may opt to serve several distinct segments. To implement a
multimarket strategy successfully, it is necessary to choose those segments withwhich the company feels most comfortable and in which the company is able to
avoid confronting companies that serve the entire market. This point may beillustrated with reference to Crown Cork and Seal Company. The company is amajor producer of metal cans, crowns (bottle caps), closures (screw caps and

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bottle lids), and filling machinery for beer and soft drink cans. The industry is
characterized by a really dynamic environment: technological breakthroughs,
new concepts of packaging, new materials, and threats of self-manufacture bylarge users are common. Crown Cork and Seal, as a matter of strategy, decided toconcentrate on two segments: (a) cans for such “hard-to-hold” products as beerand soft drinks and (b) aerosol containers. Its new strategy paid off. The company
outperformed its competitors both in sales growth and in return on sales in the
1980s and 1990s. As it should with any strategic choice, the company fully committed itself to its strategy despite the lure of serving other segments. For example, in spite of its 50 percent share in the motor oil can business, Crown Cork
decided not to continue to compete aggressively in that market.5
The multimarket strategy can be executed in one of two ways: either by selling different products in different segments or by distributing the same productin a number of segments. Toyota Motor Corporation, for example, introduced its
Lexus line of cars in 1989. The car was directed toward luxury car buyers who traditionally had looked to BMW and Mercedes-Benz. Toyota entered a different
segment with a different product. In recent years, outdoor sports (e.g,. biking,backpacking, and hiking) have experienced terrific growth. Counting on the continued strength of this outdoor trend, Timex Corporation decided to introduce aline of rugged watches. The company decided to license Timberland Co., a wellestablished name in outdoor products, to sell its watches under the brand name
Timberland. The company has introduced as many as 82 styles to keep the competitors at bay.6
In contrast, North Face, Inc., the leader in high-performance outdoor clothing, decided to broaden its market base by extending the business to the casualsportswear market. The company plans to increase the number of stores selling
North Face after 2001 from 1,500 specialty stores up to 4,000 retailers, including
such stores as Nordstrom and Footlocker.7
Total-Market
Strategy

A company using the total-market strategy serves an entire spectrum of a market
by selling different products directed toward different segments of the market.
The strategy evolves over a great number of years of operation. A company may
start with a single product. As the market grows and as different segments
emerge, leading competitors may attempt to compete in all segments by employing different combinations of product, price, promotion, and distribution strategies. These dominant companies may also attempt to enter new segments as they
emerge. As a matter of fact, the leading companies may themselves create new
segments and try to control them from the outset.
A number of companies in different industries have followed this strategy.
General Motors, for one, has traditionally directed its effort to securing an entire
market: “A car for every pocket and taste.” With its five auto lines (Chevrolet,
Pontiac, Oldsmobile, Buick, and Cadillac), along with a variety of small trucks,
the company attempts to compete in all conceivable segments.
IBM now also follows an across-the-board strategy. It has a system for meeting the requirements of all types of customers. In the mid-1980s, as the personal

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computer segment emerged, IBM was somewhat slow to respond but finallydeveloped a personal computer of its own. Similarly, in the consumer products
area, the Coca-Cola Company has Coca-Cola, Diet Coke, Tab, Sprite, Fresca, andFanta to satisfy different drinking tastes. The company even has a brand oforange juice, Minute Maid, for the segment of consumers who drink juice rather
than carbonated beverages.
The total-market strategy is highly risky. For this reason, only a very small
number of companies in an industry may follow it. Embracing an entire market
requires top management commitment. In addition, a company needs ample
resources to implement it. Finally, only companies in a strong financial position
may find this strategy attractive. As a matter of fact, a deteriorating financial position may force a company to move backward from an across-the-board market
strategy. Chrysler Corporation’s financial woes in the 1990s led it to reduce thescope of its markets overseas at a time when experts were anticipating the emergence of a single global market. The total-market strategy can be highly rewarding in terms of achieving growth and market share, but it may or may not lead toincreased profitability.
Seeking Changes inMarket Scope

There are only limited periods during which the fit between the key requirementsof a market and the particular competencies of a firm competing in that market is
at an optimum. Companies should not, therefore, tie themselves to a particularmarket strategy permanently. Environmental shifts may necessitate a change inperspective from one period to another. Consider the American Express credit
card. At one time, it had potent snob appeal meant for upscale customers. But ascompetition in the credit card business intensified, many American Express card
holders exchanged their cards for others that required no annual fee and provided revolving credit at modest interest rates. This forced American Express toredefine its market. In 1994, it began offering a number of new cards, each one targeted at a different segment of the consumer market. Some cards bore the exclusive imprimatur of AmEx with annual fee waived, others shared billing withother companies that offered a range of enticements, such as frequent-flier miles
and car discounts. All offered revolving credit at competitive rates. Where business travelers were once AmEx’s preferred clientele, every creditworthy
American was now being wooed. Similarly, Gerber Products long dominated the
U.S. baby food market, but declining birth rates forced it to seek growth elsewhere. The company has been planning to introduce foods for older people. In
the mid-1990s as microbrewers became popular, the industry leaders, Anheuserand Miller, decided to introduce their own specialty beers with the mystique ofthe micros. For example Anheuser-Busch added Redhook Ale, Red Wolf, Elk
Mountain, and Crossroads; Miller offered Red Dog, Icehouse, and Celis; andCoors came out with Sandlot and George Killian. They did so since future industry growth is dependent on specialty beers. While the U.S. beer industry continues to stagnate, the specialty beers have been growing over 40% annually.8
The J.C. Penney Company, after 75 years of being identified as a retailer ofprivate-label soft goods to price-conscious customers, decided in the 1980s to

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change the scope of its market. The company transformed itself so that it occupied a position between a traditional department store and a discount store(something along the lines of a moderately priced department store with emphasis on higher-priced fashion) in hard goods, housewares, and especially apparel.
The company continues to upgrade and has successfully been able to attract more
upscale customers.
Disney’s emphasis on the 5- to 13-year-old age market has been a phenomenon in itself. During the 1960s, this segment continued to grow, providing thecompany with opportunities for expansion. In the 1970s, however, this segment
shrank; it declined further in the 1980s, leading the company to change its strategic perspectives. It began serving the over-25 age group by making changes in its
current offerings and by undertaking new projects: Epcot Center, Disney MGM
Studios theme park, and a water park are all attached to Disney World in Florida.9
Briefly, then, markets are moving targets, and a company’s strategic perspectives must change accordingly.

MARKET-GEOGRAPHY STRATEGY
Geography has long been used as a strategic variable in shaping market strategy.
History provides many examples of how businesses started locally and gradually
expanded nationally, even internationally. Automobiles, telephones, televisions,and jet aircraft have brought all parts of the country together so that distanceceases to be important, thus making geographic expansion an attractive choice
when seeking growth.
Consider the case of Ponderosa System, a fast-food chain of steak houses (adivision of Metromedia Steak Houses, Inc.). The company started in 1969 withfour restaurants in Indiana. By 1970 it had added 10 more restaurants in Indiana
and southern Ohio. At the end of 1994, there were almost 800 Ponderosa SteakHouses all over the country.
There are a variety of reasons for seeking geographic expansion: to achieve
growth, reduce dependence on a small geographic base, use national advertising
media, realize experience (i.e., economies of scale), utilize excess capacity, andguard against competitive inroads by moving into more distant regional markets.
This section examines various alternatives of market-geography strategy. The
purpose here is to highlight strategic issues that may dictate the choice of a geographic dimension in the context of market strategy.
Local-Market
Strategy

In modern days, the relevance of local-market strategy may be limited to (a)retailers and (b) service organizations, such as airlines, banks, and medical centers. In many cases, the geographic dimensions of doing business are decided bylaw. For example, until recently, an airline needed permission from the Civil
Aeronautics Board (which was dissolved in 1983 after the airline industry deregulation) to change the areas it could cover. By the same token, banks traditionallycould only operate locally.

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Of the 2 million retailers in the United States, about half have annual sales ofless than $100,000. Presumably, these are all local operations. Even manufacturers may initially limit the distribution of new products to a local market. Localmarket strategy enables a firm to prosper by serving customers in a narrowgeographic area well. The strategy emphasizes personal service, which bigger
rivals may shun.
Regional-Market
Strategy

The regional scope of a business may vary from operations in two or three statesto those spread over larger sections of the country: New England, the Southwest,
the Midwest, or the West, for example. Regional expansion provides a good compromise between doing business locally and going national.
Regional expansion ensures that, if business in one city is depressed, favorable conditions prevailing in other regions allow the overall business to remain
satisfactory. In the 1980s, Marshall Field, the Chicago-based department store(now a division of Dayton-Hudson Company), found itself pummeled by recent
demographic and competitive trends in that city. Therefore, it decided to expand
into new regions in the South and West. This way it could lessen its concentrationin the Midwest and expand into areas where growth was expected.
Further, it is culturally easier to handle a region than an entire country. The
logistics of conducting business regionally are also much simpler. As a matter offact, many companies prefer to limit themselves to a region in order to avoid competition and to keep control centralized. Regional-market strategy allows companies to address America’s diversity by dividing the country into well-defined
geographic areas, choosing one or more areas to serve, and formulating a uniquemarketing mix to serve each region. The point may be illustrated with reference
to D.A. Davidson & Company, a regional brokerage firm based in Great Falls,
Montana. While large brokerage houses, such as Merrill Lynch and Smith Barney,
invest the bulk of their research dollars following large, well-established corporations, regional firms mainly concentrate on local companies.10 This helps inestablishing a long-term relation such that when these companies need financial
guidance, they turn to the firm that understands them.
Many businesses continue to operate successfully on a regional scale. The following large grocery chains, for example, are regional in character: Safeway in theWest, Kroger in the Midwest, and Stop & Shop in the East. Regional expansion ofa business helps achieve growth and, to an extent, gains market share. Simply
expanding a business regionally, however, may or may not affect profitability.
Geographic expansion of a business to a region may become necessary either
to achieve growth or to keep up with a competitor. For example, a small pizza
chain with about 30 restaurants in an Ohio metropolitan area had to expand its
territory when Pizza Hut started to compete aggressively with it.
At times, a regional strategy is much more desirable than going national. A
company operating nationally may do a major portion of its business in one
region, with the remainder spread over the rest of the country, or it may find itmuch more profitable to concentrate its effort in a region where it is most successful and divest itself of its business elsewhere.

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National-Market
Strategy

Going from a regional to a national market presumably opens up opportunities
for growth. This may be illustrated with reference to Borden, Inc. A dairy businessby tradition, in the 1980s Borden decided to become a major player in the snack
food arena. It acquired seven regional companies, among them Snacktime, Jays,
and Laura Scudder’s, to compete nationally, to grow, and to provide stiffer competition for PepsiCo’s Frito-Lay division.
It was the prospect of growth that influenced the Radisson Hotel Corporationof Minneapolis to go national and to become a major competitor in the hotel business. Radisson decided to move into prime “gateway” markets—New York, Los
Angeles, Boston, Chicago, and San Francisco—where it could compete against
such giants as Marriott and Hyatt.
In some cases, the profit economics of an industry requires going national.
For example, success in the beer industry today demands huge advertising outlays, new product introductions (e.g., light beer), production efficiencies, andwide distribution. These characteristics forced Adolph Coors to go national.
Going national, however, is far from easy. Each year a number of products
enter the market, hoping eventually to become national brands. Ultimately, however, only a small percentage of them hit the national market; a still smaller percentage succeed.
A national-market strategy requires top management commitment because alarge initial investment is needed for promotion and distribution. This requirement makes it easier for large companies to introduce new brands nationally,
partly because they have the resources and are in the position to take the risk andpartly because a new brand can be sheltered under the umbrella of a successful
brand. For example, a new product introduced under GE’s name has a betterchance of succeeding than one introduced by an unknown company.
To implement a national-market strategy successfully, a company needs toinstitute proper controls to make sure that things are satisfactory in different
regions. Where controls are lacking, competitors, especially regional ones, may findit easy to break in. If that situation comes about, the company may find itself losing
business in region after region. Still, a properly implemented national-market strategy can go a long way in providing growth, market share, and profitability.

InternationalMarket Strategy

A number of corporations have adopted international-market postures. The
Singer Company, for example, has been operating overseas for a long time. Theinternational-market strategy became a popular method for achieving growthobjectives among large corporations in the post-World War II period.
In its attempts to reconstruct war-torn economies, the U.S. government provided financial assistance to European countries through the Marshall Plan.
Because the postwar American economy emerged as the strongest in the world,
its economic assistance programs, in the absence of competition, stimulated
extensive corporate development of international strategies.
At the end of 1996, according to a U.S. Department of Commerce report, U.S.
direct investment abroad was estimated at $716 billion, up from $450 billion in
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developed countries. However, as many developing countries gained political
freedom after World War II, their governments also sought U.S. help to modernize their economies and to improve their living standards. Thus, developing
countries have provided additional investment opportunities for U.S. corporations, especially in more politically stable countries. It is interesting, however, that
although for cultural, political, and economic reasons more viable opportunities
were found in Western Europe, Canada, and, to a lesser extent, Japan, developing
countries provided a better return on direct U.S. investment. For example, in 1996
developing countries accounted for about 40 percent of income but less than 30
percent of investment.11
In recent years, overseas business has become a matter of necessity from theviewpoint of both U.S. corporations and the U.S. government. The increased competition facing many industries, resulting from the saturation of markets andcompetitive threats from overseas corporations doing business domestically, hasforced U.S. corporations to look to overseas markets. At the same time, the unfavorable balance of trade, partly due to increasing energy imports, has made theneed to expand exports a matter of vital national interest. Thus, although in the
1950s and 1960s international business was considered a means of capitalizing on
a new opportunity, in today’s changing economic environment it has become amatter of survival.
Generally speaking, international markets provide additional opportunities
over and above domestic markets. In some cases, however, a company may findthe international market an alternative to the domestic market. Massey-Ferguson
decided long ago to concentrate on sales outside of North America rather thancompete with powerful U.S. farm equipment producers. Massey’s entire organization, including engineering, research, and production, is geared to market
changes overseas. It has learned to live with the instability of foreign markets andto put millions of dollars into building its worldwide manufacturing and marketing networks. The payoff for the company from its emphasis on the international market has been encouraging. The company continues to outperform both
Deere and International Harvester. Similarly, the Colgate-Palmolive Company
has flourished through concentration in markets abroad despite tough competitors, i.e., Procter & Gamble and Unilever, at home.
With the world’s biggest private inventory of commercial softwood,
Weyerhaeuser has been able to build an enviable export business—a market its
competitors have virtually ignored until recently. This focus has given
Weyerhaeuser a unique advantage in a rapidly changing world market.
Consumption of forest products overseas in the 1990s has been increasing at double the domestic rate of 2 to 3 percent annually. Future prospects overseas continue to be attractive. Particularly dramatic growth is expected in the PacificBasin, which Weyerhaeuser is ideally located to serve. Moreover, dwindling timber supplies and high oil costs are putting European and Japanese producers at
an increasing disadvantage even in their own markets, creating a vacuum that
North American producers are now rushing to fill. With a product mix alreadyheavily weighted toward export commodities and with unmatched access to

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deep-water ports, Weyerhaeuser is far ahead of its competitors in what is shaping
up to be an export boom in U.S. forest products. Exports, which in 1998 accounted
for 40 percent of Weyerhaeuser’s sales and an even higher percentage of its profits, could account for fully half of the company’s total revenues by the year 2000.12
Other Dimensions ofMarket-Geography
Strategy

A company may be regional or national in character, yet it may not cover its entire
trading area. These gaps in the market provide another opportunity for growth.
For example, the Southland Corporation has traditionally avoided putting its 7Eleven stores (now a division of the Yokado Group of Japan) in downtown areas.
About 6,500 of these stores in suburban areas provide it with more than $2 billion
in sales. A few years ago, the company opened a store at 34th and Lexington in
New York City, signaling the beginning of a major drive into the last of the U.S.
markets that 7-Eleven had not yet tapped. Similarly, Hyatt Corp. has hotels in all
major cities but not in all resort and suburban areas. To continue to grow, this is
the gap the company plans to fill in the 1990s.
Gaps in the market are left unfilled either because certain markets do not initially promise sufficient potential or because local competition appears too strong
to confront. However, a corporation may later find that these markets are easy to
tap if it consolidates its position in other markets or if changes in the environment
create favorable conditions.

MARKET-ENTRY STRATEGY
Market-entry strategy refers to the timing of market entry. Basically, there arethree market-entry options from which a company can choose: (a) be first in themarket, (b) be among the early entrants, or (c) be a laggard. The importance of thetime of entry can be illustrated with reference to computers. Experience has
shown that if new product lines are acceptable to users and if their impact is properly controlled through pricing and contractual arrangements, sales of an olderline can be stimulated. Customers are more content to upgrade within the current
product line if they know that a more advanced machine is available wheneverthey need it. A successful introduction, therefore, requires that the right productis announced at the right time. If it is announced too early, the manufacturer will
suffer a drop in revenues and will lose customers to the competition.
First-In Strategy

To be the first in the market with a product provides definite advantages. The
company can create a lead for itself that others will find difficult to match.
Following the experience curve concept, if the first entrant gains a respectableshare of the market, across-the-board costs should go down by a fixed percentage
every time experience doubles. This cost advantage can be passed on to customers in the form of lower prices. Thus, competitors will find it difficult to challenge the first entrant in a market because, in the absence of experience, their costs
and hence their prices for a similar product will be higher. If the new introduction
is protected by a patent, the first entrant has an additional advantage because it
will have a virtual monopoly for the life of the patent.

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The success story of Kinder-Care Learning Centers illustrates the significanceof being first in the market. In 1968 a real estate developer, Perry Mendel, had anidea that many people thought was outrageous, impractical, and probably
immoral. He wanted to create a chain of child care centers, and he wanted to use
the same techniques of standardization that he had seen work for motels and fastfood chains. Convinced that the number of women working outside the homewould continue to increase, Mendel started Kinder-Care Learning Centers. In its
brief history, the company has become a dominant force in the commercial childcare industry.
The strategy to be the first, however, is not without risks. The first entrant
must stay ahead of technology or risk being dethroned by competitors. Docutel
Corporation provides an interesting case. This Dallas-based company was thefirst to introduce automated teller machines (ATMs) in the late 1960s. Thesemachines made it possible for customers to withdraw cash from and makedeposits to their savings and checking accounts at any time by pushing a few buttons. Docutel had virtually no competition until 1975, and as recently as 1976, thecompany had a 60 percent share of the market for ATMs. Then the downfall
began. Market share fell to 20 percent in 1977 and to 8 percent in 1978. Docutel’s
fortunes changed because the company failed to maintain its technological lead.
Its second-generation ATM failed miserably and thus made room for competitors.
Diebold was the major beneficiary of Docutel’s troubles: its share of the market
jumped to 70 percent in 1978 from barely 15 percent in 1976. Although Docutel’s
comeback efforts have been encouraging, the company may never again occupy
a dominant position in the ATM industry.
Similarly, Micro Instrumentation and Telemetry Systems invented the PC in
the mid-1970s, but ceded market leadership to latecomers (such as Apple computers and IBM) that invested heavily to turn the PC into a mass-market product.
Royal Crown was a pioneer in the consumer market for diet colas, a product that
had previously been sold only to diabetics. However, PepsiCo and Coca-Cola
were able to use their vast financial muscle in other parts of the cola market tocrush Royal Crown, despite their late arrival. Indeed, it took Diet Coke only ayear to establish market leadership after Coca-Cola launched it in 1983.13
A company whose strategy is to be the first in the market must stay ahead nomatter what happens because the cost of yielding the first position to someone
else later can be very high. Through heavy investment in promotion, the first
entrant must create a primary demand for a product where none exists.
Competitors will find it convenient to piggyback because by the time they enter
the market, primary demand is already established. Thus, even if a company has
been able to develop a new product for an entirely new need, it should carefully
evaluate whether it has sufficient technological and marketing strength to command the market for a long time. Competitors will make every effort to break in,
and if the first company is unsure of itself, it should wait. Apple Computer, forexample, was the first company in the personal computer field. Despite its best
efforts, it could not compete against IBM. The upstart company that always
talked confrontation with IBM finally decided to play second fiddle. If properly

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implemented, however, the strategy to be first can be highly rewarding in termsof growth, market share, and profitability.
Early-Entry
Strategy

Several firms may be working on the same track to develop a new product. Whenone introduces the product first, the remaining firms are forced into an earlyentry strategy, whether they had planned to be first or had purposely waited forsomeone else to take the lead. If the early entry takes place on the heels of the firstentry, there is usually a dogfight between the firms involved. By and large, thefight is between two firms, the leader and a strong follower (even though there
may be several other followers). The reason for the fight is that both firms haveworked hard on the new product, both aspire to be the first in the market, bothhave made a strong commitment to the product in terms of resources. In the final
phases of their new-product development, if one of the firms introduces the product first, the other one must rush to the market right away to prevent the firstcompany from creating a stronghold. Ultimately, the competitor with a superiormarketing strategy in terms of positioning, product, price, promotion, and distribution comes out ahead.
After the first two firms find their natural positions in the market and themarket launches itself on a growth course, other entrants may follow. These firms
exist on the growth wave of the market and exit as the market matures.
When Sara Lee Corp. introduced its new Wonderbra in the United States in
1994, the rival VF Corp. watched closely. Only after American shoppers began
buying it in large numbers did VF offer up its own It Must Be Magic version. But
once VF decided to enter the market, it moved swiftly using state-of-the-art distribution, surging with nationwide distribution ahead of Sara Lee. VF’s “secondto-the-market” approach, bringing high technology to the nitty-gritty details of
distribution, have helped it avoid the financial risk that beset clothing makers.14
Early entry on the heels of a leader is desirable if a company has an acrossthe-board superior marketing strategy and the resources to fight the leader. As amatter of fact, the later entrant may get an additional boost from the groundwork
laid by the leader (in the form of the creation of primary demand). A weak early
entrant, however, will be conveniently swallowed by the leader. The Docutel casediscussed above illustrates the point. Docutel was the leader in the ATM market.
However, being a weak leader, it paved the way for a later entrant, Diebold, totake over the market it had developed. The disposable diaper was introduced in
the mid-1930s by a small company under the brand name Chux. Although it wasprobably the best product in the early 1960s, it was relatively expensive, limiting
the market to wealthy households, or for use while traveling. However, P&G’s
experience in grocery marketing and its early research with Pampers prompted it
to aim at the mass market. Through making huge investments, P&G expanded
the market from $10 million to $370 million in seven years.15
As the market reaches the growth phase, a number of other firms may enter
it. Depending on the length of the growth phase and the point at which firms
enter the market, some could be labeled as early entrants. Most of these early
entrants prefer to operate in specific market niches rather than compete against

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major firms. For example, a firm may concentrate on doing private branding fora major retailer. Many of these firms, particularly marginal operations, may beforced out of the market as growth slows down. In summary, an early-entry strategy is justifiable in the following circumstances:
1. When the firm can develop strong customer loyalty based on perceived productquality and retain this loyalty as the market evolves.
2. When the firm can develop a broad product line to help discourage entries andcombat competitors who choose a single-market niche.
3. When either current investment is not substantial or when technological change
is not anticipated to be so rapid and abrupt as to create obsolescence problems.
4. When an early entrant can initiate the experience curve and when the amount oflearning is closely associated with accumulated experience that cannot readily be
acquired by later entrants.
5. When absolute cost advantages can be achieved by early commitment to raw
materials, component manufacture, distribution channels, and so forth.
6. When the initial price structure is likely to be high because the product offers
superior value to products being displaced.
7. When prospective competitors can be discouraged as the market is not strategically crucial to them and existing competitors are willing to see their market
shares erode.

Early entry, therefore, can be a rewarding experience if the entry is made witha really strong thrust directed against the leader’s market or if it is carefullyplanned to serve an untapped market. Early entry can contribute significantly to
profitability and growth. For the firm that takes on the leader, the early entry may
also help in gaining market share.
Laggard-Entry
Strategy

The laggard-entry strategy refers to entering the market toward the tail end of thegrowth phase or in the maturity phase of the market. There are two principal
alternatives to choose from in making an entry in the market as a laggard: to enteras imitator or as initiator. An imitator enters the market as a me-too competitor;that is, imitators develop a product that, for all intents and purposes, is similar to
one already on the market. An initiator, on the other hand, questions the statusquo and, after doing some innovative thinking, enters the market with a new
product. Between these two extremes are companies that enter stagnant markets
with modified products.
Entry into a market as an imitator is short-lived. A company may be able totap a portion of a market initially by capitalizing on the customer base of the
major competitor(s). In the long run, however, as the leader discards the product in favor of a new or improved one, the imitator is left with nowhere to go.
When Enterprise Rent-a-Car Inc. entered the business, it had to decide whether
to follow the strategy that the early starters, Hertz and Avis, had pursued orconsider an alternative strategy. It decided to go against all the conventional
wisdom. Not only has it ceded the bread-and-butter airport business to Hertz,
Avis and others, but it has also done without celebrity-driven advertisements
and catchy slogans. Sticking close to the niche it developed—providing rentals

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for customers whose cars are being repaired or who need an extra car—
Enterprise is the leader in fleet size and locations. Its sales in 1996 were $3.1 billion versus $3.8 billion for Hertz, but it probably was number one in profits,estimated to be $500 million (Hertz, a division of the Ford Motor Company,
does not disclose earnings).16
Imitators have many inherent advantages that make it possible to run a profitable business. These advantages include availability of the latest technologicalimprovements; feasibility of achieving greater economies of scale; ability toobtain better terms from suppliers, employees, or customers; and ability to offer
lower prices. Thus, even without superior skills and resources, an imitator may
perform well.
The initiator starts by seeking ways to dislodge the established competitor(s)in some way. Consider the following examples:
The blankets produced by an electrical appliance manufacturer carried the warning:“Do not fold or lie on this blanket.” One of the company’s engineers wondered why
no one had designed a blanket that was safe to sleep on while in operation. His questioning resulted in the production of an electric underblanket that was not only safe
to sleep on while in operation, but was much more efficient: being insulated by theother bed clothes, it wasted far less energy than conventional electric blankets, which
dissipate most of their heat directly into the air.
A camera manufacturer wondered why a camera couldn’t have a built-in flash thatwould spare users the trouble of finding and fixing an attachment. To ask the question
was to answer it. The company proceeded to design a 35mm camera with built-in
flash, which has met with enormous success and swept the Japanese medium-priced
single-lens market.17

These two examples illustrate how a latecomer may be able to make a markin the market through creativity and initiative. In other words, by exploiting technological change, avoiding direct competition, or changing the accepted businessstructure (e.g., a new form of distribution), the initiator has an opportunity toestablish itself in the market successfully.
The Wilmington Corporation adopted the middle course when entering thepressed glass-ceramic cookware market in 1977. Until that time, Corning Glass
Works was the sole producer of this product. Corning held a patent that expired
in January 1977. The Wilmington Corporation opted not to enter the market witha me-too product. It sought entry into the market with a modified product line:
round containers in solid colors. Corning’s product was square-shaped andwhite, with a cornflower design. The company felt that its product would enlarge
the market by appealing to a broader range of consumer tastes.18
Whatever course a company may pursue to enter the market, as a laggard, itcannot expect much in terms of profitability, growth, or market share. When laggards enter the market, it is already saturated; only established firms can operate
profitably. As a matter of fact, their built-in experience affords the establishedcompetitors an even greater advantage. An initiator, however, may be able to
make a profitable entry, at least until an established firm adds innovation to its
own line.

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MARKET-COMMITMENT STRATEGY
The market-commitment strategy refers to the degree of involvement a company
seeks in a particular market. It is widely held that not all customers are equallyimportant to a company. Often, such statements as “17 percent of our customers
account for 60 percent of our sales” and “56 percent of our customers provide 11
percent of our sales” are made, which indicate that a company should make varying commitments to different customer groups. The commitment can be in theform of financial or managerial resources or both. Presumably, the results fromany venture are commensurate with the commitment made, which explains theimportance of the commitment strategy.
Commitment to a market may be categorized as strong, average, or light.
Whatever the nature of the commitment, it must be honored: a company that fails
to regard its commitment can get into trouble. In 1946, the Liggett and Myers
Tobacco Company had a 22 percent share of the U.S. cigarette market. In 1978, its
share of the market was less than 3.5 percent; in 1989, slightly less than 3 percent.19 A variety of reasons has been given for the company’s declining fortunes,
all amounting to a lack of commitment to a market that at one time it had commanded with an imposing market share. These reasons included responding too
slowly to changing market conditions, using poor judgment in positioning
brands, and failing to attract new and younger customers. The company lagged
behind when filters were introduced and missed industry moves to both kingsize and extra-long cigarettes. It also missed the market move toward low-tar cigarettes. Its major entry in that category, Decade, was not introduced until 1977,
well after competitors had established similar brands. Liggett and Myers illustrates that a company can lose a comfortable position in any market if it fails tocommit itself adequately to it.
Strong-Commitment
Strategy

The strong-commitment strategy requires a company to operate in a market optimally by realizing economies of scale in promotion, distribution, manufacturing,and so on. If a competitor challenges a company’s position in the market, the latter must fight back aggressively by employing different forms of product, price,promotion, and distribution strategies. In other words, because the company has
a high stake in the market, it should do all it can do to defend its position.
A company with a strong commitment to a market should refuse to be content with the status quo. It should foresee its own obsolescence by developing
new products, improving product quality, and increasing expenditures for sales
force, advertising, and sales promotion relative to the market’s growth rate.
This point may be illustrated with reference to the Polaroid Corporation. The
company continues to do research and development to stay ahead of the field. The
original Land camera, introduced in 1948, produced brown-and-white pictures.
Thereafter, the company developed film that took truly black-and-white pictureswith different ASA speeds. Also, the time involved in the development of film was
reduced from the original 60 seconds to 10 seconds. In 1963 the company introduced color-print film with a development time of 60 seconds; in the early 1970s,

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the company introduced the SX-70 camera, which made earlier Polaroid cameras
obsolete. Since its introduction, a variety of changes and improvements have been
made both in the SX-70 camera and in the film that goes into it. A few years later,
the company introduced yet another much-improved camera, Spectra. In 1976
Kodak introduced its own version of the instant camera. Polaroid charged Kodak
with violating seven Polaroid patents and legally forced Kodak out of the instantphotography business.20 The result: Polaroid has retained its supremacy in the
instant photography field, a field to which it has been solely committed. Porsche
continues to excel in the crowded auto industry by making a firm commitment toa well-defined market niche (a 40-something male college graduate earning over
$200,000 per year). The company sells only about 6000 cars a year (each costing
between $40,000 and $82,000), but does well in terms of profits.21 RCA pioneered
color television in 1954, yet their product did not sell well since the vast majorityof programs were broadcast in black and white. But RCA did not give up andmade a long-term commitment to the business. It started broadcasting color TV
programs through its NBC subsidiary at a time when the majority of consumers
owned black-and-white TVs. RCA’s persistence over ten years was rewarded withlong-term market leadership of color TVs.
The nature of a company’s commitment to a market may, of course, changewith time. Consider Levi Strauss & Co. Its brand name is synonymous with rebellious youth. But while it retains its hold over the baby boomers who built thebrand into mythic proportions, it has neglected the whims of the new generationof youth, and these are the future customers. This lack of commitment has cost thecompany dearly. Its sales have been declining since 1990, forcing it to close manyfactories. As a company executive put: “It was, in part, the classic corporate goof:
taking your eyes off the ball. Projects during the last decade, such as expanding
the casual clothing line Dockers and launching its upscale cousin Slates distracted
executives from the threat to Levi’s core jeans brand.”22
Strong commitment to a market can be highly rewarding in terms of achieving growth, market share, and profitability. A warning is in order, however. The
commitment made to a market should be based on a company’s resources, its
strengths, and its willingness to take risks to live up to its commitment. For example, Procter & Gamble could afford to implement its commitment to thePittsburgh market because it had a good rapport with distributors and dealers
and the resources to launch an effective promotional campaign. A small company
could not have afforded to do all of that.
AverageCommitment
Strategy

When a company has a stable interest in a market, it must stress the maintenanceof the status quo, leading to an only average commitment to the market.
Adoption of the average-commitment strategy may be triggered by the fact thata strong-commitment strategy is not feasible. The company may lack theresources to make a strong commitment; a strong commitment may be in conflictwith top management’s value orientation; or the market in question may not constitute a major thrust of the business in, for example, a diversified company.

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In April 1976, when the Eastman Kodak Company announced its entry into
the instant photography field, the company most worried about this move was
Polaroid. Because Polaroid had a strong commitment to the instant photographymarket, it did not like Kodak being there just for the sake of competition. As
Polaroid’s president commented, “This is our very soul that we are involved
with. This is our whole life. For them it’s just another field.”23 Similarly, when
Frito-Lay (a division of PepsiCo) entered the cookie business in 1982, the industry leader, Nabisco, had to adopt a new strategy to defend its title in the business.
As an executive of the company noted, “We aren’t going to sit on our haunches
and let 82 years of business go down the drain.”24
A company with an average commitment to a market can afford to makeoccasional mistakes because it has other businesses to compensate for them.
Essentially, the average-commitment strategy requires keeping customers happy
by providing them with what they are accustomed to. This can be accomplishedby making appropriate changes in a marketing program as required by environmental shifts, thus making it difficult for competitors to lure customers away.
Where commitment is average, however, the company becomes vulnerable to thelead company as well as the underdog. The leader may wipe out the averagecommitment company by price cutting, a feasible strategy because of the experience effect. The underdog may challenge the average-commitment company byintroducing new products, focusing on new segments within the market, trying
out new forms of distribution, or launching new types of promotional thrusts.
The best defense for a company with an average commitment to a market is tokeep customers satisfied by being vigilant about developments in its market.
An average commitment may be adequate, as far as profitability is concerned,
if the market is growing. In a slow-growth market, an average commitment is notconducive to achieving either growth or profitability.
Light-Commitment
Strategy

A company may have only a passing interest in a market; consequently, it may
make only a light commitment to it. The passing interest may be explained by thefact that the market is stagnant, its potential is limited, it is overcrowded withmany large companies, and so on. In addition, a company may opt for light commitment to a market to avoid antitrust difficulties. GE maintained a light commitment in the color television market because the field was overcrowded,
particularly by Japanese companies. (In 1988, GE sold its television business toThomson, a French company.) In the early 1970s, Procter & Gamble adopted thelight-commitment strategy in the shampoo market, presumably to avoid antitrust
difficulties such as those it had encountered with Clorox several years previously;
Procter & Gamble let its share of the shampoo market slip from around 50 percent
to a little over 20 percent, delayed reformulating its established brands (Prell andHead & Shoulders), introduced only one new brand in many years, and substantially cut its promotional efforts.25
A company with a light commitment to a market operates passively and does
not make any new moves. It is satisfied as long as the business continues to be in

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the black and thus seeks very few changes in its marketing perspectives. Overall,this strategy is not of much significance for a company pursuing increasing profitability, greater market share, or growth.

MARKET-DILUTION STRATEGY
In many situations, a company may find reducing a part of its business strategically more useful than expanding it. The market-dilution strategy works out wellwhen the overall benefit that a company derives from a market, either currentlyor potentially, is less than it could achieve elsewhere. Unsatisfactory profit performance, desire for concentration in fewer markets, lack of top management
knowledge of the market, negative synergy vis-à-vis other markets that the company serves, and lack of resources to develop the market fully are other reasonsfor diluting market position.
There was a time when dilution of a market was considered an admission of
failure. In the 1970s, however, dilution came to be accepted purely as a matter ofstrategy. Different ways of diluting a market include demarketing, pruning marginal markets, key account strategy, and harvesting strategy.
Demarketing
Strategy

Demarketing, in a nutshell, is the reverse of marketing. This term became popular in the early 1970s when, as a result of the Arab oil embargo, the supply of avariety of products became short. Demarketing is the attempt to discourage customers in general or a certain class of customers in particular on either a temporary or permanent basis.
The demarketing strategy may be implemented in different ways. One way
involves keeping close track of time requirements of different customers. Thus, if
one customer needs the product in July and another in September, the former’sorder is filled first even though the latter confirmed the order first. A second wayof demarketing is rationing supplies to different customers on an equitable basis.
Shell Oil followed this route toward the end of 1978 when a gasoline shortage
occurred. Each customer was sold a maximum of 10 gallons of gasoline at eachfilling. Third, recommending that customers use a substitute product temporarily
is a form of demarketing. The fourth demarketing method is to divert a customer
with an immediate need for a product to another customer to whom the productwas recently supplied and who is unlikely to use it immediately. The company
becomes an intermediary between two customers, providing supplies of the
product to one customer whenever they are needed if present supplies are transferred to the customer in need.
The demarketing strategy is directed toward maintaining customer goodwill
during times when customer demands cannot be adequately met. By helping customers in the different ways discussed above, the company hopes that the situation requiring demarketing is temporary and that, when conditions are normal
again, customers will be inclined favorably toward the company. In the long run,the demarketing strategy should lead to increased profitability.

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Pruning-ofMarginal Markets
Strategy

A company must undertake a conscious search for those markets that do not provide rates of return comparable to those rates that could be attained if it were to
shift its resources to other markets. These markets potentially become candidates
for pruning. The pruning of marginal markets may result in a much higher
growth rate for the company as a whole. Consider two markets, one providing 10
percent and the other 20 percent on original investments of $1 million. After 15
years, the first market will show an equity value of $4 million, as opposed to $16
million for the second one. Pruning can improve return on investment andgrowth rate by ridding the company of markets that are growing more slowly
than the rest of its markets and by providing cash for investment in faster-growing, higher-return markets. Several years ago, A&P closed more than 100 stores inmarkets where its competitive position was weak. This pruning effort helped thecompany to fortify its position and to concentrate on markets where it felt strong.
Pruning also helps to restore balance. A company may be out of balance when
it has too many diverse and difficult markets to serve. By pruning, the company
may limit its operations to growth markets only. Because growth markets require
heavy doses of investment (in the form of price reductions, promotion, and market development) and because the company may have limited resources, thepruning strategy can be very beneficial. Chrysler Corporation, for example,
decided in 1978 to quit the European market so that it could use its limited
resources to restore its position in the U.S. market. The pruning strategy is especially helpful in achieving market share and profitability.

Key-Markets
Strategy

In most industries, a few customers account for a major portion of volume. This
characteristic may be extended to markets. If the breakdown of markets is properly done, a company may find that a few markets account for a very large shareof its revenues. Strategically, these key markets may call for extra emphasis interms of selling effort, after-sales service, product availability, and so on. As amatter of fact, the company may decide to limit its business to these key markets
alone.
The key-markets strategy requires:
1. A strong focus tailored to environmental differences (i.e., don’t try to do everything; rather, compete in carefully selected ways with the competitive emphasis
differing according to the market environment).
2. A reputation for high quality (i.e., turn out high-quality products with superior
performance potential and reliability).
3. Medium to low relative prices complementing high quality.
4. Low total cost to permit offering high-quality products at low prices and stillshow high profits.

Harvesting
Strategy

The harvesting strategy refers to a situation where a company may decide to let
its market share slide deliberately. The harvesting strategy may be pursued for avariety of reasons: to increase badly needed cash flow, to increase short-term
earnings, or to avoid antitrust action. Usually, only companies with high market
share can expect to harvest successfully.

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If a product reaches the stage where continued support can no longer be justified, it may be desirable to realize a short-term gain by raising the price or bylowering quality and cutting advertising to turn an active brand into a passive
one. In any event, the momentum of the product may continue for years withsales declining but with useful revenues still coming in.
Because they reduce a firm’s strategic flexibility, exit barriers may prevent a company from implementing a harvesting strategy. Exit barriers refer to circumstances
within an industry that discourage the exit of competitors whose performance inthat particular business may be marginal. Three types of exit barriers are (a) a thinresale market for the business’s assets, (b) intangible strategic barriers as deterrents
to timely exit (e.g., value of distribution networks, customer goodwill for the otherproducts of the company, or strong corporate identification with the product), and(c) management’s reluctance to terminate a sick line. When exit barriers disappear orwhen their effect ceases to be of concern, a harvesting strategy may be pursued.

SUMMARY

This chapter illustrated various types of market strategies that a company may
pursue. Market strategies rest on a company’s perspective of the customer.
Customer focus is a very important factor in market strategy. By diligently delineating the markets to be served, a company can effectively compete in an industry even with established firms.
The five different types of market strategies and the various alternatives
under each strategy that were examined in this chapter are outlined below:
1. Market-scope strategy.
a. Single-market strategy
b. Multimarket strategy
c. Total-market strategy
2. Market-geography strategy.
a. Local-market strategy
b. Regional-market strategy
c. National-market strategy
d. International-market strategy
3. Market-entry strategy.
a. First-in strategy
b. Early-entry strategyc. Laggard-entry strategy
4. Market-commitment strategy.
a. Strong-commitment strategy
b. Average-commitment strategy
c. Light-commitment strategy
5. Market-dilution strategy.
a. Demarketing strategy
b. Pruning-of-marginal-markets strategy
c. Key-markets strategy
d. Harvesting strategy

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Application of each strategy was illustrated with examples from marketing
literature. The impact of each strategy was considered in terms of its effect onmarketing objectives (i.e., profitability, growth, and market share).

DISCUSSIONQUESTIONS

NOTES

1. What circumstances may lead a business unit to change the scope of its market?
2. Under what conditions may a company adopt across-the-board market strategy?
3. Can a company operating only locally go international? Discuss and give
examples.
4. Examine the pros and cons of being the first in a market.
5. What underlying conditions must be present before a company can make astrong commitment to a market?
6. Define the term demarketing. What circumstances dictate the choice of demarketing strategy?
7. List exit barriers that may prevent a company from implementing a harvesting
strategy.

“Design and Manufacturing Corporation,” a case copyrighted in 1972 by the President
and Fellows of Harvard College, 4.
2 ”P&G May Spark Agency Battle For Tambrands,” Advertising Age (14 April 1997): 10.
3 Raju Narisetti, “P&G, Seeing Shoppers Were Being Confused, Overhauls Marketing,”
The Wall Street Journal (15 January 1997): A1.
4 “Crowning Achievement,” Forbes (29 October 1990): 178.
5 ”By Any Other Means,” Beverage-World (15 June 1997): 50.
6 Patricia Seremet, “Timex Get Watches for Outdoors Market,” Hartford Courant (15March 1996): F2.
7 ”A Slippery Slope for North Face,” Business Week (7 December 1998): 66.
8 ”From the Microbrewers Who Brought You Bud, Coors . . .,” Business Week (24 April
1995): 66.
9 John Huey, “Eisner Explains Everything,” Fortune (17 April 1995): 44.
10 Dom Del Prete, “How Regional Firms Find Their Niches,” Marketing News (13 October1997): 8.
11 Statistical Abstract of the United States (1998): 788.
12 Marc Beauchamp, “Lost in the Woods,” Forbes (16 October 1989): 22; see also
Weyerhaeuser Company’s Annual Report for 1994.
13 “Why First May Not Last,” The Economist (16 March 1996): 65.
14 “Sara Lee: Playing With the Recipe,” Business Week (27 April 1998): 114.
15 Gerald J. Tellis and Peter N. Golder,” First to Market, First to Fail? Real Causes ofEnduring Market Leadership,” Slogan Management Review (Winter 1996): 65–75.
16 Gianna Jacobson, “Comfortable in the Driver’s Seat,” New York Times (23 January1997): D1.
17 Kenichi Ohmae, “Effective Strategies for Competitive Success,” McKinsey Quarterly(Winter 1978): 55.
18 “Wilmington Corporation,” a case copyrighted in 1976 by the President and Fellows ofHarvard College.
1

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19 “How Badly Is Liggett Getting Burned?” Business Week (7 July 1997): 36.
20 Alex Taylor III, “Kodak Scrambles to Refocus,” Fortune (3 March 1986): 34. See also

James Champy, “Ending Your Company’s Slump,” Sales and Marketing Management(May 1998): 26.
21 Alex Taylor, “Porsche Slices Up Its Buyers,” Fortune (16 January 1995): 24.
22 “Levi’s Is Hiking Up Its Pants,” Business Week (1 December 1997): 70.
23 New York Times (28 April 1976): 23.
24 Ann M. Morrison, “Cookies Are Frito-Lay’s New Bag,” Fortune (9 August 1982): 64.
25 Nancy Giges, “Shampoo Rivals Wonder When P&G Will Seek Old Dominance,”
Advertising Age (23 September 1974): 3.

APPENDIX
I.
Market-Scope
Strategy

Perspectives of Market Strategies
A. Single-Market Strategy
Definition: Concentration of efforts in a single segment.
Objective: To find a segment currently being ignored or served inadequately
and meet its needs.
Requirements: (a) Serve the market wholeheartedly despite initial difficulties.
(b) Avoid competition with established firms.
Expected Results: (a) Low costs. (b) Higher profits.
B. Multimarket Strategy
Definition: Serving several distinct markets.
Objective: To diversify the risk of serving only one market.
Requirements: (a) Carefully select segments to serve. (b) Avoid confrontation
with companies serving the entire market.
Expected Results: (a) Higher sales. (b) Higher market share.
C. Total-Market Strategy
Definition: Serving the entire spectrum of the market by selling differentiatedproducts to different segments in the market.
Objective: To compete across the board in the entire market.
Requirements: (a) Employ different combinations of price, product, promotion,and distribution strategies in different segments. (b) Top management commitment to embrace entire market. (c) Strong financial position.
Expected Results: (a) Increased growth. (b) Higher market share.

II.
Market-Geography
Strategy

A. Local-Market Strategy
Definition: Concentration of efforts in the immediate vicinity.
Objective: To maintain control of the business.
Requirements: (a) Good reputation in the geographic area. (b) Good hold on
requirements of the market.

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Expected Results: Short-term success; ultimately must expand to other areas.
B. Regional-Market Strategy
Definition: Operating in two or three states or over a region of the country(e.g., New England).
Objectives: (a) To diversify risk of dependence on one part of a region. (b) To
keep control centralized.
Requirements: (a) Management commitment to expansion. (b) Adequate
resources. (c) Logistical ability to serve a regional area.
Expected Results: (a) Increased growth. (b) Increased market share. (c) Keep up
with competitors.
C. National-Market Strategy
Definition: Operating nationally.
Objective: To seek growth.
Requirements: (a) Top management commitment. (b) Capital resources.
(c) Willingness to take risks.
Expected Results: (a) Increased growth. (b) Increased market share. (c) Increased profitability.
D. International-Market Strategy
Definition: Operating outside national boundaries.
Objective: To seek opportunities beyond domestic business.
Requirements: (a) Top management commitment. (b) Capital resources.
(c) Understanding of international markets.
Expected Results: (a) Increased growth. (b) Increased market share. (c) Increased profits.
III.
Market-Entry
Strategy

A. First-In Strategy
Definition: Entering the market before all others.
Objective: To create a lead over competition that will be difficult for them tomatch.
Requirements: (a) Be willing and able to take risks. (b) Be technologically competent. (c) Strive to stay ahead. (d) Promote heavily. (e) Create primarydemand. (f) Carefully evaluate strengths.
Expected Results: (a) Reduced costs via experience. (b) Increased growth.
(c) Increased market share. (d) Increased profits.
B. Early-Entry Strategy
Definition: Entering the market in quick succession after the leader.
Objective: To prevent the first entrant from creating a stronghold in the market.

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Requirements: (a) Superior marketing strategy. (b) Ample resources. (c) Strong
commitment to challenge the market leader.
Expected Results: (a) Increased profits. (b) Increased growth. (c) Increased market share.
C. Laggard-Entry Strategy
Definition: Entering the market toward the tail end of growth phase or during
maturity phase. Two modes of entry are feasible: (a) Imitator—Entering
market with me-too product; (b) Initiator—Entering market with unconventional marketing strategies.
Objectives: Imitator—To capture that part of the market that is not brand loyal.
Initiator—To serve the needs of the market better than present firms.
Requirements: Imitator—(a) Market research ability. (b) Production capability.
Initiator—(a) Market research ability. (b) Ability to generate creative marketing strategies.
Expected Results: Imitator—Increased short-term profits. Initiator—(a) Putting
market on a new growth path. (b) Increased profits. (c) Some growth opportunities.
IV.
MarketCommitment
Strategy

A. Strong-Commitment Strategy
Definition: Fighting off challenges aggressively by employing different forms
of product, price, promotion, and distribution strategies.
Objective: To defend position at all costs.
Requirements: (a) Operate optimally by realizing economies of scale in promotion, distribution, manufacturing, etc. (b) Refuse to be content with present
situation or position. (c) Have ample resources. (d) Be willing and able totake risks.
Expected Results: (a) Increased growth. (b) Increased profits. (c) Increased market share.
B. Average-Commitment Strategy
Definition: Maintaining stable interest in the market.
Objective: To maintain the status quo.
Requirements: Keep customers satisfied and happy.
Expected Results: Acceptable profitability.
C. Light-Commitment Strategy
Definition: Having only a passing interest in the market.
Objective: To operate in the black.
Requirements: Avoid investing for any long-run benefit.
Expected Results: Maintenance of status quo (no increase in growth, profits, ormarket share).

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V.
Market-Dilution
Strategy357

A. Demarketing Strategy
Definition: Discouraging customers in general or a certain class of customers
in particular, either temporarily or permanently, from seeking the product.
Objective: To maintain customer goodwill during periods of shortages.
Requirements: (a) Monitor customer time requirements. (b) Ration productsupplies. (c) Divert customers with immediate needs to customers who
have a supply of the product but no immediate need for it. (d) Find out andsuggest alternative products for meeting customer needs.
Expected Results: (a) Increased profits. (b) Strong customer goodwill andloyalty.
B. Pruning-of-Marginal-Markets Strategy
Definition: Weeding out markets that do not provide acceptable rates ofreturn.
Objective: To divert investments in growth markets.
Requirements: (a) Gain good knowledge of the chosen markets. (b) Concentrate all energies on these markets. (c) Develop unique strategies to serve
the chosen markets.
Expected Results: (a) Long-term growth. (b) Improved return on investment.
(c) Decrease in market share.
C. Key-Markets Strategy
Definition: Focusing efforts on selected markets.
Objective: To serve the selected markets extremely well.
Requirements: (a) Gain good knowledge of the chosen markets. (b) Concentrate all energies on these markets. (c) Develop unique strategies to serve
the chosen markets.
Expected Results: (a) Increased profits. (b) Increased market share in theselected markets.
D. Harvesting Strategy
Definition: Deliberate effort to let market share slide.
Objectives: (a) To generate additional cash flow. (b) To increase short-term
earnings. (c) To avoid antitrust action.
Requirements: High-market share.
Expected Results: Sales decline but useful revenues still come in.

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Product Strategies
Good is not good where
better is expected.
THOMAS FULLER

P

roduct strategies specify market needs that may be served by different productofferings. It is a company’s product strategies, duly related to market strategies, that eventually come to dominate both overall strategy and the spirit of thecompany. Product strategies deal with such matters as number and diversity of
products, product innovations, product scope, and product design. In this chapter,
different dimensions of product strategies are examined for their essence, their significance, their limitations, if any, and their contributions to objectives and goals.
Each strategy will be exemplified with illustrations from marketing literature.

DIMENSIONS OF PRODUCT STRATEGIESThe implementation of product strategies requires cooperation among different
groups: finance, research and development, the corporate staff, and marketing.
This level of integration makes product strategies difficult to develop and implement. In many companies, to achieve proper coordination among diverse business units, product strategy decisions are made by top management. At Gould,
for example, the top management decides what kind of business Gould is andwhat type it wants to be. The company pursues products in the areas of electromechanics, electrochemistry, metallurgy, and electronics. The company works todispose of products that do not fall strictly into its areas of interest.1
In some companies, the overall scope of product strategy is laid out at the corporate level, whereas actual design is left to business units. These companies contend that this alternative is more desirable than other arrangements because it isdifficult for top management to deal with the details of product strategy in adiverse company. In this chapter, the following product strategies are recognized:
•
•
•
•
•
•
•
•
•

Product-positioning strategy
Product-repositioning strategy
Product-overlap strategy
Product-scope strategy
Product-design strategy
Product-elimination strategy
New-product strategy
Diversification strategy
Value-marketing strategy

Each strategy is examined from the point of view of an SBU. The appendix at
the end of this chapter summarizes each strategy, giving its definition, objectives,
requirements, and expected results.
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PRODUCT-POSITIONING STRATEGY
The term positioning refers to placing a brand in that part of the market where it
will receive a favorable reception compared to competing products. Because themarket is heterogeneous, one brand cannot make an impact on the entire market.
As a matter of strategy, therefore, a product should be matched with that segmentof the market in which it is most likely to succeed. The product should be positioned so that it stands apart from competing brands. Positioning tells what the
product stands for, what it is, and how customers should evaluate it.
Positioning is achieved by using marketing mix variables, especially designand communication. Although differentiation through positioning is more visible
in consumer goods, it is equally true of industrial goods. With some products,
positioning can be achieved on the basis of tangible differences (e.g., product features); with many others, intangibles are used to differentiate and position products. As Levitt has observed:
Fabricators of consumer and industrial goods seek competitive distinction via product features—some visually or measurably identifiable, some cosmetically implied,and some rhetorically claimed by reference to real or suggested hidden attributes thatpromise results or values different from those of competitors’ products.
So too with consumer and industrial services—what I call, to be accurate, “intangibles.” On the commodities exchanges, for example, dealers in metals, grains, andpork bellies trade in totally undifferentiated generic products. But what they “sell” isthe claimed distinction of their execution—the efficiency of their transactions in theirclient’s behalf, their responsiveness to inquiries, the clarity and speed of their confirmations, and the like. In short, the offered product is differentiated, though the genericproduct is identical.2

The desired position for a product may be determined using the following
procedure:
1. Analyze product attributes that are salient to customers.
2. Examine the distribution of these attributes among different market segments.
3. Determine the optimal position for the product in regard to each attribute, taking
into consideration the positions occupied by existing brands.
4. Choose an overall position for the product (based on the overall match between
product attributes and their distribution in the population and the positions ofexisting brands).

For example, cosmetics for the career woman may be positioned as “natural,”cosmetics that supposedly make the user appear as if she were wearing no
makeup at all. An alternate position could be “fast” cosmetics, cosmetics to givethe user a mysterious aura in the evenings. A third position might be “light” cosmetics, cosmetics to be worn for tennis and other leisure activities.
Consider the positioning of beer. Two positioning decisions for beer are light
versus heavy and bitter versus mild. The desired position for a new brand of beer
can be determined by discovering its rating on these attributes and by considering the size of the beer market. The beer market is divided into segments according to these attributes and the positions of other brands. It may be found that theProduct Strategies

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heavy and mild beer market is large and that Stroh and Budweiser compete in it.
In the light and mild beer market, another big segment, Miller and AnheuserBusch are the dominant competitors. Management may decide to position a new
brand in competition with Miller Lite and Bud Light.
Disney stores demonstrate how adequate positioning can lead to instant success.3 Disney stores earn more than three times what other specialty stores earn
per every square foot of floor space. Disney has created retail environments withentertainment as their chief motif. As a customer enters the store, he/she sees the
Magic Kingdom, a land of bright lights and merry sounds packed full of Mickey
Mouse merchandise. From a phone at the front of each store, a customer can get
the Disney channel or book a room in a Disney World hotel. Disney designers got
down on their hands and knees when they laid out the stores to be sure that theirsight lines would work for a three-year-old. The back wall, normally a prime display area, is given over to a large video screen that continuously plays clips from
Disney’s animated movies and cartoons. Below the screen, at kid level, sit tiers of
stuffed animals that toddlers are encouraged to play with. Adult apparel hangs at
the front of the stores to announce that they are for shoppers of all ages. Floor fixtures that hold the merchandise angle inward to steer shoppers deeper into thisflashy money trap. Managers spend six weeks in intensive preparatory classes
and training before being assigned to a store. Garnished with theatrical lighting
and elaborate ceiling displays, the stores have relatively high start-up and fixed
costs, but once up and running, they earn high margins.
Six different approaches to positioning may be distinguished:
1. Positioning by attribute (i.e., associating a product with an attribute, feature, or
customer benefit).
2. Positioning by price/quality (i.e., the price/quality attribute is so pervasive that it
can be considered a separate approach to promotion).
3. Positioning with respect to use or application (i.e., associating the product with ause or application).
4. Positioning by the product user (i.e., associating a product with a user or a classof users).
5. Positioning with respect to a product class (e.g., positioning Caress soap as a bathoil product rather than as soap).
6. Positioning with respect to a competitor (i.e., making a reference to competition,
as in Avis’s now-famous campaign: “We’re number two, so we try harder.”).

Two types of positioning strategy are discussed here: single-brand strategy
and multiple-brand strategy. A company may have just one brand that it may
place in one or more chosen market segments, or, alternatively, it may have several brands positioned in different segments.
Positioning aSingle Brand

To maximize its benefits with a single brand, a company must try to associateitself with a core segment in a market where it can play a dominant role. In addition, it may attract customers from other segments outside its core as a fringe benefit. BMW does very well, for example, positioning its cars mainly in a limited
segment to high-income young professionals.

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An alternative single-brand strategy is to consider the market undifferentiated and to cover it with a single brand. Several years ago, for example, theCoca-Cola Company followed a strategy that proclaimed that Coke quenched
the thirst of the total market. Such a policy, however, can work only in the shortrun. To seek entry into a market, competitors segment and challenge the dominance of the single brand by positioning themselves in small, viable niches.
Even the Coca-Cola Company now has a number of brands to serve different
segments: Classic Coke, Diet Coke, Fanta, Sprite, Tab, Fresca, and even orange
juice.
Consider the case of beer. Traditionally, brewers operated as if there were one
homogeneous market for beer that could be served by one product in one package. Miller, in order to seek growth, took the initiative to segment the market andpositioned its High Life brand to younger customers. Thereafter, it introduced aseven-ounce pony bottle that turned out to be a favorite among women and older
people who thought that the standard 12-ounce size was simply too much beer todrink. But Miller’s big success came in 1975 with the introduction of anotherbrand, low-calorie Lite. Lite now stands to become the most successful new beer
introduced in the United States in this century.
To protect the position of a single brand, sometimes a company may be forced
to introduce other brands. Kotler reports that Heublein’s Smirnoff brand had a 23
percent share of the vodka market when its position was challenged by
Wolfschmidt, priced at $1 less a bottle. Instead of cutting the price of its Smirnoff
brand to meet the competition, Heublein raised the price by one dollar and used
the increased revenues for advertising. At the same time, it introduced a new
brand, Relska, positioning it against Wolfschmidt, and also marketed Popov, alow-price vodka. This strategy effectively met Wolfschmidt’s challenge and gave
Smirnoff an even higher status. Heublein resorted to multiple brands to protect asingle brand that had been challenged by a competitor.4
Anheuser-Busch has been dependent on Bud and Bud Light for more than
two-thirds of its brewery volume and for over half of its sales revenues. It was thisdependence on a single brand that led the company to introduce Michelob. This
brand, however, is not doing as well as expected, and at the same time, rivals areshowing signs of fresh energy and determination, making it urgent for the company to diversify.5
Whether a single brand should be positioned in direct competition with adominant brand already on the market or be placed in a secondary position isanother strategic issue. The head-on route is usually risky, but some variation ofthis type of strategy is quite common. Avis seemingly accepted a number two
position in the market next to Hertz. Gillette, on the other hand, positioned
Silkience shampoo directly against Johnson’s Baby Shampoo and Procter &Gamble’s Prell. Generally, a single-brand strategy is a desirable choice in the shortrun, particularly when the task of managing multiple brands is beyond the managerial and financial capability of a company. Supposedly, this strategy is more
conducive to achieving higher profitability because a single brand permits better
control of operations than do multiple brands.

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There are two requisites to managing a single brand successfully: a single
brand must be so positioned that it can stand competition from the toughest rival,
and its unique position should be maintained by creating an aura of a distinctive
product. Consider the case of Cover Girl. The cosmetics field is a crowded andhighly competitive industry. The segment Cover Girl picked out—sales in supermarkets and discount stores—is one that large companies, such as Revlon, Avon,and Estee Lauder, have not tapped. Cover Girl products are sold at a freestanding display without sales help or demonstration. As far as the second requisite isconcerned, creating an aura of a distinctive product, an example is Perrier. It continues to protect its position through the mystique attached to its name. In otherwords, a single brand must have some advantage to protect it from competitive
inroads.
Positioning
Multiple Brands

Business units introduce multiple brands to a market for two major reasons: (a) toseek growth by offering varied products in different segments of the market and(b) to avoid competitive threats to a single brand. General Motors has a car to sellin all conceivable segments of the market. Coca-Cola has a soft drink for each different taste. IBM sells computers for different customer needs. Procter & Gamble
offers a laundry detergent for each laundering need. Offering multiple brands todifferent segments of the same market is an accepted route to growth.
To realize desired growth, multiple brands should be diligently positioned in
the market so that they do not compete with each other and create cannibalism.
For example, 20 to 25 percent of sales of Anheuser-Busch’s Michelob Light are tocustomers who previously bought regular Michelob but switched because of theLight brand’s low-calorie appeal.6 The introduction of Maxim by General Foods
took sales away from its established Maxwell House brand. About 20 percent ofsales of Miller’s Genuine Draft beer come from Miller High Life.7 Thus, it is necessary to be careful in segmenting the market and to position the product,
through design and promotion, as uniquely suited to a particular segment.
Of course, some cannibalism is unavoidable. But the question is how muchcannibalism is acceptable when introducing another brand. It has been said that70 percent of Mustang sales in its introductory year were to buyers who would
have purchased another Ford had the Mustang not been introduced; the remaining 30 percent of its sales came from new customers. Cadbury’s experience with
the introduction of a chocolate bar in England indicates that more than 50 percent
of its volume came from market expansion, with the remaining volume comingfrom the company’s existing products. Both the Mustang and the chocolate bar
were rated as successful introductions by their companies. The apparent difference in cannibalism rates shows that cost structure, degree of market maturity,and the competitive appeal of alternative offerings affect cannibalism sales andtheir importance to the sales and profitability of a product line and to individual
items.8
An additional factor to consider in determining actual cannibalism is the vulnerability of an existing brand to a competitor’s entry into a presumably open
spot in the market. For example, suppose that a company’s new brand derives 50

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percent of its sales from customers who would have bought its existing brand.
However, if 20 percent of the sales of this existing brand were susceptible to acompetitor’s entry (assuming a fairly high probability that the competitor would
have indeed positioned its new brand in that open spot), the actual level of cannibalism should be set at 30 percent. This is because 20 percent of the revenue
from sales of the existing brand would have been lost to a competitive brand had
there been no new brand.
Multiple brands can be positioned in the market either head-on with theleading brand or with an idea. The relative strengths of the new entry and theestablished brand dictate which of the two positioning routes is more desirable.
Although head-on positioning usually appears risky, some companies have successfully carried it out. IBM’s personal computer was positioned in head-on
competition with Apple’s. Datril, a Bristol-Myers painkiller, was introduced tocompete directly with Tylenol.
Positioning with an idea, however, can prove to be a better alternative, especially when the leading brand is well established. Positioning with an idea was
attempted by Kraft when it positioned three brands (Breyers and Sealtest ice
cream and Light ‘n’ Lively ice milk) as complements rather than as competitors.
Vick Chemical positioned Nyquil, a cold remedy, with the idea that Nyquil
assured a good night’s sleep. Seagram successfully introduced its line of cocktail
mixes, Party Tyme, against heavy odds in favor of Holland House, a National
Distillers brand, by promoting it with the Snowbird winter drink.
Positioning of multiple brands and their management in a dynamic environment call for ample managerial and financial resources. When these resources arelacking, a company is better off with a single brand. In addition, if a company
already has a dominant position, its attempt to increase its share of the market byintroducing an additional brand may invite antitrust action. Such an eventuality
should be guarded against. On the other hand, there is also a defensive, or sharemaintenance, issue to be considered here even if one has the dominant entry. A
product with high market share may not remain in this position forever if competitors are permitted to chip away at its lead with unchallenged positions.
As a strategy, the positioning of multiple brands, if properly implemented,
can lead to increases in growth, market share, and profitability.

PRODUCT-REPOSITIONING STRATEGY
Often, a product may require repositioning. This can happen if (a) a competitive
entry is positioned next to the brand, creating an adverse effect on its share of themarket; (b) consumer preferences change; (c) new customer preference clusters
with promising opportunities are discovered; or (d) a mistake is made in the original positioning.
Citations from the marketing literature serve to illustrate how repositioning
becomes desirable under different circumstances. When A & W went national in
1989 with its cream soda, it failed to clearly articulate the position. As a result,research showed that consumers perceived cream soda as an extension of the root

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beer family. To correct this, the company repositioned the brand as a separate
soda category by emphasizing the vanilla flavor through advertising and packaging. Following the repositioning, cream soda’s sales increased rapidly.9
Over the years, Coca-Cola’s position has shifted to keep up with the changing mood of the market. In recent years, the theme of Coca-Cola’s advertising has
evolved from “Things go better with Coke” to “It’s the real thing” to “Coke is it”
to “Can’t beat the feeling” to “Catch the Wave” to “Always new, always real,
always you, always Coke.” The current perspective of Coca-Cola’s positioning is
to reach a generation of young people and those young at heart.
The risks involved in positioning or repositioning a product or service arehigh. The technique of perceptual mapping may be used gainfully to substantially reduce those risks. Perceptual mapping helps in examining the position ofa product relative to competing products. It helps marketing strategists• Understand how competing products or services are perceived by various consumer groups in terms of strengths and weaknesses.
• Understand the similarities and dissimilarities between competing products andservices.
• Understand how to reposition a current product in the perceptual space of consumer segments.
• Position a new product or service in an established marketplace.
• Track the progress of a promotional or marketing campaign on the perceptions oftargeted consumer segments.

The use of perceptual mapping may be illustrated with reference to the automobile industry. Exhibit 14-1 shows how different cars are positioned on a perceptual map. The map helps the marketing strategist in calculating whether acompany’s cars are on target. The concentration of dots, which represent competing models, shows how much opposition there is likely to be in a specific territoryon the map. Presumably, cars higher up on the graph fetch a higher price thanmodels ranked toward the bottom where the stress is on economy and practicality.
After looking at the map, General Motors might find that its Chevrolet division,
traditionally geared to entry-level buyers, ought to move down in practicality andmore to the right in youthfulness. Another problem for General Motors, which themap so clearly demonstrates, is the close proximity of its Buick and Oldsmobile
divisions. This close proximity suggests that the two divisions are waging a marketing war more against each other than against the competition.
Basically, there are three ways to reposition a product: among existing users,
among new users, and for new uses. The discussion that follows will elaborate onthese repositioning alternatives.
Repositioning
among Existing
Customers

Repositioning a product among existing customers can be accomplished by promoting alternative uses for it. To revitalize its stocking business, Du Pont adopted
a repositioning strategy by promoting the “fashion smartness” of tinted hose.
Efforts were directed toward expanding women’s collections of hosiery by creating a new fashion image for hosiery: hosiery was not simply a neutral accessory;

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EXHIBIT 14-1
Perceptual Map of Brand Images

rather, a suitable tint and pattern could complement each garment in a woman’s
wardrobe.
General Foods Corporation repositioned Jell-O to boost its sales by promoting it as a base for salads. To encourage this usage, the company introduced avariety of vegetable-flavored Jell-Os. A similar strategy was adopted by 3M
Company, which introduced a line of colored, patterned, waterproof, invisible,
and write-on Scotch tapes for different types of gift wrapping.
The purpose of repositioning among current users is to revitalize a product’s
life by giving it a new character as something needed not merely as a staple product but as a product able to keep up with new trends and new ideas.
Repositioning among users should help the brand in its sales growth as well as
increasing its profitability.
Repositioning
among New Users

Repositioning among new users requires that the product be presented with a different twist to people who have not hitherto been favorably inclined toward it. In
so doing, care must be taken to see that, in the process of enticing new customers,
current customers are not alienated. Miller’s attempts to win over new customers

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for Miller High Life beer are noteworthy. Approximately 15 percent of the population consumes 85 percent of all the beer sold in the United States. Miller’s slogan “the champagne of bottled beer” had more appeal for light users than forheavy users. Also, the image projected too much elegance for a product like beer.
Miller decided to reposition the product slightly to appeal to a wider range ofbeer drinkers without weakening its current franchise: “Put another way, theneed was to take Miller High Life out of the champagne bucket, but not to put itin the bathtub.” After conducting a variety of studies, Miller came up with a newpromotional campaign built around this slogan: “If you’ve got the time, we’ve got
the beer.” The campaign proved to be highly successful. Through its new slogan,the brand communicated three things: that it was a quality product worth taking
time out for; that it was friendly, low-key, and informal; and that it offered relaxation and reward after the pressures of the workday.
At Du Pont, new users of stockings were created by legitimizing the wearingof hosiery among early teenagers and subteenagers. This was achieved by working out a new ad campaign with an emphasis on the merchandising of youthfulproducts and styles to tempt young consumers. Similarly, Jell-O attempted todevelop new users among consumers who did not perceive Jell-O as a dessert orsalad product. Jell-O was advertised with a new concept—a fashion-oriented,
weight-control appeal.
The addition of new users to a product’s customer base helps enlarge theoverall market and thus puts the product on a growth route. Repositioning
among new users also helps increase profitability because very few new investments, except for promotional costs, need to be made.
Repositioning for
New Users

Repositioning for new uses requires searching for latent uses of the product. The
case of Arm and Hammer’s baking soda is a classic example of an unexplored useof a product. Today this product is popular as a deodorizer, yet deodorizing was not
the use originally conceived for the product. Although new uses for a product canbe discovered in a variety of ways, the best way to discover them is to gain insights
into the customer’s way of using a product. If it is found that a large number of customers are using the product for a purpose other than the one originally intended,this other use could be developed with whatever modifications are necessary.
Repositioning for new uses may be illustrated with reference to DisneyWorld’s efforts to expand its business. In 1991, it opened a Disney Fairy Tale
Weddings Department, which puts on more than 200 full-service weddings ayear, each costing about $10,000.10
At Du Pont, new uses for nylon sprang up in varied types of hosiery (stretch
stockings and stretch socks), tires, bearings, etc. Its new uses have kept nylon on
the growth path: wrap knits in 1945, tire cord in 1948, textured yarns in 1955, carpet yarns in 1959, and so on. Without these new uses, nylon would have hit thesaturation level as far back as 1962.
General Foods found that women used powdered gelatin dissolved in liquid
to strengthen their fingernails. Working on this clue, General Foods introduced aflavorless Jell-O as a nail-building agent.

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The new-use strategy is directed toward revamping the sales of a productwhose growth, based on its original conceived use, has slowed down. This strategy has the potential to increase sales growth, market share, and profitability.

PRODUCT-OVERLAP STRATEGY
The product-overlap strategy refers to a situation where a company decides tocompete against its own brand. Many factors lead companies to adopt such a
strategic posture. For example, A&P stores alone cannot keep the company’s 42
manufacturing operations working at full capacity. Therefore, A&P decided to
distribute many of its products through independent food retailers. A&P’s EightO’Clock coffee, for example, is sold through 7-Eleven stores. Procter & Gamble
has different brands of detergents virtually competing in the same market. Eachbrand has its own organization for marketing research, product development,
merchandising, and promotion. Although sharing the same sales force, eachbrand behaves aggressively to outdo others in the marketplace. Sears’ large appliance brands are actually manufactured by the Whirlpool Corporation. Thus,
Whirlpool’s branded appliances compete against those that it sells to Sears.
There are alternative ways in which the product-overlap strategy may be
operationalized. Principal among them are having competing lines, doing private
labeling, and dealing with original-equipment manufacturers.
Competing Brands

In order to gain a larger share of the total market, many companies introduce competing products to the market. When a market is not neatly delineated, a single
brand of a product may not be able to make an adequate impact. If a second brandis placed to compete with the first one, overall sales of the two brands should
increase substantially, although there will be some cannibalism. In other words,
two competing brands provide a more aggressive front against competitors.
Often the competing-brands strategy works out to be a short-term phenomenon. When a new version of a product is introduced, the previous version isallowed to continue until the new one has fully established itself. In this way, thecompetition is prevented from stealing sales during the time that the new product is coming into its own. In 1989, Gillette introduced the Sensor razor, a revolutionary new product that featured flexible blades that adjusted to follow theunique contours of the face. At the same time, its previous razor, Atra, continued
to be promoted as before. It is claimed that together the two brands were very
effective in the market. It is estimated that 36 percent of Sensor users converted
from Atra. If Atra had not been promoted, this figure would have been muchmore, and Sensor would have been more vulnerable to the Schick Tracer andother rigid Atra look-alikes.11 Interestingly, however, when Gillette introduced
the Mach 3 razor in 1998, it decided to run down stocks of its Sensor and Atrashavers ahead of the new product’s launch.12
To expand its overall coffee market, Procter & Gamble introduced a more economical form of ground coffee under the Folgers label. A more efficient milling
process that refines coffee into flakes allows hot water to come into contact with

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more of each coffee particle when brewing, resulting in savings of up to 15 percent per cup. The new product, packaged in 13-, 26-, and 32-ounce cans, yielded
the same number of cups of coffee as standard 16-, 32-, and 48-ounce cans, respectively. Both the new and the old formulations were promoted aggressively, competing with each other and, at the same time, providing a strong front against
brands belonging to other manufacturers.
Reebok International products under the Reebok brand name directly compete with its subsidiary’s brand, Avia. As noted earlier, the competing-brands
strategy is useful in the short run only. Ultimately, each brand, Avia and Reebok,
should find its special niche in the market. If that does not happen, they will create confusion among customers and sales will be hurt. Alternatively, in the longrun, one of the brands may be withdrawn, thereby yielding its position to theother brand. This strategy is a useful device for achieving growth and for increasing market share.
Private Labeling

Private labeling refers to manufacturing a product under another company’s
brand name. In the case of goods whose intermediaries have significant control ofthe distribution sector, private labeling, or branding, has become quite common.
For large food chains, items produced with their label by an outside manufacturer
contribute significantly to sales. Sears, J.C. Penney, and other such companies
merchandise many different types of goods—textile goods, electronic goods,
large appliances, sporting goods, etc.—each carrying the company’s brand name.
The private-label strategy from the viewpoint of the manufacturer is viable
for the following reasons:• Private labeling represents a large (and usually growing) market segment.
• Economies of scale at each step in the business system (manufacturing capacity,
distribution, merchandising, and so on) justify the search for additional volume.
• Supplying private labeling will improve relationships with a powerful organized
trade.
• Control over technology and raw materials reduces the risk.
• There is a clear consumer segmentation between branded and unbranded goods
that supports providing private labels.
• Private labeling helps eliminate small, local competitors.
• Private labeling offers an opportunity to compete on price against other branded
products.
• Private labeling increases share of shelf space—a critical factor in motivating
impulse purchases.

But here are also strong arguments against the private-label strategy:• Market share growth through private-label supply always happens at the expenseof profitability, as price sensitivity rises and margins fall.
• Disclosing cost information to the trade—usually essential for a private-label supplier—can threaten a firm’s branded products.
• In order to displace existing private-label suppliers, new entrants must undercut
current prices, and thus risk starting a price war—in an environment where trade
loyalty offers little protection.

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369• In young, growing markets, it is the brand leaders, not the private-label suppliers, that influence whether the market will develop toward branded or commodity goods.
• Private labeling is inconsistent with a leader’s global brand and product strategy—it raises questions about quality and standards, dilutes management attention, and affects consumers’ perception of the main branded business.

Many large manufacturers deal in private brands while simultaneously offering their own brands. In this situation, they are competing against themselves.
They do so, however, hoping that overall revenues will be higher with the offering of the private brand than without it. Coca-Cola, for example, supplies to A&P
stores both its own brand of orange juice, Minute Maid, and the brand it produces
with the A&P label. At one time, many companies equated supplying private
brands with lowering their brands’ images. But the business swings of the 1980schanged attitudes on this issue. Frigidaire appliances at one time were not offeredunder a private label. However, in the 1980s Frigidaire began offering them underMontgomery Ward’s name. An interesting question that can be raised about private branding is whether cars can be sold under a distributor’s own label. The
idea has surfaced at Auto Nation, the country’s biggest car retailer, who might
one day buy a car manufactured in, say, South Korea, and sell it under its own
label.13
A retailer’s interest in selling goods under its own brand name is also motivated by economic considerations. The retailer buys goods with its brand nameat low cost, then offers the goods to customers at a slightly lower price than theprice of a manufacturer’s brand (also referred to as a national brand). The
assumption is that the customer, motivated by the lower price, will buy a private
brand, assuming that its quality is on a par with that of the national brand. This
assumption is, of course, based on the premise that a reputable retailer will notoffer something under its name if it is not high quality. Consider the Save-A-Lot
chain, a unit of Minneapolis food distribution Super Valu Inc. whose 85% of sales
come from private-label items. With a total of 706 stores in 31 states, with sales
amounting to $ 3 billion, it is one of the nation’s fastest growing grocery chains.14
Dealing with
Original-Equipment
Manufacturers(OEMs)

Following the strategy of dealing with an OEM, a company may sell to competitors the components used in its own product. This enables competitors to compete with the company in the market. For example, in the initial stages of color
television, RCA was the only company that manufactured picture tubes. It soldthese picture tubes to GE and to other competitors, enabling them to competewith RCA color television sets in the market.
The relevance of this strategy may be discussed from the viewpoint of boththe seller and the OEM. The motivation for the seller comes from two sources: thedesire to work at near-capacity level and the desire to have help in promoting primary demand. Working at full capacity is essential for capitalizing on the experience effect (see Chapter 12). Thus, by selling a component to competitors, acompany may reduce the across-the-board costs of the component for itself, andit will have the price leverage to compete with those manufacturers to whom it

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sold the component. Besides, the company will always have the option of refusing to do business with a competitor who becomes a problem.
The second source of motivation is the support competitors can provide instimulating primary demand for a new product. Many companies may be working on a new-product idea. When one of them successfully introduces the product, the others may be unable to do so because they lack an essential component
or the technology that the former has. Since the product is new, the innovator may
find the task of developing primary demand by itself tedious. It may make astrategic decision to share the essential-component technology with other competitors, thus encouraging them to enter the market and share the burden of stimulating primary demand.
A number of companies follow the OEM strategy. Auto manufacturers sellparts to each other. Texas Instruments sold electronic chips to its competitors during the initial stages of the calculator’s development. In the 1950s, Polaroidbought certain essential ingredients from Kodak to manufacture film. IBM has
shared a variety of technological components with other computer producers. In
many situations, however, the OEM strategy may be forced upon companies by
the Justice Department in its efforts to promote competition in an industry. BothKodak and Xerox shared the products of their technology with competitors at thebehest of the government. Thus, as a matter of strategy, when government interference may be expected, a company will gain more by sharing its components
with others and assuming industry leadership. From the standpoint of results,
this strategy is useful in seeking increased profitability, though it may not havemuch effect on market share or growth.
As far as the OEMs are concerned, the strategy of depending upon a competitor for an essential component only works in the short run because the supplier may at some point refuse entirely to sell the component or may make it
difficult for the buyer to purchase it by delaying deliveries or by increasing prices
enormously.

PRODUCT-SCOPE STRATEGY
The product-scope strategy deals with the perspective of the product mix of acompany (i.e., the number of product lines and items in each line that the company may offer). The product-scope strategy is determined by making reference
to the business unit mission. Presumably, the mission defines what sort of business it is going to be, which helps in selecting the products and services that are
to become a part of the product mix.
The product-scope strategy must be finalized after a careful review of all
facets of the business because it involves long-term commitment. In addition, thestrategy must be reviewed from time to time to make any changes called for
because of shifts in the environment. The point may be elaborated with reference
to Eastman Kodak Company’s decision to enter the instant photography market
in the early 1970s. Traditionally, Polaroid bought negatives for its films, worth $50
million, from Kodak. In 1969, Polaroid built its own negative plant. This meant

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that Kodak would lose some $50 million of Polaroid’s business and be left withidle machinery that had been dedicated to filling Polaroid’s needs. Further, byproducing its own film, Polaroid could lower its costs; if it then cut prices, instantphotography might become more competitive with Kodak’s business. Alternatively, if Polaroid held prices high, it would realize high margins and would
soon be very rich indeed. Encouraged by such achievements, Polaroid could evendevelop a marketing organization rivaling Kodak’s and threaten it in every
sphere. In brief, Kodak was convinced that it would be shut out of the instantphotography market forever if it delayed its entry any longer. Subsequently,
however, a variety of reasons led Kodak to change its decision to go ahead withinstant photography. Its pocket instamatic cameras turned out to be highly successful, and some of the machinery and equipment allocated to instant photography had to be switched over to pocket instamatics. A capital shortage also
occurred, and Kodak, as a matter of financial policy, did not want to borrow to
support the instant photography project. In 1976, Kodak again revised its positionand did enter the field of instant photography.15
In brief, commitment to the product-scope strategy requires a thoroughreview of a large number of factors both inside and outside the organization. The
three variants of product-scope strategy that will be discussed in this section are
single-product strategy, multiple-products strategy, and system-of-products strategy. It will be recalled that in the previous chapter three alternatives were discussed under market-scope strategy: single-market strategy, multimarket strategy,
and total-market strategy. These market strategies may be related to the three variants of product-scope strategy, providing nine different product/market-scopealternatives.
Single ProductA business unit may have just one product in its line and must try to live on the
success of this one product. There are several advantages to this strategy. First,
concentration on a single product leads to specialization, which helps achieve
scale and productivity gains. Second, management of operations is much more
efficient when a single product is the focus. Third, in today’s environment,
where growth leads most companies to offer multiple products, a single-product company may become so specialized in its field that it can stand any competition.
A narrow product focus, for example, cancer insurance, has given American
Family Life Assurance Company of Columbus, Georgia, a fast track record.
Cancer is probably more feared than any other disease in the United States today.
Although it kills fewer people than heart ailments, suffering is often lingering andsevere. Cashing in on this fear, American Family Life became the nation’s firstmarketer of insurance policies that cover the expenses of treating cancer.
Despite its obvious advantages, the single-product company has two drawbacks: First, if changes in the environment make the product obsolete, the single-product company can be in deep trouble. American history is full of
instances where entire industries were wiped out. The disposable diaper, initially introduced by Procter & Gamble via its brand Pampers, pushed the cloth

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diaper business out of the market. The Baldwin Locomotive Company’s steam
locomotives were made obsolete by General Motors’ diesel locomotives.
Second, the single-product strategy is not conducive to growth or market
share. Its main advantage is profitability. If a company with a single-product focus
is not able to earn high margins, it is better to seek a new posture. Companies interested in growth or market share will find the single-product strategy of limited
value.
Multiple Products

The multiple-products strategy amounts to offering two or more products. A variety of factors lead companies to choose this strategic posture. A company with asingle product has nowhere to go if that product gets into trouble; with multiple
products, however, poor performance by one product can be balanced out. In
addition, it is essential for a company seeking growth to have multiple productofferings.
In 1970, when Philip Morris bought the Miller Brewing Company, it was a
one-product business ranking seventh in beer sales. Growth prospects led thecompany to offer a number of other products. By 1978, Miller had acquired thenumber two position in the industry with 15 percent of the market. Miller continues to maintain its position (market share in 1998 was 18.2 percent), although
Anheuser-Busch, the industry leader, has taken many steps to dislodge it.16 As
another example, consider Chicago-based Dean Foods Company, which traditionally has been a dairy concern. Over the years, diet-conscious and aging consumers have increasingly shunned high-fat dairy products in favor of low-calorie
foods, and competition for the business that remains is increasingly fierce. To successfully operate in such an environment, the company decided to add otherfaster-growing, higher-margin refrigerated foods, such as party dips and cranberry drink, to the company’s traditional dairy business. Dean’s moves have beenso successful that, although many milk processors were looking to sell out, Dean
was concerned that it might be bought out. Similarly, Nike began with a shoesolely for serious athletes. Over the years, the company has added a number of
new products to its line. It now makes shoes, for both males and females, for running, jogging, tennis, aerobics, soccer, basketball, and walking. Lately, it has
expanded its offerings to include children.
Multiple products can be either related or unrelated. Unrelated products will
be discussed later in the section on diversification. Related products consist of different product lines and items. A food company may have a frozen vegetable line,
a yogurt line, a cheese line, and a pizza line. In each line, the company may produce different items (e.g., strawberry, pineapple, apricot, peach, plain, and blueberry yogurt). Note, in this example, the consistency among the different foodlines: (a) they are sold through grocery stores, (b) they must be refrigerated, and(c) they are meant for the same target market. These underpinnings make them
related products.
Although not all products may be fast moving, they must complement eachother in a portfolio of products. The subject of product portfolios was examined
in Chapter 10. Suffice it to say, the multiple-products strategy is directed toward

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achieving growth, market share, and profitability. Not all companies get rich simply by having multiple products: growth, market share, and profitability are functions of a large number of variables, only one of which is having multiple
products.
System of Products

The word system, as applied to products, is a post-World War II phenomenon.
Two related forces were responsible for the emergence of this phenomenon: (a)the popularity of the marketing concept that businesses sell satisfaction, not products; and (b) the complexities of products themselves often call for the use of complementary products and after-sale services. A cosmetics company does not sell
lipstick, it sells the hope of looking pretty; an airline should not sell plane tickets,
it should sell pleasurable vacations. However, vacationers need more than an airline ticket. Vacationers also need hotel accommodations, ground transportation,and sightseeing arrangements. Following the systems concept, an airline may
define itself as a vacation packager that sells air transportation, hotel reservations,meals, sightseeing, and so on. IBM is a single source for hardware, operating systems, packaged software, maintenance, emergency repairs, and consulting services. Thus, IBM offers its customers a system of different products and services
to solve data management problems. Likewise, ADT Ltd. is a company whose
product is security systems. Beginning with consulting on the type of security
systems needed, ADT also provides the sales, installation, service, updating on
new technologies to existing systems, and the actual monitoring of these alarmsystems either by computer or with patrol services and security watchmen.
Offering a system of products rather than a single product is a viable strategy
for a number of reasons. It makes the customer fully dependent, thus allowing thecompany to gain monopolistic control over the market. The system-of-products
strategy also blocks the way for the competition to move in. With such benefits,
this strategy is extremely useful in meeting growth, profitability, and market
share objectives. If this strategy is stretched beyond its limits, however, a company can get into legal problems. Several years ago, IBM was charged by theJustice Department with monopolizing the computer market. In the aftermath of
this charge, IBM has had to make changes in its strategy. Lately, Microsoft has
been under fire for its dominant hold on the Internet technology.
The successful implementation of the system-of-products strategy requires athorough understanding of customer requirements, including the processes andfunctions the consumer must perform when using the product. Effective implementation of this strategy broadens both the company’s concept of its productand market opportunities for it, which in turn support product/market objectivesof growth, profitability, and market share.

PRODUCT-DESIGN STRATEGY
A business unit may offer a standard or a custom-designed product to each individual customer. The decision about whether to offer a standard or a customized
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capabilities? What business are we in? With respect to the first question, there isa danger of overidentification of capabilities for a specific product. If capabilities
are overidentified, the business unit may be in trouble. When the need for the
product declines, the business unit will have difficulty in relating its product’s
capabilities to other products. It is, therefore, desirable for a business unit to havea clear perspective about its capabilities. The answer to the second question determines the limits within which customizing may be pursued.
Between the two extremes of standard and custom products, a business unit
may also offer standard products with modifications. These three strategic alternatives, which come under the product-design strategy, are discussed below.
Standard Products

Offering standard products leads to two benefits. First, standard products are
more amenable to the experience effect than are customized products; consequently, they yield cost benefits. Second, standard products can be merchandised
nationally much more efficiently. Ford’s Model T is a classic example of a successful standard product. The standard product has one major problem, however.
It orients management thinking toward the realization of per-unit cost savings tosuch an extent that even the need for small changes in product design may beignored.
There is considerable evidence to suggest that larger firms derive greater
profits from standardization by taking advantage of economies of scale and longproduction runs to produce at a low price. Small companies, on the other hand,must use the major advantage they have over the giants, that is, flexibility. Hence,the standard-product strategy is generally more suitable for large companies.
Small companies are better off as job shops, doing customized work at a higher
margin.
A standard product is usually offered in different grades and styles withvarying prices. In this manner, even though a product is standard, customers
have broader choices. Likewise, distribution channels get the product in different
price ranges. The result: standard-product strategy helps achieve theproduct/market objectives for growth, market share, and profitability.

Customized
Products

Customized products are sold on the basis of the quality of the finished product, that is, on the extent to which the product meets the customer’s specifications. The producer usually works closely with the customer, reviewing the
progress of the product until completion. Unlike standard products, price is nota factor for customized products. A customer expects to pay a premium for acustomized product. As mentioned above, a customized product is more suitable for small companies to offer. This broad statement should not be interpreted to mean that large companies cannot successfully offer customized
products. The ability to sell customized products successfully actually depends
on the nature of the product. A small men’s clothing outlet is in a better position
to offer custom suits than a large men’s suit manufacturer. On the other hand,
GE is better suited to manufacture a custom-designed engine for military aircraft than a smaller business.

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An innovative aspect of this product strategy is mass customization, making
goods to each customer’s requirements. One company that practices mass customization is Customer Foot. It makes shoes that meet individual tastes and size
requirements, yet does so on a mass-production basis, at slightly lower prices
than many premium brands sold off the shelf.17 This requires a flexible manufacturing system that anticipates a wide range of options. Many companies can findan important competitive edge in mass customization. If Company X offers a onesize-fits-all product and Company Y can tailor the same product to individual
tastes without charging much more, the latter will be more successful. It is a powerful tool for building relationships with customers, since it requires a company
to gather information, often of a very personal nature, about customers’ tastes
and needs.
Over and above price flexibility, dealing in customized products provides acompany with useful experience in developing new standard products. A number of companies have been able to develop mass market products out of theircustom work for NASA projects. The microwave oven, for example, is an offshootof the experience gained from government contracts. Customized products also
provide opportunities for inventing new products to meet other specific needs. In
terms of results, this strategy is directed more toward realizing higher profitability than are other product-design strategies.
Standard Productswith Modifications

The strategy of modifying standard products represents a compromise between
the two strategies already discussed. With this strategy, a customer may be given
the option to specify a limited number of desired modifications to a standard
product. A familiar example of this strategy derives from the auto industry. The
buyer of a new car can choose type of shift (standard or automatic), air conditioning, power brakes, power steering, size of engine, type of tires, and color.
Although some modifications may be free, for the most part the customer is
expected to pay extra for modifications.
This strategy is directed toward realizing the benefits of both a standard anda customized product. By manufacturing a standard product, the business unit
seeks economies of scale; at the same time, by offering modifications, the productis individualized to meet the specific requirements of the customer. The experience of a small water pump manufacturer that sold its products nationallythrough distributors provides some insights into this phenomenon. The company
manufactured the basic pump in its facilities in Ohio and then shipped it to its
four branches in different parts of the country. At each branch, the pumps were
finished according to specifications requested by distributors. Following thisstrategy, the company lowered its transportation costs (because the standard
pump could be shipped in quantity) even while it provided customized pumps
to its distributors.
Among other benefits, this strategy permits the business unit to keep in close
contact with market needs that may be satisfied through product improvements
and modifications. It also enhances the organization’s reputation for flexibility inmeeting customer requirements. It may also encourage new uses of existingProduct Strategies

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products. Other things being equal, this strategy can be useful in achieving
growth, market share, and profitability.

PRODUCT-ELIMINATION STRATEGY
Marketers have believed for a long time that sick products should be eliminated.
It is only in recent years that this belief has become a matter of strategy. A business unit’s various products represent a portfolio, with each product playing aunique role in making the business viable. If a product’s role diminishes or if it
does not fit into the portfolio, it ceases to be important.
When a product reaches the stage where continued support is no longer justified because performance is falling short of expectations, it is desirable to pull
the product out of the marketplace. Poor performance is easy to spot. It may becharacterized by any of the following:
1. Low profitability.
2. Stagnant or declining sales volume or market share that is too costly to rebuild.
3. Risk of technological obsolescence.
4. Entry into a mature or declining phase of the product life cycle.
5. Poor fit with the business unit’s strengths or declared mission.

Products that are not able to limp along must be eliminated. They drain abusiness unit’s financial and managerial resources, resources that could be used
more profitably elsewhere. Hise, Parasuraman, and Viswanathan cite examples ofa number of companies, among them Hunt Foods, Standard Brands, and Crown
Zellerbach, that have reported substantial positive results from eliminating products.18 The three alternatives in the product-elimination strategy are harvesting,line simplification, and total-line divestment.
Harvesting

Harvesting refers to getting the most from a product while it lasts. It is a controlled divestment whereby the business unit seeks to get the most cash flow it
can from the product. The harvesting strategy is usually applied to a product orbusiness whose sales volume or market share is slowly declining. An effort ismade to cut the costs associated with the business to improve cash flow.
Alternatively, price is increased without simultaneous increase in costs.
Harvesting leads to a slow decline in sales. When the business ceases to provide
a positive cash flow, it is divested.
Du Pont followed the harvesting strategy in the case of its rayon business.
Similarly, BASF Wyandotte applied harvesting to soda ash. As another example,
GE harvested its artillery business a few years ago. Even without making any
investments or raising prices, the business continued to provide GE with positive
cash flow and substantial profits. Lever Brothers applied this strategy to its
Lifebuoy soap. The company continued to distribute this product for a long time
because, despite higher price and virtually no promotional support, it continued
to be in popular demand.

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Implementation of the harvesting strategy requires severely curtailing newinvestment, reducing maintenance of facilities, slicing advertising and researchbudgets, reducing the number of models produced, curtailing the number of distribution channels, eliminating small customers, and cutting service in terms ofdelivery time, speed of repair, and sales assistance. Ideally, harvesting strategy
should be pursued when the following conditions are present:
1. The business entity is in a stable or declining market.
2. The business entity has a small market share, but building it up would be too
costly; or it has a respectable market share that is becoming increasingly costly todefend or maintain.
3. The business entity is not producing especially good profits or may even be producing losses.
4. Sales would not decline too rapidly as a result of reduced investment.
5. The company has better uses for the freed-up resources.
6. The business entity is not a major component of the company’s business portfolio.
7. The business entity does not contribute other desired features to the businessportfolio, such as sales stability or prestige.

Line Simplification

Line-simplification strategy refers to a situation where a product line is trimmed
to a manageable size by pruning the number and variety of products or services
offered. This is a defensive strategy that is adopted to keep a falling line stable.
It is hoped that the simplification effort will restore the health of the line. This
strategy becomes especially relevant during times of rising costs and resource
shortages.
The application of this strategy in practice may be illustrated with an example from GE’s housewares business. In the early 1970s, the housewares industry
faced soaring costs and stiff competition from Japan. GE took a hard look at its
housewares business and raised such questions as: Is this product segment
mature? Is it one we should be harvesting? Is it one we should be investingmoney in and expanding? Analysis showed that there was a demand for housewares, but demand was just not attractive enough for GE at that time. The company ended production of blenders, fans, heaters, and vacuum cleaners because
they were found to be on the downside of the growth curve and did not fit in with
GE’s strategy for growth.
Similarly, Sears, Roebuck & Co. overhauled its retail business in 1993, dropping its famous catalog business, which contributed over $3 billion in annual
sales. Sears’s huge catalog operations had been losing money for nearly a decade(about $175 million in 1992), as specialty catalogs and specialty stores grabbed
market share from the country’s once-supreme mail-order house.19 Kodak discovered that more than 80% of all its sales are achieved by less than 20% of the
product line. Therefore, the company eliminated 27% of all sales items.20 Procter& Gamble got rid of marginal brands such as Bain de Soleil sun-care products. In
addition, the company cut product items by axing extraneous sizes, flavors, andother variants.

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The implementation of a line-simplification strategy can lead to a variety of
benefits: potential cost savings from longer production runs; reduced inventories;
and a more forceful concentration of marketing, research and development, andother efforts behind a shorter list of products.
However, despite obvious merits, simplification efforts may sometimes besabotaged. Those who have been closely involved with a product may sincerely
feel either that the line as it is will revive when appropriate changes are made in
the marketing mix or that sales and profits will turn up once temporary conditions in the marketplace turn around. Thus, careful maneuvering is needed on thepart of management to simplify a line unhindered by corporate rivalries andintergroup pressures.
The decision to drop a product is more difficult if it is a core product that has
served as a foundation for the company. Such a product achieves the status of
motherhood, and a company may like to keep it for nostalgic reasons. For example, the decision by General Motors to drop the Cadillac convertible was probably a difficult one to make in light of the prestige attached to the vehicle. Despite
the emotional aspects of a product-deletion decision, the need to be objective inthis matter cannot be overemphasized. Companies establish their own criteria toscreen different products for elimination.
In finalizing the decision, attention should be given to honoring prior commitments. For example, replacement parts must be provided even though an item
is dropped. A well-implemented program of product simplification can lead toboth growth and profitability. It may, however, be done at the cost of market
share.
Total-Line
Divestment

Divestment is a situation of reverse acquisition. It may also be a dimension ofmarket strategy. But to the extent that the decision is approached from the product’s perspective (i.e., to get rid of a product that is not doing well even in a growing market), it is an aspect of product strategy. Traditionally, companies resisted
divestment for the following reasons, which are principally either economic or
psychological in nature:
1. Divestment means negative growth in sales and assets, which runs counter to thebusiness ethic of expansion.
2. Divestment suggests defeat.
3. Divestment requires changes in personnel, which can be painful and can result inperceived or real changes in status or have an adverse effect on the entire organization.
4. Divestment may need to be effected at a price below book and thus may have an
adverse effect on the year’s earnings.
5. The candidate for divestment may be carrying overhead, buying from other business units of the company, or contributing to earnings.

With the advent of strategic planning in the 1970s, divestment became an
accepted option for seeking faster growth. More and more companies are now
willing to sell a business if the company will be better off strategically. These

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companies feel that divestment should not be regarded solely as a means of ridding the company of an unprofitable division or plan; rather, there are some persuasive reasons supporting the divestment of even a profitable and growing
business. Businesses that no longer fit the corporate strategic plan can bedivested for a number of reasons:• There is no longer a strategic connection between the base business and the partto be divested.
• The business experiences a permanent downturn, resulting in excess capacity forwhich no profitable alternative use can be identified.
• There may be inadequate capital to support the natural growth and developmentof the business.
• It may be dictated in the estate planning of the owner that a business is not toremain in the family.
• Selling a part of the business may release assets for use in other parts of the business where opportunities are growing.
• Divestment can improve the return on investment and growth rate both by ridding the company of units growing more slowly than the basic business and byproviding cash for investment in faster-growing, higher-return operations.

Whatever the reason, a business that may have once fit well into the overall
corporate plan can suddenly find itself in an environment that causes it to becomea drain on the corporation, either financially, managerially, or opportunistically.
Such circumstances suggest divestment.
Divestment helps restore balance to a business portfolio. If the company has
too many high-growth businesses, particularly those at an early stage of development, its resources may be inadequate to fund growth. On the other hand, if acompany has too many low-growth businesses, it will often generate more cashthan is required for investment and will build up redundant equity. For a business to grow evenly over time while showing regular increments in earnings, a
portfolio of fast- and slow-growth businesses is necessary. Divestment can help
achieve this kind of balance. Finally, divestment helps restore a business to a sizethat will not lead to an antitrust action.
The use of this strategy is reflected in GE’s decision to divest its consumer
electronics business in the early 1980s. In order to realize a return that GE considered adequate, the company would have had to make additional heavy investments in this business. GE figured that it could use the money to greater
advantage in an area other than consumer electronics. Hence, it divested the business by selling it to Thomson, a French company.
Essentially following the same reasoning, Olin Corporation divested its aluminum business on the grounds that maintaining its small 4 percent sharerequired big capital expenditures that could be employed more usefully elsewhere in the company. Westinghouse sold its major appliance line because it
needed at least an additional 3 percent beyond the 5 percent share it held before
it could compete effectively against industry leaders GE and Whirlpool. GE andWhirlpool divided about half the total market between them. Between 1986 andProduct Strategies

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1988, Beatrice sold two-thirds of its business, including such well-known names
as Playtex, Avis, Tropicana, and Meadow Gold. The company considered thesedivestments necessary to transform itself into a manageable organization.21
It is difficult to prescribe generalized criteria to determine whether to divest
a business. However, the following questions may be raised, the answers towhich should provide a starting point for considering divestment:
1. What is the earnings pattern of the unit? A key question is whether the unit isacting as a drag on corporate growth. If so, then management must determine
whether there are any offsetting values. For example, are earnings stable compared to the fluctuation in other parts of the company? If so, is the low-growth
unit a substantial contributor to the overall debt capacity of the business?
Management should also ask a whole series of “what-if” questions relating toearnings: What if we borrowed additional funds? What if we brought in new
management? What if we made a change in location? etc.
2. Does the business generate any cash? In many situations, a part of a company
may be showing a profit but may not be generating any discretionary cash. Thatis, every dime of cash flow must be pumped right back into the operation just to
keep it going at existing levels. Does this operation make any real contribution to
the company? Will it eventually? What could the unit be sold for? What would bedone with the cash from this sale?
3. Is there any tie-in value—financial or operating—with existing business?
Are
there any synergies in marketing, production, or research and development? Is
the business countercyclical? Does it represent a platform for growth internallybased or through acquisitions?
4. Will selling the unit help or hurt the acquisitions effort? What will be the immediate impact on earnings (write-offs, operating expenses)? What effect, if any, will
the sale have on the company’s image in the stock market? Will the sale have any
effect on potential acquisitions? (Will I, too, be sold down the river?) Will thedivestment be functional in terms of the new size achieved? Will a smaller size
facilitate acquisitions by broadening the “market” of acceptable candidates, or, bycontrast, will the company become less credible because of the smaller size?

In conclusion, a company should undertake continual in-depth analysis of
the market share, growth prospects, profitability, and cash-generating power of
each business. As a result of such reviews, a business may need to be divested tomaintain balance in the company’s total business. This, however, is feasible only
when the company develops enough self-discipline to avoid increasing sales volume beyond a desirable size and instead buys and sells businesses with the sole
objective of enhancing overall corporate performance.

NEW-PRODUCT STRATEGY
New-product development is an essential activity for companies seeking growth.
By adopting the new-product strategy as their posture, companies are better able
to sustain competitive pressures on their existing products and make headway.
The implementation of this strategy has become easier because of technologicalinnovations and the willingness of customers to accept new ways of doing things.

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Despite their importance in strategy determination, however, implementation of new-product programs is far from easy. Too many products never make itin the marketplace. The risks and penalties of product failure require that companies move judiciously in adopting new-product strategies.
Interestingly, however, the mortality rate of new product ideas has declined
considerably since the 1960s. In 1968, on average, 58 new-product ideas were considered for every successful new product. In 1981, only seven ideas were required
to generate one successful new product. However, these statistics vary by industry. Consumer nondurable companies consider more than twice as many newproduct ideas in order to generate one successful new product, compared toindustrial or consumer durable manufacturers.22
Top management can affect the implementation of new-product strategy;
first, by establishing policies and broad strategic directions for the kinds of new
products the company should seek; second, by providing the kind of leadershipthat creates the environmental climate needed to stimulate innovation in the organization; and third, by instituting review and monitoring procedures so that managers are involved at the right decision points and can know whether or not work
schedules are being met in ways that are consistent with broad policy directions.
The term new product is used in different senses. For our purposes, the newproduct strategy will be split into three alternatives: (a) product improvement/
modification, (b) product imitation, and (c) product innovation.
Product improvement/modification is the introduction of a new version or an
improved model of an existing product, such as “new, improved Crest.”
Improvements and modifications are usually achieved by adding new features orstyles, changing processing requirements, or altering product ingredients. When acompany introduces a product that is already on the market but new to the company, it is following a product-imitation strategy. For example, Schick was imitating when it introduced its Tracer razor to compete with Gillette’s Sensor. For our
purposes, a product innovation will be defined as a strategy with a completely
new approach in fulfilling customer desires (e.g., Polaroid camera, television,
typewriter) or one that replaces existing ways of satisfying customer desires (e.g.,
the replacement of slide rules by pocket calculators). About 90% of new products
are simply line extensions, such as Frito-Lay’s Doritos Flamin, Hot Tortilla Chips
in snack-size bags. This is despite the fact that truly original products—the remaining 10%—possess the real profit potential.23
New-product development follows the experience curve concept; that is,
the more you do something, the more efficient you become at doing it (for additional details, see Chapter 12). Experience in introducing products enables companies to improve new-product performance. Specifically, with increased
new-product experience, companies improve new-product profitability by
reducing the cost per introduction. More precisely, with each doubling of thenumber of new-product introductions, the cost of each introduction declines at
a predictable and constant rate. For example, among the 13,000 new products
introduced by 700 companies surveyed by Booz, Allen, and Hamilton between
1976 and 1981, the experience effect yielded a 71 percent cost curve. At eachProduct Strategies

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doubling of the number of new products introduced, the cost of each introduction declined by 29 percent.24
Product
Improvement
Modification

An existing product may reach a stage that requires that something be done tokeep it viable. The product may have reached the maturity stage of the productlife cycle because of shifts in the environment and thus has ceased to provide anadequate return. Or product, pricing, distribution, and promotion strategies
employed by competitors may have reduced the product to the me-too category.
At this stage, management has two options: either eliminate the product or revitalize it by making improvements or modifications. Improvements or modifications are achieved by redesigning, remodeling, or reformulating the product sothat it satisfies customer needs more fully. This strategy seeks not only to restore
the health of the product but sometimes seeks to help distinguish it from competitors’ products as well. For example, it has become fashionable these days totarget an upscale, or premium, version of a product at the upper end of the priceperformance pyramid. Fortune‘s description of Kodak’s strategy is relevant here:
On the one hand, the longer a particular generation of cameras can be sold, the more
profitable it will become. On the other hand, amateur photographers tend to use lessfilm as their cameras age and lose their novelty; hence, it is critical that Kodak keep
the camera population eternally young by bringing on new generations from time totime. In each successive generation, Kodak tries to increase convenience and reliability in order to encourage even greater film consumption per camera—a high “burnrate,” as the company calls it. In general, the idea is to introduce as few major newmodels as possible while ringing in frequent minor changes powerful enough to stimulate new purchases.
Kodak has become a master of this marketing strategy. Amateur film sales took off
with a rush after 1963. That year the company brought out the first cartridge-loading,easy-to-use instamatic, which converted many people to photography and doubled
film usage per camera. A succession of new features and variously priced models followed to help stimulate film consumption for a decade. Then Kodak introduced thepocket instamatic, which once again boosted film use both because of its novelty andbecause of its convenience. Seven models of that generation have since appeared.25

Kodak’s strategy points out that it is never enough just to introduce a new
product. The real payoff comes if the product is managed in such a way that it
continues to flourish year after year in a changing and competitive marketplace.
In the 1990s, the company continued to pursue the strategy with yet anothernew product, the throwaway camera. Fun, cheap, and easy to use are the featuresthat have turned the disposable camera (basically a roll of film with a cheap plastic case and lens) into a substantial business. In 1992, the sales at retail reachedover $200 million with Kodak holding over 65% of the market.26
There is no magic formula for restoring the health of a product. Occasionally,
it is the ingenuity of the manager that may bring to light a desired cure. Generally,
however, a complete review of the product from marketing perspectives isneeded to analyze underlying causes and to come up with the modifications andimprovements necessary to restore the product to health. For example, General

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Mills continues to realize greater profits by rejuvenating its old products—cakemixes, Cheerios, and Hamburger Helper. The company successfully builds excitement for old products better than anyone else in the food business by periodically
improving them. Compared with Kellogg, which tends not to fiddle with its coreproducts, General Mills takes much greater risks with established brands. For
instance, the company introduced two varieties of Cheerios—Honey Nut in 1979
and Apple Cinnamon in 1988—and successfully created a megabrand.27
To identify options for restoring a damaged product to health, it may be necessary to tear down competing products and make detailed comparative analyses of quality and price. One framework for such an analysis is illustrated in
Exhibit 14-2.
The basic premise of Exhibit 14-2 is that by comparing its product with thatof its competitors, a company is able to identify unique product strengths on
which to pursue modifications and improvements. The use of the analysis suggested by Exhibit 14-2 may be illustrated with reference to a Japanese manufacturer. In 1978, Japan’s amateur color film market was dominated by Kodak, Fuji,
and Sakura, the last two being Japanese companies. For the previous 15 years,
Fuji had been gaining market share, whereas Sakura, the market leader in theearly 1950s with over half the market, was losing ground to both its competitors.
By 1976, Sakura had only about a 16 percent market share. Marketing researchshowed that, more than anything else, Sakura was the victim of an unfortunate
word association. Its name in Japanese means “cherry blossom,” suggesting asoft, blurry, pinkish image. The name Fuji, however, was associated with the blue
skies and white snow of Japan’s sacred mountain. Being in no position to change
perceptions, the company decided to analyze the market from structural, economic, and customer points of view. Sakura found a growing cost consciousness
among film customers: to wit, amateur photographers commonly left one or two
frames unexposed in a 36-exposure roll, but they almost invariably tried tosqueeze extra exposures onto 20-exposure rolls. Here Sakura saw an opportunity.
It decided to introduce a 24-exposure film. Its marginal costs would be trivial, but
its big competitors would face significant penalties in following suit. Sakura wasprepared to cut its price if the competition lowered the price of their 20-framerolls. Its aim was twofold. First, it would exploit the growing number of costminded users. Second, and more important, it would be drawing attention to theissue of economics, where it had a relative advantage, and away from the image
issue, where it could not win. Sakura’s strategy paid off. Its market share
increased from 16 percent to more than 30 percent.28 PepsiCo has developed a
new product, Pepsi One, to fulfill the unmet needs of young men. The company
launched the product with about $100 million promotion and hoped to generate$1 billion in annual retail sales.29 Overall, the product-improvement strategy isconducive to achieving growth, market share, and profitability alike.
Product Imitation

Not all companies like to be first in the market with a new product. Some let others take the initiative. If the innovation is successful, they ride the bandwagon of
the successful innovation by imitating it. In the case of innovations protected byProduct Strategies

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EXHIBIT 14-2
Product-Change Options after Competitive Teardown

Source: Kenichi Ohmae, “Effective Strategies for Competitive Success,” McKinsey Quarterly (Winter1978): 57. Reprinted with permission of the publisher.

patents, imitators must wait until patents expire. In the absence of a patent, however, the imitators work diligently to design and produce products not very different from the innovator’s product to compete vigorously with the innovator.
The imitation strategy can be justified in that it transfers the risk of introducing an unproven idea/product to someone else. It also saves investment inresearch and development. This strategy particularly suits companies with limited resources. Many companies, as a matter of fact, develop such talent that they
can imitate any product, no matter how complicated. With a limited investment

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in research and development, the imitator may sometimes have a lower cost, giving it a price advantage in the market over the leader.
Another important reason for pursuing an imitation strategy may be to gainfully transfer the special talent a company may have for one product to other similar products. For example, the Bic Pen Corporation decided to enter the razor
business because it thought it could successfully use its aggressive marketing
posture in that market. In the early 1970s, Hanes Corporation gained resounding
success with L’eggs, an inexpensive pantyhose that it sold from freestanding
racks in food and drugstore outlets.
The imitation strategy may also be adopted on defensive grounds. Being sureof its existing product(s), a company may initially ignore new developments inthe field. If new developments become overbearing, however, they may cut into
the share held by an existing product. In this situation, a company may be forced
to imitate the new development as a matter of survival. Colorado’s Adolph Coors
Company conveniently ignored the introduction of light beer and dismissed
Miller Lite as a fad. Many years later, however, the company was getting bludgeoned by Miller Lite. Also, Anheuser-Busch began to challenge the supremacyof Coors in the California market with its light beer. The matter became so serious that Coors decided to abandon its one-product tradition and introduced alow-calorie light beer.
Another example of product imitation is the introduction of specialty beers
by major brewers. While the U.S. beer industry has been stagnating throughout
the 1990s, the specialty brews have been growing at better than a 40 percent
annual rate. This has led the four major beer companies that control 80 percent of
the market to offer their own brands of specialty beers: Anheuser (Redhook Ale,
Red Wolf, Elk Mountain, Crossroads); Miller (Red Dog, Icehouse, Celis); Coors(Sandlot, George Killman); and Stroh (Steeman, Red River Valley).30
Imitation also works well for companies that want to enter new markets without resorting to expensive acquisitions or special new-product development programs. For example, Owens-Illinois adapted heavy-duty laboratory glassware
into novelty drinking glasses for home use.
Although imitation does avoid the risks involved in innovation, it is wrong
to assume that every imitation of a successful product will succeed. The marketing program of an imitation should be as carefully chalked out and implemented
as that of an innovation. Imitation strategy is most useful for achieving increases
in market share and growth.
Product Innovation

Product-innovation strategy includes introducing a new product to replace anexisting product in order to satisfy a need in an entirely different way or to provide a new approach to satisfy an existing or latent need. This strategy suggeststhat the entrant is the first firm to develop and introduce the product. The ballpoint pen is an example of a new product; it replaced the fountain pen. The VCR
was a new product introduced to answer home entertainment needs.
Product innovation is an important characteristic of U.S. industry. Year after
year companies spend billions of dollars on research and development to innovate.

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In 1997, for example, American industry spent almost $100 billion on research anddevelopment. Research and development expenditures are expected to continue
rising at an average of 10 percent annually as we enter the next century. This showsthat industry takes a purposeful attitude toward new-product and new-processdevelopment.
Product innovation, however, does not come easy. Besides involving major
financial commitments, it requires heavy doses of managerial time to cut acrossorganizational lines. And still the innovation may fail to make a mark in the market. A number of companies have discovered the risks of this game. Among themis Texas Instruments, which lost $660 million before withdrawing from the homecomputer market. RCA lost $500 million on ill-fated videodisc players. RCA, GE,
and Sylvania, leaders in vacuum-tube technology, lost out when transistor technology revolutionized the radio business. RJR Nabisco abandoned the “smokeless” cigarette, Premier, after a 10-year struggle and after spending over $500
million.31
Most innovative products are produced by large organizations. Initially, anindividual or a group of individuals may be behind it, but a stage is eventuallyreached where individual efforts require corporate support to finally develop andlaunch the product. To encourage innovation and creativity, many large companies are spinning off companies. For example, Colgate-Palmolive Co. launched
Colgate Venture Co. to support entrepreneurship and risk taking. In this way, acongenial environment within the large corporation is maintained for generating
and following creative pursuits.32
In essence, innovation flourishes where divisions are kept small (permitting
better interaction among managers and staffers), where there is willingness to tolerate failure (encouraging plenty of experimentation and risk taking), wherechampions are motivated (through encouragement, salaries, and promotions),
where close liaison is maintained with the customer (visiting customers routinely;
inviting them to brainstorm product ideas), where technology is shared corporate
wide (technology, wherever it is developed, belongs to everyone), and where projects are sustained, even if initial results are discouraging.33
The development of a product innovation typically passes through various
stages: idea generation, screening, business analysis, development of a prototype,
test market, and commercialization. The idea may emerge from different sources:
customers, private researchers, university researchers, employees, or research labs.
An idea may be generated by recognizing a consumer need or just by pursuing ascientific endeavor, hoping that it may lead to a viable product. Companies follow
different procedures to screen ideas and to choose a few for further study. If an
idea appears promising, it may be carried to the stage of business analysis, which
may consist of investment requirements, revenue and expenditure projections,and financial analysis of return on investment, pay-back period, and cash flow.
Thereafter, a few prototype products may be produced to examine engineeringand manufacturing aspects of the product. A few sample products based on the
prototype may be produced for market testing. After changes suggested in market
testing have been incorporated, the innovation may be commercially launched.

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Procter & Gamble’s development of Pringles is a classic case of recognizing aneed in a consumer market and then painstakingly hammering away to meet it.34
Americans consume about one billion dollars’ worth of potato chips annually, butmanufacturers of potato chips face a variety of problems. Chips made in the traditional way are so fragile that they can rarely be shipped for more than 200 miles;
even then, a quarter of the chips get broken. They also spoil quickly; their shelf
life is barely two months. These characteristics have kept potato chip manufacturers split into many small regional operations. Nobody, before Procter &Gamble, had applied much technology to the product since it was invented in
1853.
Procter & Gamble knew these problems because it sold edible oils to thepotato chip industry, and it set out to solve them. Instead of slicing potatoes andfrying them in the traditional way, Procter & Gamble’s engineers developed aprocess somewhat akin to paper making. They dehydrated and mashed potatoes
and pressed them for frying into a precise shape, which permitted the chips to be
stacked neatly on top of one another in hermetically sealed containers that resemble tennis ball cans. Pringles potato chips stay whole and have a shelf life of atleast a year.
After a new product is screened through the lab, the division that will manufacture it takes over and finances all further development and testing. In somecompanies, division managers show little interest in taking on new products
because the costs of introduction are heavy and hold down short-term profits. At
Procter & Gamble, executives ensure that a manager’s short-term record is notmarred by the cost of a new introduction.
Before a new Procter & Gamble product is actually introduced to the market,
it must prove that it has a demonstrable margin of superiority over its prospective competitors. A development team begins refining the product by trying variations of the basic formula, testing its performance under almost any conceivablecondition, and altering its appearance. Eventually, a few alternative versions of
the product are produced and tested among a large number of Procter & Gamble
employees. If the product gets the approval of employees, the company presents
it to panels of consumers for further testing. Procter & Gamble feels satisfied if a
proposed product is chosen by fifty-five out of one hundred consumers tested.
Though Pringles potato chips passed all these tests, they only recently started
showing any profits for Procter & Gamble.
There is hardly any doubt that, if an innovation is successful, it pays off lavishly. For example, nylon still makes so much money for Du Pont that the company would qualify for the Fortune 500 list even if it made nothing else.35
However, developing a new product is a high-risk strategy requiring heavy commitment and having a low probability of achieving a breakthrough. Thus, thechoice of this strategy should be dictated by a company’s financial and managerial strengths and by its willingness to take risks. Consider the case of Kevlar, asuper-tough fiber (lightweight but five times stronger than steel) invented by Du
Pont. It took the company 25 years and $900 million to come out with this product, more time and money than the company had ever spent on a single product.

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Starting in 1985, however, the payoff began: annual sales reached $300 million.
Du Pont forecasts Kevlar’s annual sales growth at 10 percent during the 1990s.
Meanwhile, the company continues its quest for new applications that it hopes
will make Kevlar a blockbuster.36
Exhibit 14-3 suggests an approach that may be used to manage innovations
successfully. As a company grows more complex and decentralized, its new-product development efforts may fail to keep pace with change, weakening vital lines
between marketing and technical people and leaving key decisions to be made by
default. The possible result is the ultimate loss of competitive edge. To solve theproblem, as shown in Exhibit 14-3a, both technical and market opportunity may
be plotted on a grid. From this grid, innovations may be grouped into threeclasses: heavy emphasis (deserving full support, including basic research anddevelopment); selective opportunistic development (i.e., may be good or may bebad; may require a careful approach and top management attention); and limited
defense support (i.e., merits only minimum support). Exhibit 14-3b lists the relevant kinds of programs for each area. This approach helps gear research efforts topriority strategic projects.

DIVERSIFICATION STRATEGY
Diversification refers to seeking unfamiliar products or markets or both in the
pursuit of growth. Every company is best at certain products; diversification
requires substantially different knowledge, thinking, skills, and processes. Thus,
diversification is at best a risky strategy, and a company should choose this path
only when current product/market orientation does not seem to provide further
opportunities for growth. A few examples will illustrate the point that diversification does not automatically bring success. CNA Financial Corporation faced
catastrophe when it expanded the scope of its business from insurance to realestate and mutual funds: it ended up being acquired by Loews Corporation.
Schrafft’s restaurants did little for Pet Incorporated. Pacific Southwest Airlines
acquired rental cars and hotels, only to see its stock decline quickly.
Diversification into the wine business (by acquiring Taylor Wines) did not workfor the Coca-Cola Company.37
The diversification decision is a major step that must be taken carefully. On
the basis of a sample from 200 Fortune 500 firms and the PIMS database (seeChapter 12), Biggadike notes that it takes an average of 10 to 12 years before thereturn on investment from diversification equals that of mature businesses.38
The term diversification must be distinguished from integration and merger.
Integration refers to the accumulation of additional business in a field throughparticipation in more of the stages between raw materials and the ultimate market or through more intensive coverage of a single stage. Merger implies a combination of corporate entities that may or may not result in integration.
Diversification is a strategic alternative that implies deriving revenues and profits from different products and markets. The following factors usually lead companies to seek diversification:

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EXHIBIT 14-3
Managing Innovations
Low

Market Opportunity
ModerateHeavyemphasis

High

Technical Moderate
Opportunity

Low

High

Selectiveemphasis

Limitedsupport(a) The R&D Effort Portfolio
R&D Program Elements

Technical
Risk

Acceptable
Time forPayoff

Projects to
Exceed orMaintainCompetitive
ParityBalance between Highnew and existingproducts

High

Long

Many

Medium

Mainly existingproducts

Low

MediumMediumFew

Low

Existing
processes

Very
low

Low

Short

Very
few

R&D
EmphasisPrimary
Level of
Funding

Heavy

High

Selective
Limited

Focus ofWork

Level of
Basic
Research(b) Implied Nature of R&D Effort
Source: Richard N. Foster, “Linking R&D to Strategy,” Business Horizons, December 1980. Copyright
1980, by the Foundation for the School of Business at Indiana University. Reprinted by permission.

1. Firms diversify when their objectives can no longer be met within the
product/market scope defined by expansion.
2. A firm may diversify because retained cash exceeds total expansion needs.
3. A firm may diversify when diversification opportunities promise greater profitability than expansion opportunities.
4. Firms may continue to explore diversification when the available information is
not reliable enough to permit a conclusive comparison between expansion anddiversification.

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Diversification can take place at either the corporate or the business unit
level. At the corporate level, it typically entails entering a promising business outside the scope of existing business units. At the business unit level, it is most
likely to involve expanding into a new segment of the industry in which the business presently participates. The problems encountered at both levels are similar
and may differ only in magnitude.
Diversification strategies include internal development of new products ormarkets (including development of international markets for current products),
acquisition of an appropriate firm or firms, a strategic alliance with a complementary organization, licensing of new product technologies, and importing or
distributing a line of products manufactured by another company. The final
choice of an entry strategy involves a combination of these alternatives in mostcases. This combination is determined on the basis of available opportunities andof consistency with the company’s objectives and available resources.
Caterpillar Tractor Company’s entry into the field of diesel engines is a caseof internal diversification. Since 1972, the company has poured more than $1 billion into developing new diesel engines “in what must rank as one of the largest
internal diversifications by a U.S. corporation.”39 Hershey Foods ventured into
the restaurant business by buying the Friendly Ice Cream Corporation, illustrating diversification by acquisition. Hershey adopted the diversification strategy
for growth because its traditional business, chocolate and candy, was stagnant
because of a decline in candy consumption, sharp increases in cocoa prices, andchanges in customer habits. Hershey subsequently sold Friendly in 1988 to a private company, Tennessee Restaurant Co.40
An empirical study of entry strategy shows that higher barriers are more
likely to be associated with acquisition than with entry through internal development. Thus, in choosing between these two entry modes, business unit managers
should take into account, among other factors, the entry barriers surrounding themarket and the cost of breaching them. Despite high apparent barriers, theentrant’s relatedness to the new entry may make entry financially more desirable.
Essentially, there are three different forms of diversification a company may
pursue: concentric diversification, horizontal diversification, and conglomerate
diversification. No matter what kind of diversification a company seeks, the threeessential tests of success are
1. The attractiveness test—The industries chosen for diversification must be structurally attractive or capable of being made attractive.
2. The cost-of-entry test—The cost of entry must not capitalize all future profits.
3. The better-off test—The new unit must either gain competitive advantage fromits link with the corporation or vice versa.41

Concentric
Diversification

Concentric diversification bears a close synergistic relationship to either the company’s marketing or its technology, or both. Thus, new products that are introduced share a common thread with the firm’s existing products, either throughmarketing or production. Usually, the new products are directed to a new group

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of customers. Texas Instrument’s venture into pocket calculators illustrates thistype of diversification. Using its expertise in integrated circuits, the company
developed a new product that appealed to a new set of customers. On the other
hand, PepsiCo’s venture into the fast-food business through the acquisition of
Pizza Hut is a case of concentric diversification in which the new product bears a
synergistic relationship to the company’s existing marketing experience.
(Recently, PepsiCo spun off Pizza Hut along with Taco Bell and Kentucky Fried
Chicken into a new $8.5 billion-a-year company called Tricon.)
Toys “R” Us branched into children’s clothing on the ground that its marketing as well as technological skills (purchasing power, brand name, storage facilities, retail outlets, and sophisticated information systems) would give it an edgein the new business. Similar logic persuaded Honda to diversify from motorcycles to lawn mowers and cars; and Black & Decker from power tools to home
appliances.42
Although a diversification move per se is risky, concentric diversification
does not lead a company into an entirely new world because in one of two major
fields (technology or marketing), the company will operate in familiar territory.
The relationship of the new product to the firm’s existing product(s), however,
may or may not mean much. All that the realization of synergy does is make thetask easier; it does not necessarily make it successful. For example, Gilletteentered the market for pocket calculators in 1974 and for digital watches in 1976.
Later it abandoned both businesses. Both pocket calculators and digital watches
were sold to mass markets where Gillette had expertise and experience. Despite
this marketing synergy, it failed to sell either calculators or digital watches successfully. Gillette found that these lines of business called for strategies totally different from those it followed in selling its existing products.43 Two lessons can be
drawn from Gillette’s experience. One, there may be other strategic reasons for
successfully launching a new product in the market besides commonality of markets or technology. Two, the commonality should be analyzed in breadth anddepth before drawing conclusions about the transferability of current strengths tothe new product.
Philip Morris’s acquisition of Miller Brewing Company illustrates how acompany may achieve marketing synergies through concentric diversification.
Cigarettes and beer are distributed through many of the same retail outlets, andPhilip Morris had been dealing with them for years. In addition, both products
serve hedonistic consumer markets. Small wonder, therefore, that the marketing
research techniques and emotional promotion appeals of cigarette merchandising
worked equally well for beer. Miller moved from seventh to second place in thebeer industry in the short span of six years.
Horizontal
Diversification

Horizontal diversification refers to new products that technologically are unrelated to a company’s existing products but that can be sold to the same group of
customers to whom existing products are sold. A classic case of this form of diversification is Procter & Gamble’s entry into potato chips (Pringles), toothpaste(Crest and Gleem), coffee (Folgers), and orange juice (Citrus Hill). Traditionally aProduct Strategies

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soap company, Procter & Gamble diversified into these products, which were
aimed at the same customers who bought soap. Similarly, Maytag’s entry into themedium-priced mass market to sell refrigerators and ranges, in addition to selling
its traditional line of premium-priced dishwashers, washers, and dryers, is a formof horizontal diversification. Mattel’s introduction of clothing items (skirts, shoes,
jeans, shirts, and pajamas) for little girls, sizes 4 to 6x, under the Barbie brand nameis another example of horizontal diversification. Using the Barbie phenomenon,
the company has successfully launched the new business. As a company executive
puts it, “Barbie is a designer brand for the little customers, their Calvin Klein.”44
Note that in the case of concentric diversification, the new product may havecertain common ties with the marketing of a company’s existing product exceptthat it is sold to a new set of customers. In horizontal diversification, by contrast,
the customers for the new product are drawn from the same ranks as those for an
existing product.
Other things being equal, in a competitive environment horizontal diversification is more desirable if present customers are favorably disposed toward thecompany and if one can expect this loyalty to carry over to the new product; inthe long run, however, a new product must stand on its own. For example, if
product quality is lacking, if promotion is not effective, or if the price is not right,
a new product will flop despite customer loyalty to the company’s other products. Thus, while Crest and Folgers made it for Procter & Gamble, Citrus Hill has
been struggling, and Pringles has been disappointing, even though all these products are sold to the same “loyal” customers. In other words, horizontal diversification should not be regarded as a route to success in all cases. An important
limitation of horizontal diversification is that the new product is introduced andmarketed in the same economic environment as the existing products, which canlead to rigidity and instability. Stated differently, horizontal diversification tends
to increase the company’s dependence on a few market segments.
Conglomerate
Diversification

In conglomerate diversification, the new product bears no relationship to either
the marketing or the technology of the existing product(s). In other words,
through conglomerate diversification, a company launches itself into an entirely
new product/market arena. ITT’s ventures into bakery products (Continental
Baking Company), insurance (Hartford Insurance Group), car rentals (Avis RentA-Car System, Inc.), and the hotel business (Sheraton Corporation) illustrate theimplementation of conglomerate diversification. (ITT divested its car rental business a few years ago.)
Dover Corp. provides another example of conglomerate diversification. The
company, with annual sales of over $3 billion, is a manufacturer with 54 operating companies engaged in more than 70 diverse businesses, from elevators andgarbage trucks to valves and welding torches.45
It is necessary to remember here that companies do not flirt with unknown
products in unknown markets without having some hidden strengths to handle
conglomerate diversification. For example, the managerial style required for a
new product to prosper may be just the same as the style the company already

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has. Thus, managerial style becomes the basis of synergy between the new product and an existing product. By the same token, another single element may serve
as a dominant factor in making a business attractive for diversification.
Inasmuch as conglomerate diversification does not bear an obvious relationship to a company’s existing business, there is some question as to why companies adopt it. There are two major advantages of conglomerate diversification.
One, it can improve the profitability and flexibility of a firm by venturing intobusinesses that have better economic prospects than those of the firm’s existing
businesses. Two, a conglomerate firm, because of its size, gets a better reception
in capital markets.
Overall, this type of diversification, if successful, has the potential of providing increased growth and profitability.

VALUE-MARKETING STRATEGY
In the 1990s, value has become the marketer’s watchword. Today, customers aredemanding something different than they did in the past. They want the rightcombination of product quality, good service, and timely delivery. These are thekeys to performing well in the next century. It is for this reason that we examine
this new strategic focus.
Value marketing strategy stresses real product performance and delivering
on promises. Value marketing doesn’t mean high quality if it is only available atever-higher prices. It doesn’t necessarily mean cheap, if cheap means bare bones
or low-grade. It doesn’t mean high prestige, if the prestige is viewed as snobbish
or self-indulgent. At the same time, value is not about positioning and image
mongering. It simply means providing a product that works as claimed, is accompanied by decent service, and is delivered on time.
The emphasis on value is part atmospherics, part economics, and part demographics. Consumers are repudiating the wretched excesses of the 1980s and aresearching for more traditional rewards of home and family. They are concerned
about the seemingly nonending economic ups and down. The growing focus onvalue also stems from profound changes in the American consumer marketplace.
For example, real income growth for families got a boost when womenentered the work force. But now, with many women already working and many
baby boomers assuming new family responsibilities, the growth in disposable
income is scarily slow. Aging baby boomers whose debt burden is already highrealize that they must worry about their children’s college tuitions and their own
retirement. At the same time, the new generation of consumers is both savvier
and more cynical than were its predecessors. Briefly, consumers want productsthat perform, sold by advertising that informs. They are concerned about intrinsic value, not simply buying to impress others.
Quality Strategy

Traditionally, quality has been viewed as a manufacturing concern. Strategically,
however, the idea of total quality is perceived in the market; that is, quality must
exude from the offering itself and from all the services that come with it. The

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important point is that quality perspectives should be based on customer preferences, not on internal evaluations. The ultimate objective of quality should be todelight the customer in every way possible, providing levels of service, productquality, product performance, and support that are beyond his/her expectations.
Ultimately, quality may mean striving for excellence throughout the entire organization. For assessing perceived quality, the step-by-step procedure used by theStrategic Planning Institute may be followed:
1. A meeting is held, in which a multifunctional team of managers and staff specialists identify the nonprice product and service attributes that affect customer buying decisions. For an office equipment product, these might include durability,
maintenance costs, flexibility, credit terms, and appearance.
2. The team is then asked to assign “importance weights” for each attribute representing their relative decisions. These relative importance weights sum to 100.
(For markets in which there are important segments with different importanceweights, separate weights are assigned to each segment.)
3. The management team creates its business unit’s product line, and those of leading competitors, on each of the performance dimensions identified in Step 1.
From these attribute-by-attribute ratings, each weighted by its respective importance weight, an overall relative quality score is constructed.
4. The overall relative quality score and other measures of competitive position (relative price and market share) and financial performance (ROI, ROS, and ROE) are
validated against benchmarks based on the experience of “look-alike” businesses
in similar strategic positions in order to check the internal consistency of strategic
and financial data and confirm the business and market definition.
5. Finally, the management team tests its plans and budgets for reality, develops a
blueprint for improving market perceived quality, relative to competitors’, andcalibrates the financial payoff.
In many cases, the judgmental ratings assigned by the management team aretested (and, when appropriate, modified) by collecting ratings from customers via
field interviews.46

This approach to assessing relative quality is similar to the multiattributemethods used in marketing research. These research methods are, however,
employed primarily for evaluating or comparing individual products (actual orprospective), whereas the scores here apply to a business unit’s entire productline.
Attaining adequate levels of excellence and customer satisfaction often
requires significant cultural change; that is, change in decision-making processes,
interfunctional relationships, and the attitudes of each member of the company.
In other words, achieving total quality objectives requires teamwork and cooperation. People are encouraged and rewarded for doing their jobs right the first timerather than for their success in resolving crises. People are empowered to makedecisions and instilled with the feeling that quality is everyone’s responsibility.
The following are the keys to success in achieving world-class total quality.
First, the program requires unequivocal support of top management. The second
key to success is understanding customer need. The third key is to fix the businessprocess, if there are gaps in meeting customer needs. The fourth key is to compress

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cycle time to avoid bureaucratic hassles and delays. The next is empowering people so that they are able to exert their best talents. Further, measurement andreward systems must be reassessed and revamped to recognize people. Finally, thetotal quality program should be a continuous concern, a constant focus on identifying and eliminating waste and inefficiency throughout the organization.47
Organizationally, the single most important aspect of implementing a quality
strategy is to maintain a close liaison with the customer. Honda’s experience inthis matter in designing the new Accord is noteworthy:
When Honda’s engineers began to design the third-generation (or 1986) Accord in theearly 1980s, they did not start with a sketch of a car. The engineers started with a concept—”man maximum, machine minimum” that captured in a short, evocative phrase
the way they wanted customers to feel about the car. The concept and the car havebeen remarkably successful: since 1982, the Accord has been one of the best-sellingcars in the United States; in 1989, it was the top-selling car. Yet when it was time todesign the 1990 Accord, Honda listened to the market, not to its own success. Market
trends were indicating a shift away from sporty sedans toward family models. To satisfy future customers’ expectations and to reposition the Accord, moving it up-market
just a bit, the 1990 model would have to send a new set of product messages—”an
adult sense of reliability.” The ideal family car would allow the driver to transportfamily and friends with confidence, whatever the weather or road conditions; passengers would always feel safe and secure.
This message was still too abstract to guide the engineers who would later be making concrete choices about the new Accord’s specifications, parts, and manufacturing
processes. So the next step was finding an image that would personify the car’s message to consumers. The image that managers emerged with was “a rugby player in abusiness suit.” It evoked rugged, physical contact, sportsmanship, and gentlemanly
behavior—disparate qualities the new car would have to convey. The image was also
concrete enough to translate clearly into design details. The decision to replace the old
Accord’s retractable head lamps with headlights made with a pioneering technology
developed by Honda’s supplier, Stanley, is a good example. To the designers and engineers, the new lights’ totally transparent cover glass symbolized the will of a rugby
player looking into the future calmly, with clear eyes.
The next and last step in creating the Accord’s product concept was to break down
the rugby player image into specific attributes the new car would have to possess.
Five sets of key words captured what the product leader envisioned: “open minded,”“friendly communication,” “tough spirit,” “stress-free,” and “love forever.” Individually and as a whole, these key words reinforced the car’s message to consumers.
“Tough spirit” in the car, for example, meant maneuverability, power, and sure handling in extreme driving conditions, while “love forever” translated into long-term
reliability and customer satisfaction. Throughout the course of the project, thesephrases provided a kind of shorthand to help people make coherent design and hardware choices in the face of competing demands.48

There are three generic approaches to improving quality performance: catching up, pulling ahead, and leapfrogging.49 Catching up involves restoring those
aspects about which the firm has been behind to standard. Catching up is a defensive strategy where the emphasis is either to be as good as the competition or tobarely meet market requirements. Pulling ahead, going further than the customer

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asks or achieving superiority over the competition, provides a firm competitive
advantage that may lead to greater profitability. Thus, it makes sense to resist thetemptation to focus on just catching up and to find a way to make a sustainable
move to pull ahead. Finally, leapfrogging involves negating competitive disadvantage, that is, creating a sustainable competitive advantage through differentiation. In other words, leapfrogging comprises coming from behind and getting
ahead of the competition through providing a quality product in keeping withcustomer demands. For example, by leapfrogging Detroit on several key attributes, Japanese companies rolled further up the “quality-for-price curve”; that is,they shifted into better value positions.
Several benefits accrue to businesses that offer superior perceived quality,
including stronger customer loyalty, more repeat purchases, less vulnerability to
price wars, ability to command higher relative price without affecting share,
lower marketing costs, and share improvements.
Customer-Service
Strategy

Customer service has come to occupy an important place in today’s competitivemarket. Invariably, customers want personal service, the kind of service deliveredby live bodies behind a sales counter, a human voice at the other end of a telephone, or people in the teller’s cage at the bank. Paying attention to the customer
is not a new concept. In the 1950s, General Motors went all the way toward consumer satisfaction by designing cars for every lifestyle and pocketbook, a breakthrough for an industry that had been largely driven by production needs eversince Henry Ford promised to deliver any color car as long as it was black.
General Motors rode its insights into customers’ needs to a 52 percent share of the
U.S. car market in 1962.50 But with a booming economy, a rising population, andvirtually no foreign competition, many U.S. companies had it too easy. Throughthe 1960s and into the 1970s, many U.S. car makers could sell just about anything
they could produce. With customers seemingly satisfied, management concentrated on cutting production costs and making splashy acquisitions. To manage
these growing behemoths, CEOs turned to strategic planning, which focused on
winning market share, not on getting in touch with remote customers. Markets
came to be defined as aggregations of competitors, not as customers.
In recent times, Japanese companies were the first to recognize a problem.
They started to rescue customers from the limbo of so-so merchandise and takeit-or-leave-it service. They built loyalty among U.S. car buyers by assiduously
uncovering and accommodating customer needs. The growing influence ofJapanese firms as well as demographics and hard economic times have forced
American companies to realize the need to listen to customers.
Creative changes in service can make the difference. For example, companies
offering better service can charge 10 percent more for their products than competitors.51 Even smaller companies with fewer management layers are finding that
personal relationships between senior executives and customers can help in various ways. Many companies attach so much importance to service that they require
their senior managers to put in time at the front lines. For example, Xerox requiresthat its executives spend one day a month taking complaints from customers

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about machines, bills, and service. Similarly, at Hyatt Hotels, senior executives put
in time as bellhops.52
Briefly, a company must decide who it wants to serve, discover what thosecustomers want, and set a strategy that single-mindedly provides that service tothose customers. With such clearly articulated goals, top management can give
frontline employees responsibility for responding instantly to customer needs inthose crucial moments that determine the company’s success or failure. The following episode, which underlines Scandinavian Airlines’s emphasis on service,shows how far a company can go to stand by the customer.
Rudy Peterson was an American businessman staying at the Grand Hotel in Stockholm. Arriving at Stockholm’s Arlanda airport for an important day trip with a colleague to Copenhagen on a Scandinavian Airlines (SAS) flight, he realized he’d left his
ticket in his hotel room.
Everyone knows you can’t board an airplane without a ticket, so Rudy Peterson
resigned himself to missing the flight and his business meeting in Copenhagen. But
when he explained his dilemma to the ticket agent, he got a pleasant surprise. “Don’t
worry, Mr. Peterson,” she said with a smile. “Here’s your boarding card. I’ll insert atemporary ticket in here. If you just tell me your room number at the Grand Hotel andyour destination in Copenhagen, I’ll take care of the rest.”
While Rudy and his colleague waited in the passenger lounge, the ticket agent
dialed the hotel. A bellhop checked the room and found the ticket. The ticket agent
then sent an SAS limo to retrieve it from the hotel and bring it directly to her. They
moved so quickly that the ticket arrived before the Copenhagen flight departed. No
one was more surprised than Rudy Peterson when the flight attendant approached
him and said calmly, “Mr. Peterson? Here’s your ticket.”
What would have happened at a more traditional airline? Most airline manuals areclear: “No ticket, no flight.” At best, the ticket agent would have informed her supervisor of the problem, but Rudy Peterson almost certainly would have missed his
flight. Instead, because of the way SAS handled his situation, he was both impressedand on time for his meeting.53

The SAS experience shows how far a business must be willing to go to becomea truly customer-driven company, a company that recognizes that its only true
assets are satisfied customers, all of whom expect to be treated as individuals.
Many firms argue that service by definition is difficult to guarantee. Services
are generally delivered by human beings, who are less predictable than machines.
Services are also usually produced at the same time that they are consumed.
Although there can be exceptions to the rule, service can be guaranteed in any
field. Consider the guarantee offered by “Bugs” Burger Bug Killers (BBBK), a
Miami-based pest extermination company, a division of S.C. Johnson and Sons:
Most of BBBK’s competitors claim that they will reduce pests to “acceptable levels”;
BBBK promises to eliminate them entirely. Its service guarantee to hotel and restaurant clients promises:• You don’t owe one penny until all pests on your premises have been eradicated.
• If you are ever dissatisfied with BBBK’s service, you will receive a refund for up to
12 months of the company’s services plus fees for another exterminator of yourchoice for the next year.

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PART 6 Marketing Strategies• If a guest spots a pest on your premises, BBBK will pay for the guest’s meal orroom, send a letter of apology, and pay for a future meal or stay.
• If your facility is closed down due to the presence of roaches or rodents, BBBK will
pay any fines, as well as all lost profits, plus $5,000. In short, BBBK says, “If we
don’t satisfy you 100%, we don’t take your money.”54

The company’s service program has been extremely successful. It charges up
to 10 times more than its competitors and yet has a disproportionately high market share in its operating areas.
In designing a good service program, a company should be conversant witha number of important trends. First, customers don’t read (e.g., customers don’tread assembly and operation instructions). Second, customers don’t understandownership responsibilities (e.g., some hotels require customers to program theirown wake-up calls into a confusing computerized system). Third, high technology and product complexity make product differentiation difficult (i.e., with like
products, better service can become an important differentiating factor). Fourth,consumers have lower confidence and expectations for products and services(i.e., customer service can have an enormous impact on consumer confidence).
Fifth, high-quality service has become a product attribute (i.e., consumers ratequalitative service factors as more important than product cost and features).
Sixth, consumer attention is drawn to negative publicity (i.e., negative word of
mouth is extremely detrimental). Seventh, consumers believe they are not getting
their money’s worth.
Improved customer service can play a major role in changing customer perceptions about a product and its value and can directly affect a company’s successand profitability. The quality of service a company provides depends largely on
people, not only those with direct customer responsibility but also with managers, supervisors, and support staff. Thus, success in providing adequate service
largely depends on preparing employees for it.
Time-Based
Strategy

When a product market changes quickly, companies must respond quickly if theywant to preserve their positions. In today’s changing markets, time-based strategy that aims to beat the competition has assumed new dimensions.
GE has cut the time to deliver a custom-made industrial circuit breaker box
from three weeks to three days. In the past, AT&T needed two years to design a
new phone; now it needs only one year. Motorola used to take three weeks to turnout electronic pagers after the factory received the order; now it takes twohours.55
Time-based strategy brings about important competitive benefits. Market
share grows because customers love getting their orders now. Inventories of finished goods shrink because they are not necessary to ensure quick delivery; thefastest manufacturers can make and ship an order the day it is received. For thisand other reasons, costs fall. Many employees become satisfied because they are
working for a more responsive, more successful company and because speeding
operations requires giving them more flexibility and responsibility. Quality also
improves. Briefly, doing it fast forces a firm to do it right the first time.

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Speed can also pay off in product development even if it means going overbudget by as much as 50 percent. For example, a model developed by McKinsey
and Co. shows that high-tech products that come to market on budget but six
months late earn 33 percent less profit over five years. In contrast, coming out 50
percent over budget but on time cuts profits only by 4 percent.56
To implement a time-based strategy, the entire production process must be
redesigned for speed. GE’s experience is relevant here. Its circuit breaker business
was old and stagnant. Market growth was slow and Siemens and Westinghousewere strong competitors. GE assembled a team of manufacturing, design, andmarketing experts to focus on overhauling the entire process. The goal was to cut
the time between order and delivery from three weeks to three days. Six plants
around the United States were producing circuit breaker boxes. The team consolidated production into one plant and automated its facilities. But the team did not
automate operations as they were. In the old system, engineers custom-designed
each box, a task that took about a week. Engineers chose from 28,000 unique parts
to create a box. To set up an automated system to handle that many parts would
have been a nightmare. The design team reduced the number of parts to 1,275,
making most parts interchangeable. Even with this drastic reduction in parts, customers were still given 40,000 different sizes, shapes, and configurations fromwhich to choose.
The team also devised a way to phase out the engineers, by replacing themwith computers. Now a salesperson enters the specifications for a circuit breaker
into a computer at GE’s main office and the order flows to a computer at theplant, which automatically programs factory machines to custom-make the orderwith minimum waste.
Although these advances are indeed impressive, the team still had to conquer
another source of delay—solving problems and making decisions on the factory
floor. The solution was to eliminate all line supervisors and quality inspectors,
reducing the organizational layers between worker and plant manager from three
to one. Everything middle managers used to handle—vacation scheduling, quality, work rules—became the responsibility of the 129 workers on the floor, whowere divided into teams of 15 to 20. It worked. The more responsibility GE gave
the workers, the faster problems were solved and decisions were made.
The results: The plant that used to have a two-month backlog of orders now
works with a two-day backlog. Productivity has increased 20 percent over the
past year. Manufacturing costs have dropped 30 percent, or $5.5 million a year,
and return on investment is running at over 20 percent. The speed of delivery fora higher-quality product with more features has shrunk from three weeks to threedays. And GE is gaining share in a flat market.57
Another area ripe for time-based strategy is the administrative/approval
area. According to the Thomas Group, a Dallas-based consulting firm specializing in speed, manufacturing typically takes only 5 to 20 percent of the total timethat is needed to get an order for a given product to market; the rest is administrative.58 For example, at Adca Bank, a subsidiary of West Germany’s
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through numerous layers of bureaucracy. A branch would send a loan application
to a loan officer at headquarters, who would look at it and change it. Then theloan officer’s manager would look at the application and change it, and so on. The
bank eventually got rid of five layers of management and gave officers in all
branches more authority to make loans. It used to take 24 managers to approve aloan. Now it takes 12.
Teamwork seems to be the key ingredient among the fastest companies.
Nearly all of them form multidepartment teams. AT&T formed teams of six totwelve members, including engineers, manufacturers, and marketers, with complete authority to make every decision about how a product would look, work,
be made, and cost. At AT&T the key was setting rigid speed requirements, suchas six weeks, and leaving the rest to the team. Teams could meet these strict deadlines because they did not need to send each decision up the line for approval.
With this new approach, AT&T cut development time for its new 4200 phonefrom two years to just a year while lowering costs and increasing quality.
Application of time-based strategy to distribution is equally important. Even
the world’s fastest factory cannot provide much of a competitive advantage if
everything it produces gets snagged in the distribution chain. For example,
Benetton takes its distribution very seriously and has created an electronic loopthat links sales agent, factory, and warehouse. If a saleswoman in one of
Benetton’s Los Angeles shops finds that she is starting to run out of a best-sellingsweater, she calls one of Benetton’s 80 sales agents, who enters the order in a personal computer, which sends it to a mainframe in Italy. The mainframe computer,which has all of the measurements for the sweater, sets the knitting machines inmotion. Once the sweaters are finished, workers box them up and label the box
with a bar code containing the Los Angeles address. The box then goes into thewarehouse. The computer next sends a robot flying. The robot finds the box andany others going to Los Angeles, picks them up, and loads them onto a truck.
Including manufacturing time, Benetton can get an order to Los Angeles in fourweeks.
Implementation of time-based strategy requires a number of steps. First, startfrom scratch (i.e., set a time goal and revamp entire operations to meet this goal
rather than simply improving efficiency in current operations). Second, wipe out
approvals (i.e., cut down bureaucratic layers of control and let people make decisions on the spot). Third, emphasize teamwork (i.e., establish multidepartment
teams to handle the work). Fourth, worship the schedule (i.e., nothing short ofdisaster should be a valid excuse for delay). Fifth, develop time-effective distribution (i.e., snags in distribution must be simultaneously worked out). Sixth, put
speed in the culture (i.e., train people in the company at all levels to understandand appreciate the significance of speed).
The advantages of speed are undeniably impressive. Although it is a common precept that time is money, in practice, companies have paid only lip service to it. The time it took to do a job, whatever the amount, was considered anecessity to meet organizational requirements, systems, procedures, and hierarchical relationships. Now, however, there is a new realization that time saved is

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a strategic factor for gaining competitive advantage. Companies that grasp andappreciate the unprecedented advantages of getting new products to market
sooner and orders to customers faster hold the key for achieving competitive
preeminence in the 1990s and beyond.

SUMMARY

Product strategies reflect the mission of the business unit and the business it is in.
Following the marketing concept, the choice of product strategy should bear aclose relationship to the market strategy of the company. The various productstrategies and the alternatives under each strategy that were discussed in thischapter are outlined below:
1. Product-positioning strategy
a. Positioning a single brandb. Positioning multiple brands
2. Product-repositioning strategy
a. Repositioning among existing customers
b. Repositioning among new users
c. Repositioning for new uses
3. Product-overlap strategy
a. Competing brands
b. Private labelingc. Dealing with original-equipment manufacturers (OEMs)
4. Product-scope strategy
a. Single productb. Multiple productsc. System of products
5. Product-design strategy
a. Standard productsb. Customized productsc. Standard product with modifications
6. Product-elimination strategy
a. Harvestingb. Line simplificationc. Total-line divestment
7. New-product strategy
a. Product improvement/modificationb. Product imitationc. Product innovation

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8. Diversification strategy
a. Concentric diversificationb. Horizontal diversificationc. Conglomerate diversification
9. Value-marketing strategy
a. Quality strategy
b. Customer-service strategy
c. Time-based strategy

The nature of different strategies was discussed, and their relevance for different types of companies was examined. Adaptations of different strategies inpractice were illustrated with citations from published sources.

DISCUSSIONQUESTIONS

1. Discuss how a business unit may avoid problems of cannibalism among competing brands.
2. Conceptualize how a lagging brand (assume a grocery product) may be repositioned for new uses.
3. What criteria may be employed to determine the viable position for a brand in
the market?
4. What conditions justify a company’s dealing in multiple products?
5. Are there reasons other than profitability for eliminating a product? Discuss.
6. What factors must be weighed to determine the viability of divesting an entire
product line?
7. Under what circumstances is it desirable to adopt a product-imitation strategy?

NOTES

1 Edward H. Kolcum, “Gould Will Use Same Market Strategy under Encore Ownership,”

Aviation Week and Space Technology (17 April 1989): 53.
2 Theodore Levitt, “Marketing Success through Differentiation of Anything,” Harvard

Business Review (January–February 1980): 82.
3 See Frank Rose, “Mickey Online,” Fortune (28 September 1995): 273.
4 Philip Kotler, Marketing Management, 5th ed. (Englewood Cliffs, NJ: Prentice-Hall,

1994): 310.
5 Subhash C. Jain,“Global Competitiveness in the Beer Industry: A Case Study,” Food

Marketing Policy Center, University of Connecticut, Research Report No. 28,
November, 1994.
6 Prudential Securities Incorporated, Anheuser-Busch Company Update, June 1993.
7 Ira Teinowitz, “Beer Battle Heats Up: New Brands Score,” Advertising Age (13 August1990): 21.
8 Roger A. Kerin, Michael G. Harvey, and James T. Rothe, “Cannibalism and New
Product Development,” Business Horizons (October 1978): 31.
9 Alison Fahey, “A&W Aims Younger,” Advertising Age (27 January 1992): 12.
10 Eric Morgenthaler, “People Are So Goofy About Disney World, They Marry There,”
The Wall Street Journal (28 October 1992): A1.

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11 Based on an interview with a Gillette executive. See also Lawrence Ingrassia, “SchickRazor to Try for Edge against Gillette,” The Wall Street Journal (9 October 1990): B1.
12 See “The Gillette Company,” in Subhash C. Jain, International Marketing Management,

6th edition, (Storrs, CT: Digital Publishing Company, 1999): 852–856.
13 ”Sticky Label?" The Economist (25 July 1998): 63.
14 Colmetta Y. Coleman, “Dr. Pop and Frisk Help a Grocery Chain Grow,” The Wall Street

Journal (13 April 1998): B1.
15 Alex Taylor III, “Kodak Scrambles to Reforms,” Fortune (3 March 1986): 34.
16 ”From the Microbrewers Who Brought You Bud, Coors. . . ,” Business Week (24 April

1995): 66.
17 Justin Martin, “Give ‘em Exactly What They Want,” Fortune (November 1997): 283.
18 Richard T. Hise, A. Parasuraman, and Ramaswamy Viswanathan, “ProductElimination: The Neglected Management Responsibility,” Journal of Business Strategy(Spring 1984): 56–63.
19 Gregory A. Patterson and Christina Duff, “Sears Trims Operations, Ending an Era,”
The Wall Street Journal (26 January 1993): B1.
20 Linda Grant, “Why Kodak Still Isn’t Fixed,” Fortune (11 May 1998): 179.
21 ”How Sweet It Is to Be out from under Beatrice’s Thumb,” Business Week (9 May 1988):
98.
22 New Products Management for the 1980s (New York: Booz, Allen, & Hamilton Inc., 1982):
14.
23 Justin Martin, “Ignore Your Customer,” Fortune (1 May 1995): 121.
24 New Products Management for the 1980s, 18.
25 Bro Uttal, “Eastman Kodak’s Orderly Two-Front War,” Fortune (September 1976): 123.
26 Linda Grant, “Why Kodak Still Isn’t Fixed.” Also see Eastman Kodak Company’s Annual
Report for 1998.
27 Patricia Sellers, “A Boring Brand Can Be Beautiful,” Fortune (18 November 1991): 48.
28 Kenichi Ohmae, “Effective Strategies for Competitive Success,” McKinsey Quarterly(Winter 1978): 56–57.
29 Nikhil Deogun, “Pepsi Takes Aim at Coke With New One-Calorie Drink, “ The WallStreet Journal (6 October 1998): B4.
30 ”From the Microbrewers Who Brought You Bud, Coors. . . .”31 ”Flops,” Business Week (16 August 1993): 76.
32 Ronald Alsop, “Consumer-Product Giants Relying on ‘Intrapreneurs’ in New
Ventures,” The Wall Street Journal (22 April 1988): 35.
33 Joyce Ranney and Mark Deck, “Making Teams Work: Lessons from Leaders in New
Product Development,” Planning Forum (July/August 1995).
34 Peter Vanderwicken, “P&G’s Secret Ingredient,” Fortune (July 1974): 75. See also “The
Miracle Company,” Business Week (19 October 1987): 84.
35 The Economist (23 January 1988): 75.
36 Laurie Hays, “Du Pont’s Difficulties in Selling Kevlar Show Hurdles of Innovation,”
The Wall Street Journal (29 September 1987): 1. See also E. I. du Pont de Nemours andCompany, Annual Report for 1990.
37 ”Coke’s Man on the Spot,” Business Week (25 July 1985): 56.
38 E. Ralph Biggadike, “The Risky Business of Diversification,” Harvard Business Review(May–June 1979): 103–111. See also E. Ralph Biggadike, Corporate Diversification: Entry
Strategy and Performance (Boston: Division of Research, Harvard Business School,1979).

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39 ”A Revved-up Market for Diesel Engine Makers,” Business Week (5 February 1979): 76.
40 Richard Gibson, “Restaurant Rescuer Don Smith Hopes for More Than Potluck at

Friendly’s,” The Wall Street Journal (11 August 1988): 34.
41 Michael E. Porter, “From Competitive Advantage to Corporate Strategy,” McKinsey

Quarterly (Spring 1988): 43.
42 ”Hopelessly Seeking Synergy,” The Economist (20 August 1994): 53.
43 ”Gillette: After Diversification That Failed,” Business Week (28 February 1977): 58–62.
44 ”Barbie’s Secret Plan for World Domination,” Fortune (23 November 1998): 38.
45 ”Who Says the Conglomerate Is Dead?” Business Week (23 January 1995): 92.
46 Bradley T. Grale and Robert D. Buzzell, “Market Perceived Quality: Key Strategic

Concept,” Planning Review (March–April 1989): 11.
47 Bradley T. Gale, “The Role of Marketing in Total Quality Management,” Quest for

Excellence Conference, Washington, D.C., 1990.
48 Kim B. Clark and Takahiro Fujimoto, “The Power of Product Integrity,” Harvard

Business Review (November–December 1990): 110.
49 Gale and Buzzell, “Market Perceived Quality,” 7–8 and 14–16.
50 Frank Rose, “Now Quality Means Service Too,” Fortune (22 April 1991): 98.
51 ”King Customer,” Business Week (12 March 1990): 90.
52 Rose, “Now Quality Means Service Too,” 100.
53 Jan Carlzon, “Putting the Customer First: The Key to Service Strategy,” McKinsey

Quarterly (Summer 1987): 38–39.
54 Christopher W. L. Hart, “The Power of Unconditional Service Guarantees,” Harvard

Business Review (July–August 1988): 54.
55 Brian Dumaine, “How Managers Can Succeed through Speed,” Fortune (13 February1989): 54. See also Warren B. Brown and Necmi Karagozoglu, “Leading the ProductDevelopment,” Academy of Management Executive (1993): 36–47.
56 Edward G. Krubasik, “Customize Your Product Development,” Harvard Business
Review (November–December 1988): 46–52.
57 Dumaine, “How Managers Can Succeed through Speed,” 57–58. See also “Mattel’s
Wild Race to Market,” Business Week (12 February 1994): 62.
58 This example and the ones that follow are based on Dumaine, “How Managers Can
Succeed through Speed.”

APPENDIX
I.
Product-Positioning
Strategy

Perspectives of Product Strategies
Definition: Placing a brand in that part of the market where it will have a favorable reception compared with competing brands.
Objectives: (a) To position the product in the market so that it stands apart fromcompeting brands. (b) To position the product so that it tells customers what
you stand for, what you are, and how you would like customers to evaluateyou. In the case of positioning multiple brands: (a) To seek growth by offering
varied products in differing segments of the market. (b) To avoid competitive
threats to a single brand.
Requirements: Use of marketing mix variables, especially design and communication efforts. (a) Successful management of a single brand requires positioning

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the brand in the market so that it can stand competition from the toughest rivaland maintaining its unique position by creating the aura of a distinctive product. (b) Successful management of multiple brands requires careful positioning
in the market so that multiple brands do not compete with nor cannibalize
each other. Thus it is important to be careful in segmenting the market and toposition an individual product as uniquely suited to a particular segment
through design and promotion.
Expected Results: (a) Meet as much as possible the needs of specific segments ofthe market. (b) Limit sudden changes in sales. (c) Make customers faithful tothe brands.
II.
ProductRepositioning
Strategy

Definition: Reviewing the current positioning of the product and its marketingmix and seeking a new position for it that seems more appropriate.
Objectives: (a) To increase the life of the product. (b) To correct an original positioning mistake.
Requirements: (a) If this strategy is directed toward existing customers, repositioning is sought through promotion of more varied uses of the product. (b) If
the business unit wants to reach new users, this strategy requires that the
product be presented with a different twist to the people who have not beenfavorably inclined toward it. In doing so, care should be taken to see that, inthe process of enticing new customers, current ones are not alienated. (c) If
this strategy aims at presenting new uses of the product, it requires searching
for latent uses of the product, if any. Although all products may not havelatent uses, there are products that may be used for purposes not originallyintended.
Expected Results: (a) Among existing customers: increase in sales growth andprofitability. (b) Among new users: enlargement of the overall market, thus
putting the product on a growth route, and increased profitability. (c) New
product uses: increased sales, market share, and profitability.

III.
Product-Overlap
Strategy

Definition: Competing against one’s own brand through introduction of competing products, use of private labeling, and selling to original-equipment manufacturers.
Objectives: (a) To attract more customers to the product and thereby increase theoverall market. (b) To work at full capacity and spread overhead. (c) To sell tocompetitors; to realize economies of scale and cost reduction.
Requirements: (a) Each competing product must have its own marketing organization to compete in the market. (b) Private brands should not become profit
drains. (c) Each brand should find its special niche in the market. If that
doesn’t happen, it will create confusion among customers and sales will behurt. (d) In the long run, one of the brands may be withdrawn, yielding its
position to the other brand.
Expected Results: (a) Increased market share. (b) Increased growth.

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IV.
Product-Scope
Strategy

Definition: The product-scope strategy deals with the perspectives of the productmix of a company. The product-scope strategy is determined by taking into
account the overall mission of the business unit. The company may adopt asingle-product strategy, a multiple-product strategy, or a system-of-products
strategy.
Objectives: (a) Single product: to increase economies of scale by developing specialization. (b) Multiple products: to cover the risk of potential obsolescence ofthe single product by adding additional products. (c) System of products: toincrease the dependence of the customer on the company’s products as well as
to prevent competitors from moving into the market.
Requirements: (a) Single product: company must stay up-to-date on the productand even become the technology leader to avoid obsolescence. (b) Multiple
products: products must complement one another in a portfolio of products.
(c) System of products: company must have a close understanding of customer
needs and uses of the products.
Expected Results: Increased growth, market share, and profits with all three strategies. With system-of-products strategy, the company achieves monopolistic
control over the market, which may lead to some problems with the JusticeDepartment, and enlarges the concept of its product/market opportunities.

V.
Product-Design
Strategy

Definition: The product-design strategy deals with the degree of standardization ofa product. The company has a choice among the following strategic options: standard product, customized product, and standard product with modifications.
Objectives: (a) Standard product: to increase economies of scale of the company.
(b) Customized product: to compete against mass producers of standardized
products through product-design flexibility. (c) Standard product with modifications: to combine the benefits of the two previous strategies.
Requirements: Close analysis of product/market perspectives and environmental
changes, especially technological changes.
Expected Results: Increase in growth, market share, and profits. In addition, thethird strategy allows the company to keep close contacts with the market andgain experience in developing new standard products.

VI.
ProductElimination
Strategy

Definition: Cuts in the composition of a company’s business unit product portfolio by pruning the number of products within a line or by totally divesting adivision or business.
Objectives: To eliminate undesirable products because their contribution to fixed
cost and profit is too low, because their future performance looks grim, or
because they do not fit in the business’s overall strategy. The productelimination strategy aims at shaping the best possible mix of products and balancing the total business.
Requirements: No special resources are required to eliminate a product or a division.
However, because it is impossible to reverse the decision once the elimination

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has been achieved, an in-depth analysis must be done to determine (a) the causesof current problems; (b) the possible alternatives, other than elimination, that
may solve problems (e.g., Are any improvements in the marketing mix possible?); and (c) the repercussions that elimination may have on remaining products
or units (e.g., Is the product being considered for elimination complementary toanother product in the portfolio? What are the side effects on the company’s
image? What are the social costs of an elimination?).
Expected Results: In the short run, cost savings from production runs, reduced
inventories, and in some cases an improved return on investment can be
expected. In the long run, the sales of the remaining products may increase
because more efforts are now concentrated on them.
VII.
New-ProductStrategy

Definition: A set of operations that introduces (a) within the business, a productnew to its previous line of products; (b) on the market, a product that provides a new type of satisfaction. Three alternatives emerge from the above:
product improvement/modification, product imitation, and product innovation.
Objectives: To meet new needs and to sustain competitive pressures on existingproducts. In the first case, the new-product strategy is an offensive one; in thesecond case, it is a defensive one.
Requirements: A new-product strategy is difficult to implement if a “new productdevelopment system” does not exist within a company. Five components ofthis system should be assessed: (a) corporate aspirations toward new products,(b) organizational openness to creativity, (c) environmental favor toward creativity, (d) screening method for new ideas, and (e) evaluation process.
Expected Results: Increased market share and profitability.

VIII.
Diversification
Strategy

Definition: Developing unfamiliar products and markets through (a) concentric
diversification (products introduced are related to existing ones in terms ofmarketing or technology), (b) horizontal diversification (new products areunrelated to existing ones but are sold to the same customers), and (c) conglomerate diversification (products are entirely new).
Objectives: Diversification strategies respond to the desire for (a) growth whencurrent products/markets have reached maturity, (b) stability by spreading therisks of fluctuations in earnings, (c) security when the company may fear backward integration from one of its major customers, and (d) credibility to havemore weight in capital markets.
Requirements: In order to reduce the risks inherent in a diversification strategy, abusiness unit should (a) diversify its activities only if current product/market
opportunities are limited, (b) have good knowledge of the area in which it
diversifies, (c) provide the products introduced with adequate support, and (d)forecast the effects of diversification on existing lines of products.
Expected Results: (a) Increase in sales. (b) Greater profitability and flexibility.

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IX.
Value-Marketing
Strategy

Definition: The value-marketing strategy concerns delivering on promises madefor the product or service. These promises involve product quality, customer
service, and meeting time commitments.
Objectives: Value-marketing strategies are directed toward seeking total customer
satisfaction. It means striving for excellence to meet customer expectations.
Requirements: (a) Examine customer value perspectives. (b) Design programs tomeet customer quality, service, and time requirements. (c) Train employees anddistributors to deliver on promises.
Expected Results: This strategy enhances customer satisfaction, which leads tocustomer loyalty and, hence, to higher market share. This strategy makes thefirm less vulnerable to price wars, permitting the firm to charge higher prices
and, thus, earn higher profits.

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CHAPTER FIFTEEN

Pricing Strategies
The real price ofeverything is thetoil and trouble ofacquiring it.

Pricing has traditionally been considered a me-too variable in marketing strategy.
The stable economic conditions that prevailed during the 1960s may be particularly responsible for the low status ascribed to the pricing variable. Strategically,
the function of pricing has been to provide adequate return on investment. Thus,
the timeworn cost-plus method of pricing and its sophisticated version, return-oninvestment pricing, have historically been the basis for arriving at price. In the
1970s, however, a variety of events gave a new twist to the task of making pricing
decisions. Double-digit inflation, material shortages, the high cost of money, consumerism, and Post-price controls behavior all made pricing important. Since thenpricing continues to play a key role in formulating marketing strategy.
Despite the importance attached to it, effective pricing is not an easy task,even under the most favorable conditions. A large number of internal and external variables must be studied systematically before price can be set. For example,
the reactions of a competitor often stand out as an important consideration indeveloping pricing strategy. Simply knowing that a competitor has a lower priceis insufficient; a price strategist must know how much flexibility a competitor has
in further lowering price. This presupposes a knowledge of the competitor’s cost
structure. In the dynamics of today’s environment, however, where unexpectedeconomic changes can render cost and revenue projections obsolete as soon as
they are developed, pricing strategy is much more difficult to formulate.
This chapter provides a composite of pricing strategies. Each strategy is
examined for its underlying assumptions and relevance in specific situations. The
application of different strategies is illustrated with examples from pricing literature. The appendix at the end of this chapter summarizes each strategy by giving
its definition, objectives, requirements, and expected results.

ADAM SMITH

REVIEW OF PRICING FACTORS
Basically, a pricer needs to review four factors to arrive at a price: pricing objectives, cost, competition, and demand. This section briefly reviews these factors,
which underlie every pricing strategy alternative.
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Pricing Objectives

Broadly speaking, pricing objectives can be either profit oriented or volume oriented. The profit-oriented objective may be defined either in terms of desired net
profit percentage or as a target return on investment. The latter objective has been
more popular among large corporations. The volume-oriented objective may bestated as the percentage of market share that the firm would like to achieve.
Alternatively, it may simply be stated as the desired sales growth rate. Many
firms also consider the maintenance of a stable price as a pricing goal. Particularly
in cyclical industries, price stability helps to sustain the confidence of customers
and thus keeps operations running smoothly through peaks and valleys.
For many firms, there can be pricing objectives other than those of profitability and volume, as shown in Exhibit 15-1. Each firm should evaluate different objectives and choose its own priorities in the context of the pricing problems
that it may be facing. The following list contains illustrations of typical pricing
problems:
1. Decline in sales.
2. Higher or lower prices than competitors.
3. Excessive pressure on middlemen to generate sales.
4. Imbalance in product line prices.
5. Distortion vis-à-vis the offering in the customer’s perceptions of the firm’s price.
6. Frequent changes in price without any relationship to environmental realities.

EXHIBIT 15-1
Potential Pricing Objectives
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.

Maximum long-run profits
Maximum short-run profits
GrowthStabilize market
Desensitize customers to price
Maintain price-leadership arrangement
Discourage entrants
Speed exit of marginal firms
Avoid government investigation and control
Maintain loyalty of middlemen and get their sales support
Avoid demands for “more” from suppliers
Enhance image of firm and its offerings
Be regarded as “fair” by customers (ultimate)
Create interest and excitement about the item
Be considered trustworthy and reliable by rivals
Help in the sale of weak items in the line
Discourage others from cutting prices
Make a product “visible”“Spoil market” to obtain high price for sale of business
Build traffic

Source: Alfred R. Oxenfeldt, “A Decision-Making Structure for Price Decisions,” Journal of Marketing(January 1973): 50. Reprinted by permission of the American Marketing Association.

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These problems suggest that a firm may have more than one pricing objective, even though these objectives may not be articulated as such. Essentially, pricing objectives deal directly or indirectly with three areas: profit (setting a highenough price to enable the company to earn an adequate margin for profit andreinvestment), competition (setting a low enough price to discourage competitorsfrom adding capacity), and market share (setting a price below competition to
gain market share).
As an example of pricing objectives, consider the goals that Apple Computerset for Macintosh:1
1. To make the product affordable and a good value for most college students.
2. To get certain target market segments to see the Macintosh as a better value thanthe IBM PC.
3. To encourage at least 90 percent of all Apple retailers to carry the Macintosh
while providing a strong selling effort.
4. To accomplish all this within 18 months.

Cost

Fixed and variable costs are the major concerns of a pricer. In addition, the pricer
may sometimes need to consider other types of costs, such as out-of-pocket costs,
incremental costs, opportunity costs, controllable costs, and replacement costs.
To study the impact of costs on pricing strategy, the following three relationships may be considered: (a) the ratio of fixed costs to variable costs, (b) the
economies of scale available to a firm, and (c) the cost structure of a firm vis-à-vis
competitors. If the fixed costs of a company in comparison to its variable costs
form a high proportion of its total costs, adding sales volume will be a great help
in increasing earnings. Consider, for example, the case of the airlines, whose fixed
costs are as high as 60 to 70 percent of total costs. Once fixed costs are recovered,any additional tickets sold add greatly to earnings. Such an industry is called volume sensitive. There are some industries, such as the consumer electronics industry, where variable costs constitute a higher proportion of total costs than do fixed
costs. Such industries are price sensitive because even a small increase in priceadds much to earnings.
If the economies of scale obtainable from a company’s operations are substantial, the firm should plan to expand market share and, with respect to longterm prices, take expected declines in costs into account. Alternatively, if
operations are expected to produce a decline in costs, then prices may be loweredin the long run to gain higher market share.
If a manufacturer is a low-cost producer relative to its competitors, it will
earn additional profits by maintaining prices at competitive levels. The additional profits can be used to promote the product aggressively and increase theoverall market share of the business. If, however, the costs of a manufacturer are
high compared to those of its competitors, the manufacturer is in no position to
reduce prices because that tactic may lead to a price war that it would most
likely lose.
Different elements of cost must be differently related in setting price. Exhibit
15-2 shows, for example, how computations of full cost, incremental cost, and414

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EXHIBIT 15-2
Effect of Costs on Pricing
Cost Pricing
Costs

Product A

Product B

$ 80
160
40
280
240
120

$120
80
80
280
200
200

Markup (M’)

Product A

Product B

Full-Cost Pricing
P = FC + (M’)FC

20%

$336

$336

Incremental-Cost Pricing
P = (L + M) + M’(L + M)

40%

336

280

Conversion-Cost Pricing
P = (L + O) + M’(L + O)

180%

336

560

Labor (L)Material (M)Overhead (O)Full cost (L + M + O)
Incremental cost (L + M)
Conversion cost (L + O)
Product Line Pricing

conversion cost may vary and how these costs affect product line prices. Exhibit
15-3 shows the procedure followed for setting target-return pricing.
Competition

Exhibit 15-4 shows the competitive information needed to formulate a pricing
strategy. The information may be analyzed with reference to these competitive
characteristics: number of firms in the industry, relative size of different membersof the industry, product differentiation, and ease of entry.

EXHIBIT 15-3
Computation of Target-Return Pricing
Manufacturing capacity
Standard volume (80%)
Standard full cost before profit
Target profit
Investment
ROI target$20,000,000
20%

ROI target
Profit per unit at standard ($4,000,000 ÷ 160,000)$4,000,000$25/unit

Price200,000
160,000$100/unit$125/unit

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EXHIBIT 15-4
Competitive Information Needed for Pricing Strategy
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.

Published competitive price lists and advertising
Competitive reaction to price moves in the past
Timing of competitors’ price changes and initiating factors
Information on competitors’ special campaigns
Competitive product line comparison
Assumptions about competitors’ pricing/marketing objectives
Competitors’ reported financial performance
Estimates of competitors’ costs—fixed and variable
Expected pricing retaliation
Analysis of competitors’ capacity to retaliate
Financial viability of engaging in price war
Strategic posture of competitors
Overall competitive aggressivenessIn an industry where there is only one firm, there is no competitive activity.
The firm is free to set any price, subject to constraints imposed by law. As an
Illinois Bell executive said about pricing (before the AT&T split): “All we had to do
was determine our costs, and then we would go to the commission—the Illinois
Commerce Commission, and they would give us the allowable rate of return.”2
Conversely, in an industry comprising a large number of active firms, competitionis fierce. Fierce competition limits the discretion of a firm in setting price. Where
there are a few firms manufacturing an undifferentiated product (such as in thesteel industry), only the industry leader may have the discretion to change prices.
Other industry members will tend to follow the leader in setting price.
The firm with a large market share is in a position to initiate price changes
without worrying about competitors’ reactions. Presumably, a competitor with alarge market share has the lowest costs. The firm can, therefore, keep its prices
low, thus discouraging other members of the industry from adding capacity, andfurther its cost advantage in a growing market.
If a firm operates in an industry that has opportunities for product differentiation, it can exert some control over pricing even if the firm is small and competitors are many. This latitude concerning price may occur if customers perceive
one brand to be different from competing brands: whether the difference is real or
imaginary, customers do not object to paying a higher price for preferred brands.
To establish product differentiation of a brand in the minds of consumers, companies spend heavily for promotion. Product differentiation, however, offers an
opportunity to control prices only within a certain range.
In an industry that is easy to enter, the price setter has less discretion in establishing prices; if there are barriers to market entry, however, a firm already in theindustry has greater control over prices. Barriers to entry may take any of the following forms:

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1. Capital investment.
2. Technological requirements.
3. Nonavailability of essential materials.
4. Economies of scale that existing firms enjoy and that would be difficult for a newcomer to achieve.
5. Control over natural resources by existing firms.
6. Marketing expertise.

In an industry where barriers to entry are relatively easy to surmount, a new
entrant will follow what can be called keep-away pricing. This pricing strategy isnecessarily on the lower side of the pricing spectrum.
DemandExhibit 15-5 contains the information required for analyzing demand. Demand isbased on a variety of considerations, of which price is just one. Some of these considerations are
1. Ability of customers to buy.
2. Willingness of customers to buy.
3. Place of the product in the customer’s lifestyle (whether a status symbol or a
product used daily).
4. Benefits that the product provides to customers.
5. Prices of substitute products.
6. Potential market for the product (is demand unfulfilled or is the market saturated?).

EXHIBIT 15-5
Customer Information Needed for Pricing Strategy
1. The customer’s value analysis of the product: performance, utility, profit-rendering
potential, quality, etc.
2. Market acceptance level: the price level of acceptance in each major market, including the influence of substitutes.
3. The price the market expects and the differences in different markets.
4. Price stability.
5. The product’s S curve and its present position on it.
6. Seasonal and cyclical characteristics of the industry.
7. The economic conditions now and during the next few periods.
8. The anticipated effect of recessions; the effect of price change on demand in a declining market (e.g., very little with luxury items).
9. Customer relations.
10. Channel relations and channel costs to figure in calculations.
11. The markup at each channel level (company versus intermediary costs).
12. Advertising and promotion requirements and costs.
13. Trade-in, replacement parts, service, delivery, installation, maintenance, preorderand postorder engineering, inventory, obsolescence, and spoilage problems andcosts.
14. The product differentiation that is necessary.
15. Existing industry customs and reaction of the industry.
16. Stockholder, government, labor, employee, and community relations.

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7. Nature of nonprice competition.
8. Customer behavior in general.
9. Segments in the market.

All these factors are interdependent, and it may not be easy to estimate theirrelationship to each other precisely.
Demand analysis involves predicting the relationship between price leveland demand while considering the effects of other variables on demand. The relationship between price and demand is called elasticity of demand or sensitivityof price. Elasticity of demand refers to the number of units of a product thatwould be demanded at different prices. Price sensitivity should be considered at
two different levels: total industry price sensitivity and price sensitivity for a particular firm.
Industry demand for a product is considered to be elastic if, by lowering
prices, demand can be substantially increased. If lowering price has little effect on
demand, demand is considered inelastic. The environmental factors previously
mentioned have a definite influence on demand elasticity. Let us illustrate with afew examples. During the energy crisis, the price of gasoline went up, leading
consumers to reduce gasoline usage. By the same token, since gasoline prices
have gone down, people have again started using gas more freely. Thus, demand
for gasoline can be considered somewhat elastic.
A case of inelastic demand is provided by salt. No matter how much the pricefluctuates, people are not going to change the amount of salt that they consume.
Similarly, the demand for luxury goods, yachts, for example, is inelastic because
only a small proportion of the total population can afford to buy yachts.
Sometimes the market for a product is segmented so that demand elasticity
in each segment must be studied. The demand for certain types of beverages by
senior citizens might be inelastic, though demand for the same products among a
younger audience may be especially elastic. If the price of a product goes up, customers have the option of switching to another product. Thus, availability of substitute products is another factor that should be considered.
When the total demand of an industry is highly elastic, the industry leader
may take the initiative to lower prices. The loss in revenue due to decreased prices
will be more than compensated for by the additional demand expected to be generated; therefore, the total dollar market expands. Such a strategy is highly attractive in an industry where economies of scale are achievable. Where demand isinelastic and there are no conceivable substitutes, price may be increased, at leastin the short run. In the long run, however, the government may impose controls,
or substitutes may be developed.
The demand for the products of an individual firm derives from total industry demand. An individual firm is interested in finding out how much market
share it can command by changing its own prices. In the case of undifferentiatedstandardized products, lower prices should help a firm increase its market share
as long as competitors do not retaliate by matching the firm’s prices. Similarly,
when business is sought through bidding prices, lower prices should help achieve
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can be improved even when higher prices are maintained (within a certain range).
Products may be differentiated in various real and imaginary ways. For example,
by providing adequate guarantees and after-sale service, an appliance manufacturer may maintain higher prices and still increase market share. Brand name, animage of prestige, and the perception of high quality are other factors that may
help to differentiate a product in the marketplace and thus create an opportunity
for the firm to increase prices and not lose market share. Of course, other elementsof the marketing mix should reinforce the product’s image suggested by its price.
In brief, a firm’s best opportunity lies in differentiating the product and then communicating this fact to the customer. A differentiated product offers more opportunity for increasing earnings through price increases.
The sensitivity of price can be measured by taking into account historical
data, consumer surveys, and experimentation. Historical data can either be studied intuitively or analyzed through quantitative tools, such as regression, to see
how demand goes up or down based on price. A consumer survey to study thesensitivity of prices is no different from any other market research study.
Experiments to judge what level of price generates what level of demand can be
conducted either in a laboratory situation or in the real world. For example, acompany interested in studying the sensitivity of prices may introduce a newly
developed grocery product in a few selected markets for a short period at different prices. Information obtained from this experiment should provide insights
into the elasticity of demand for the product. In one study, the prices of 17 foodproducts were varied in 30 food stores. It was found that the product sales generally followed the law of demand: when prices were raised 10 percent, sales
decreased about 25 percent; a price increase of 5 percent led to a decrease in salesof about 13 percent; a lowering of prices by 5 percent increased sales by 12 percent; and a 10 percent decrease in price improved sales by 26 percent. In anotherstudy, a new deodorant that was priced at 63 cents and at 85 cents in different
markets resulted in the same volume of sales. Thus, price elasticity was found to
be absent, and the manufacturer set the product price at 85 cents.3
A recent study of the top 500 brands in the United Kingdom showed that a
10% price cut produced an 18.5% increase in sales. This excludes a small group of
mainly luxury brands with a positive price elasticity whose sales increase when
their price goes up. The study found wide variation across brands and categories.
The household cleaning products were much less price-sensitive than, say dairy
and bakery products.4
To conclude this discussion on pricing factors, it would not be out of place tosay that, while everybody thinks businesses go about setting prices scientifically,
very often the process is incredibly arbitrary. Packaged goods companies forexample, have long recognized that pricing is a key lever in managing brands forprofitability. Yet it is so neglected at present that improving price management
can raise margins substantially. Companies seeking to capture this potential must
make efforts to understand the behavior of consumers and find ways to apply thisunderstanding to the thousands of frontline pricing decisions they make every

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year. Although businesses of all types devote a great deal of time and study todetermine the prices to put on their products, pricing is often more art than science. In some cases, setting prices does involve the use of a straightforward equation: material and labor costs + overhead and other expenses + profit = price. But
in many other cases, the equation includes psychological and other such subtle
subjective factors that the pricing decision may essentially rest on gut feeling.
Exhibit 15-6 suggests one way of combining information on different pricing factors to make an objective pricing decision in industrial marketing. For example,
price sensitivity, visibility to competition, and strength of supplier relationships
are used to rank various customers, allowing a different pricing strategy to be
adopted for each customer to effectively achieve profit, share, and communication objectives.
The following eight steps deal with the essentials of setting the right priceand then monitoring that decision so that the benefits are sustainable.5
1. Assess what value your customers place on a product or service.
2. Look for variations in the way customers value the product3. Assess customers’ price sensitivity.
4. Identify an optimal pricing structure.
5. Consider competitors’ reactions.
6. Monitor prices realized at the transaction level.
7. Assess customers’ emotional response.
8. Analyze whether the returns are worth the cost to serve.

The above eight steps assess the factors affecting price. Companies need toassess their customers to discover how a product or service is valued. Variationsin the way customers value the same product may be turned to a company’s benefit through clever pricing.

EXHIBIT 15-6
Pricing Guide
Company Relationshipwith Customer(Leverage)

Visibility of Priceto Competition(Knowledge)

Weak

Low

High

Low

To gain profit andTo maintain sharecommunicate high price and communicate
willingness to fightTo gain profit

High

To communicate high priceLow

To gain share

High
StrongCustomer’s Price Sensitivity

Source: Robert A. Garda, “Industrial Pricing: Strategy vs. Tactics.” Reprinted by permission of publisher, from Management Review, November 1983, © 1983. American Management Association, New
York. All rights reserved.

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PRICING STRATEGY FOR NEW PRODUCTS
The pricing strategy for a new product should be developed so that the desired
impact on the market is achieved while the emergence of competition is discouraged. Two basic strategies that may be used in pricing a new product are skimming pricing and penetration pricing.
Skimming Pricing

Skimming pricing is the strategy of establishing a high initial price for a productwith a view to “skimming the cream off the market” at the upper end of thedemand curve. It is accompanied by heavy expenditure on promotion. A skimming strategy may be recommended when the nature of demand is uncertain,
when a company has expended large sums of money on research and development for a new product, when the competition is expected to develop and market
a similar product in the near future, or when the product is so innovative that themarket is expected to mature very slowly. Under these circumstances, a skimming
strategy has several advantages. At the top of the demand curve, price elasticity islow. Besides, in the absence of any close substitute, cross-elasticity is also low.
These factors, along with heavy emphasis on promotion, tend to help the productmake significant inroads into the market. The high price also helps segment themarket. Only nonprice-conscious customers will buy a new product during its initial stage. Later on, the mass market can be tapped by lowering the price.
If there are doubts about the shape of the demand curve for a given productand the initial price is found to be too high, price may be slashed. However, it isvery difficult to start low and then raise the price. Raising a low price may annoy
potential customers, and anticipated drops in price may retard demand at a particular price. For a financially weak company, a skimming strategy may provide
immediate relief. This model depends on selling enough units at the higher priceto cover promotion and development costs. If price elasticity is higher than anticipated, a lower price will be more profitable and “relief giving.”
Modern patented drugs provide a good example of skimming pricing. At thetime of its introduction in 1978, Smithkline Beecham’s anti-ulcer drug, Tagamet,
was priced as high as $10 per unit. By 1990, the price came down to less than $2; it
was sold for about 60 cents in 1994. (Tagamet was to lose patent protection in the
United States in 1995, unleashing a flood of cheaper generics onto the American
market.)6 Many new products are priced following this policy. Videocassetterecorders (VCRs), frozen foods, and instant coffee were all priced very high at thetime of their initial appearance in the market. But different versions of these products are now available at prices ranging from very high to very low. No conclusive
research has yet been done to indicate how high an initial price should be in relation to cost. As a rule of thumb, the final price to the consumer should be at least
three or four times the factory door cost.
The decision about how high a skimming price should be depends on two factors: (a) the probability of competitors entering the market and (b) price elasticity
at the upper end of the demand curve. If competitors are expected to introduce
their own brands quickly, it may be safe to price rather high. On the other hand, if

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competitors are years behind in product development and a low rate of return tothe firm would slow the pace of research at competing firms, a low skimming pricecan be useful. However, price skimming in the face of impending competition may
not be wise if a larger market share makes entry more difficult. If limiting the saleof a new product to a few selected individuals produces sufficient sales, a very
high price may be desirable.
Determining the duration of time for keeping prices high depends entirely on
the competition’s activities. In the absence of patent protection, skimming prices
may be forced down as soon as competitors join the race. However, in the case of
products that are protected through patents (e.g., drugs), the manufacturer slowly
brings down the price as the patent period draws near an end; then, a year or so
before the expiration of the patent period, the manufacturer saturates the market
with a very low price. This strategy establishes a foothold for the manufacturer inthe mass market before competitors enter it, thereby frustrating their expectations.
So far, skimming prices have been discussed as high prices in the initial stageof a product’s life. Premium and umbrella prices are two other forms of priceskimming. Some products carry premium prices (high prices) permanently andbuild an image of superiority for themselves. When a mass market cannot be
developed and upper-end demand seems adequate, manufacturers will not risktarnishing the prestigious image of their products by lowering prices, thereby
offering the product to everybody. Estee Lauder cosmetics, Olga intimate apparel,
Rolex watches, Waterford Crystal, Armani suits, and Hermes scarves are productsthat fall into this category.
Sometimes, higher prices are maintained in order to provide an umbrella forsmall high-cost competitors. Umbrella prices have been aided by limitation lawsthat specify minimum prices for a variety of products, such as milk.
Du Pont provides an interesting example of skimming pricing. The company
tends to focus on high-margin specialty products. Initially, it prices its products
high; it then gradually lowers price as the market builds and as competition
grows. Polaroid also pursues a skimming pricing strategy. The company introduces an expensive model of a new camera and follows up the introduction withsimpler lower-priced versions to attract new segments.
Penetration Pricing

Penetration pricing is the strategy of entering the market with a low initial priceso that a greater share of the market can be captured. The penetration strategy isused when an elite market does not exist and demand seems to be elastic over theentire demand curve, even during early stages of product introduction. High
price elasticity of demand is probably the most important reason for adopting apenetration strategy. The penetration strategy is also used to discourage competitors from entering the market. When competitors seem to be encroaching on amarket, an attempt is made to lure them away by means of penetration pricing,which yields lower margins. A competitor’s costs play a decisive role in this pricing strategy because a cost advantage over the existing manufacturer might persuade another firm to enter the market, regardless of how low the margin of theformer may be.

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One may also turn to a penetration strategy with a view to achieving
economies of scale. Savings in production costs alone may not be an importantfactor in setting low prices because, in the absence of price elasticity, it is difficult
to generate sufficient sales. Finally, before adopting penetration pricing, onemust make sure that the product fits the lifestyles of the mass market. For example, although it might not be difficult for people to accept imitation milk, cereals
made from petroleum products would probably have difficulty in becoming
popular.
How low the penetration price should be differs from case to case. There areseveral different types of prices used in penetration strategies: restrained prices,elimination prices, promotional prices, and keep-out prices. Restraint is appliedso that prices can be maintained at a certain point during inflationary periods.
In this case, environmental circumstances serve as a guide to what the pricelevel should be. Elimination prices are fixed at a point that threatens the survival of a competitor. A large, multiproduct company can lower prices to a level
where a smaller competitor might be wiped out of the market. The pricing ofsuits at factory outlets illustrates promotional prices. Factory outlets constantly
stress low prices for comparable department-store-quality suits. Keep-out
prices are fixed at a level that prevents competitors from entering the market.
Here the objective is to keep the market to oneself at the highest chargeable
price.
A low price acts as the sole selling point under penetration strategy, but themarket should be broad enough to justify low prices. Thus, price elasticity ofdemand is probably the most important factor in determining how low prices cango. This point can be easily illustrated.7 Convinced that shoppers would willingly
sacrifice convenience for price savings, an entrepreneur in 1981 introduced a concentrated cleaner called 4 + 1. Unlike such higher-priced cleaners as Windex,
Fantastik, and Formula 409, this product did not come in a spray bottle. It alsoneeded to be diluted with water before use. The entrepreneur hoped for 10 percent of the $200 million market. But the product did not sell well. The productwas not as price elastic as the entrepreneur had assumed. Though the consumer
tends to talk a lot about economy, the lure of convenience is apparently stronger
than the desire to save a few cents. Ultimately, 4 + 1 had to be withdrawn frommost markets.
Unlike Du Pont, Dow Chemical Company stresses penetration pricing. It concentrates on lower-margin commodity products and low prices, builds a dominant market share, and holds on for the long haul. Texas Instruments also
practices penetration pricing. Texas Instruments starts by building a large plant
capacity. By setting the price as low as possible, it hopes to penetrate the market
fast and gain a large market share.
Penetration pricing reflects a long-term perspective in which short-term profits are sacrificed in order to establish sustainable competitive advantage.
Penetration policy usually leads to above-average long-run returns that fall in a
relatively narrow range. Price skimming, on the other hand, yields a wider rangeof lower average returns.

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PRICING STRATEGIES FOR ESTABLISHED PRODUCTS
Changes in the marketing environment may require a review of the prices of
products already on the market. For example, an announcement by a large firmthat it is going to lower its prices makes it necessary for other firms in the industry to examine their prices. In 1976, Texas Instruments announced that it would
soon sell a digital watch for about $20. The announcement jolted the entire industry because only 15 months earlier the lowest-priced digital was selling for $125.
It forced a change in everyone’s strategy and gave some producers real problems.
Fairchild Camera and Instrument Corporation reacted with its own version of a
$20 plastic-cased digital watch. So did National Semiconductor Corporation.
American Microsystems, however, decided to get completely out of the finishedwatch business.8
A review of pricing strategy may also become necessary because of shifts indemand. In the late 1960s, for example, it seemed that, with the popularity ofminiskirts, the pantyhose market would continue to boom. But its growth slowed
when the fashion emphasis shifted from skirts to pants. Pants hid runs, or tears,
making it unnecessary to buy as many pairs of pantyhose. The popularity ofpants also led to a preference for knee-high hose over pantyhose. Knee-high hose,which cost less, meant lower profits for manufacturers. Although the pantyhosemarket was dwindling, two new entrants, Bic Pen Corporation and Playtex
Corporation, were readying their brands for introduction. Their participation
made it necessary for the big three hosiery manufacturers—Hanes, Burlington,
and Kayser-Roth—to review their prices and protect their market shares. An
examination of existing prices may lead to one of three strategic alternatives:maintaining the price, reducing the price, or increasing the price.
Maintaining
the Price

If the market segment from which the company derives a big portion of its sales
is not affected by changes in the environment, the company may decide not toinitiate any change in its pricing strategy. The gasoline shortage in the aftermathof the fall of the Shah of Iran did not affect the luxury car market because buyers of Cadillac, Mercedes-Benz, and Rolls-Royce were not concerned about
higher gas prices. Thus, General Motors did not need to redesign the Cadillac to
reduce its gas consumption or lower its price to make it attractive to the averagecustomer.
The strategy of maintaining price is appropriate in circumstances where aprice change may be desirable, but the magnitude of change is indeterminable. If
the reaction of customers and competitors to a price change cannot be predicted,
maintaining the present price level may be appropriate. Alternatively, a pricechange may have an impact on product image or sales of other products in a company’s line that it is not practical to assess. Several years ago, when Magnavox
and Sylvania cut the prices of their color television sets, Zenith maintained prices
at current levels. Because the industry appeared to be in good shape, Zenith could
not determine why its competitors adopted such a strategic posture. Zenith continued to maintain prices and earned higher profits.

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Politics may be another reason for maintaining prices. During the year from1978 to 1979, President Carter urged voluntary control of wages and prices. Manycompanies restrained themselves from seeking price changes in order to alignthemselves behind the government’s efforts to control inflation.
Concern for the welfare of society may be another reason for maintaining
prices at current levels. Even when supply is temporarily short of demand, somebusinesses may adopt a socially responsible posture and continue to charge current prices. For example, taxi drivers may choose not to hike fares when subway
and bus service operators are on strike.
Reducing the Price

There are three main reasons for lowering prices. First, as a defensive strategy,
prices may be cut in response to competition. For example, in October 1978,
Congress authorized the deregulation of the airline industry. Deregulation gave
airlines almost total freedom to set ticket prices. Thus, in spring of 1998, in
response to Continental Airline’s $298 round-trip fare on its New York–Los
Angeles route, United Airlines acted to meet this competitive fare. United’s regular round-trip coach fare at the time was about $750. Similarly, other carriers wereforced to reduce their fares on different routes to match these prices. In addition,
to successfully compete in mature industries, many companies reduce prices, following a strategy that is often called value pricing. For example, in light of slipping profit margins and lower customer counts, McDonald’s cut prices underpressure from major rivals Burger King, Wendy’s, and Taco Bell.9
A second reason for lowering prices is offensive in nature. Following the experience curve concept (see Chapter 12), costs across the board go down by a fixed
percentage every time experience doubles. Consequently, a company with greater
experience has lower costs than one whose experience is limited. Lower costs havea favorable impact on profits. Thus, as a matter of strategy, it behooves a company
to shoot for higher market share and to secure as much experience as possible inorder to gain a cost and, hence, a profit advantage. A company that successfully
follows this strategy is Home Depot, the largest home repair chain in the country.
The policy of everyday low prices has enabled the company to grow into a $4.0 billion chain of 150 stores, mostly in the sunbelt. Home Depot’s goal is to go nationalwith $10 billion in sales at more than 350 locations by the year 2000.10
Technological advances have made possible the low-cost production of highquality electronics gear. Many companies have translated these advances into low
retail prices to gain competitive leverage. For example, in 1978 a Sony clock radio,with no power backup and a face that showed nothing more than the current
time, sold for $80. In 1988, a Sony clock radio priced at about $40 had auxiliary
power and showed the time at which the alarm was set as well as the current
time. In 1997, the same radio was available for less than $20.
Texas Instruments has followed the experience curve concept in achieving
cost reductions in the manufacture of integrated circuits. This achievement isduly reflected in its strategy to slowly lower prices of such products as electronic
calculators. Compaq Computer Corp. followed a similar strategy to make a dramatic comeback in the PC market. Even in other businesses where technological425

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advances have a less critical role to play in the success of the business, a pricereduction strategy may work out. Consider the case of Metpath, a clinical laboratory. In the late 1960s, at about the time Metpath was formed, the industry leader,Damon Corporation, was acquiring local labs all around the country; by the early
1970s, other large corporations in the business—Revlon, Bristol-Myers, Diamond
Shamrock, and W.R. Grace—began doing the same. Metpath, however, adopted a
price-cutting strategy. In order to implement this strategy, it took a variety of measures to achieve economies of scale. Figuring that there were not many economies
of scale involved in simply putting together a chain of local labs that operated
mostly as separate entities, to reduce costs, Metpath focused on centralizing its
testing. A super lab that did have those economies of scale was created, alongwith a nationwide network to collect specimens and distribute test results.
Metpath’s strategy paid off well. It emerged as the industry leader in the clinicallab-testing field. Heavy price competition, much of it attributed to Metpath, ledsome of the big diversified companies, including W.R. Grace and Diamond
Shamrock, to pull out of the business.11
The recession in the early 1990s caused consumers to tighten belts and to be
more sensitive to prices. Sears, therefore, adopted a new pricing policy whereby
prices on practically all products were permanently lowered. The company
closed its 824 stores for two days to remark price tags and to implement its“everyday low pricing” strategy. A number of other companies, such as WalMart, Toys “R” Us, and Circuit City, also pursue this strategy by keeping prices
low year-round, avoiding the practice of marking them up and down. Consumers
like year-round low prices because constantly changing sale prices makes it hard
to recognize a fair deal.12 Similarly, fast-food chains have started offering “value”
menus of higher-priced items.
The third and final reason for price cutting may be a response to customer
need. If low prices are a prerequisite for inducing the market to grow, customer
need may then become the pivot of a marketing strategy, all other aspects of themarketing mix being developed accordingly.
As an example, in 1993 Philip Morris used price as an aggressive marketingtactic to seek growth for its Marlboro brand of cigarette. Its 40-cents-per-pack cut
grabbed consumers’ attention, narrowed the gap with discount brands, andsqueezed competitors. In less than a year, Marlboro’s share of the U.S. cigarettemarket increased from 20 percent to 25 percent, higher than it has been before.13
However, Philip Morris’s move depressed the profits of the entire industry,
since other cigarette manufacturers responded by reducing their own brands’
prices. Philip Morris repeated the same strategy by cutting down prices about 20%
on its Post and Nabisco ready-to-eat cereals. However, other cereal companies,
such as Kellogg and General Mills, did not go along with Philip Morris’s lead.14
In adopting a low-price strategy for an existing product, a variety of considerations must be taken into account. The long-term impact of a price cut against
a major competitor is a factor to be reckoned with. For example, a regional pizza
chain can cut prices to prevent Pizza Hut from gaining a foothold in its market
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through price competition. Pizza Hut may lower prices to such an extent that the
local chain may find it difficult even to recover its costs. Thus, competitive
strength should be duly evaluated in opting for low-price strategy.
In a highly competitive situation, a product may command a higher pricethan other brands if it is marketed as a “different” product—for example, as oneof deluxe quality. If the price of a deluxe product is reduced, the likely impact on
its position should be looked into. Sony television sets have traditionally sold atpremium prices because they have been promoted as quality products. Sony’s
higher-price strategy paid off: the Sony television rose to prominence as a quality
product and captured a respectable share of the market. A few years later, however, consumer pressures led Sony dealers to reduce prices. This action not only
hurt Sony’s overall prestige, it made some retailers stop selling Sony because it
had now become just one of the many brands they carried. In other words, theprice cut, though partly initiated by its dealers, cost Sony its distinction. Even if
its sales increased in the short run, the price cut did not prove to be a viable strategy in the long run because it went against the perception consumers had ofSony’s being a distinctive brand. Ultimately, consumers may perceive Sony as justanother brand, which will affect both sales and profits.
It is also necessary to examine thoroughly the impact of a price cut of one
product on other products in the line.
Finally, the impact of a price cut on a product’s financial performance must
be reviewed before the strategy is implemented. If a company is so positioned
financially that a price cut will weaken its profitability, it may decide not to lower
the price even if lowering price may be in all other ways the best course to follow.
For instance, a mere 1 percent price decrease for an average company might
destroy over 11 percent of the company’s operating profit dollars.15
Increasing
the Price

An increase in price may be implemented for various reasons. First, in an inflationary economy, prices may need to be adjusted upward in order to maintainprofitability. During periods of inflation, all types of costs go up, and to maintainadequate profits, an increase in price becomes necessary. How much the priceshould be increased is a matter of strategy that varies from case to case.
Conceptually, however, price should be increased to such a level that the profits
before and after inflation are approximately equal. An increase in price should
also take into account any decline in revenue caused by shifts in demand due toprice increases. Strategically, the decision to minimize the effects of inflationarypressures on the company through price increases should be based on the longterm implications of achieving a short-run vantage.
It must also be mentioned that it is not always necessary for a company toincrease prices to offset inflationary pressures. A company can take nonpricemeasures as well to reduce the effects of inflation. For example, many fast-foodchains expanded menus and seating capacity to partially offset rising costs.
Similarly, a firm may substantially increase prices, much more than justified byinflation alone, by improving product quality or by raising the level of accompanying services. High quality should help keep prices and profits up because

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inflation-weary customers search for value in the marketplace. Improved product quality and additional services should provide such value.
Price may also be increased by downsizing (i.e., decreasing) package size
while maintaining price. In a recession, downsizing helps hold the line on prices
despite rising costs. Under inflationary conditions, downsizing provides a way ofkeeping prices from rising beyond psychological barriers. Downsizing is commonly practiced by packaged-goods companies. For example, recently Procter &Gamble cut the number of diapers in a package from 88 to 80 while leaving theprice the same. In this example, downsizing effectively resulted in a price increaseof 9.1 percent. Similarly, H. J. Heinz reduced the contents of its 6.5-ounce StarKist
Seafood (tuna) can by three-eighths of an ounce. By keeping exactly the same
price as before, the company gained an invisible 5.8 percent price increase.16
Prices may also be increased when a brand has a monopolistic control overthe market segments it serves. In other words, when a brand has a differential
advantage over competing brands in the market, it may take advantage of its
unique position, increasing its price to maximize its benefits. Such a differential
advantage may be real or may exist just in the mind of the consumer. In seekinga price increase in a monopolistic situation, the increase should be such that customers will absorb it and still remain loyal to the brand. If the price increase isabnormal, differential advantage may be lost, and the customer will choose abrand based on price.
The downside of increasing price may be illustrated with reference to coffee.
Let us say that there is a segment of customers who ardently drink Maxwell
House coffee. In their minds, Maxwell House has something special. If the priceof Maxwell House goes up (assuming that the prices of other brands remainunchanged), these coffee drinkers may continue to purchase it because the brandhas a virtual monopoly over their coffee-drinking behavior. There is a limit, however, to what these Maxwell House loyalists will pay for their favorite brand ofcoffee. Thus, if the price of Maxwell House is increased too much, these customers may shift their preference.
From the perspective of strategy, this example indicates that, in monopolistic
situations, the price of a brand may be set high to increase revenues and profits.
The extent of the increase, however, depends on many factors. Each competitor
has a different optimum price level for a given end product for a given customer
group. It is rare that such optimum prices are the same for any two competitors.
Each competitor has different options based on different cost components, capacity constraints, financial structure, product mix, customer mix, logistics, culture,and growth rate. The competitor with the lowest optimum price has the option ofsetting the common price; all others must follow or retreat. However, the continued existence of competitors depends on each firm retreating from competition
when it is at a disadvantage until each competes primarily in a “competitive segment,” a monopolistic situation where it has an advantage compared to all others. This unique combination of characteristics, matched with differentials in thecompetitive environment, enables each firm to coexist and prosper in its chosenarea (i.e., where it has monopolistic control).

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Sometimes prices must be increased to adhere to an industry situation. Of the
few firms in an industry, one (usually the largest) emerges as a leader. If the leader
raises its price, other members of the industry must follow suit, if only to maintain the balance of strength in the industry. If they refuse to do so, they are liable
to be challenged by the leader. Usually, no firm likes to fight the industry leader
because it has more at stake than the leader.
In the U.S. auto industry, there are three domestic firms: General Motors,
Ford, and Chrysler. General Motors is the industry leader in terms of market
share. If General Motors increases its prices, all other members of the industry
increase prices. Thus, a firm may be compelled to increase price in response to asimilar increase by the industry leader. The leader also sets a limit on priceincreases, with followers frequently setting their prices very close to those of theleader. Although an increase is forced on a firm in this situation, it is a good strategic move to set a price that, without being obviously different, is higher than theleader’s price.
Prices may also be increased to segment the market. For example, a soft drink
company may come out with a new brand and direct it toward busy executives/professionals. This brand may be differentiated as one that provides stamina and invigoration without adding calories. To substantiate the brand’s worth
and make it appear different, the price may be set at double the price of existing
soft drinks. Similarly, the market may be segmented by geography, with varying
prices serving different segments. For example, in New York City, a 6.4-ounce
tube of Crest toothpaste may sell for $3.89 on Park Avenue, for $3.29 on the Upper
East Side, and for $2.39 on the Lower East Side. Furthermore, companies withproducts that customers want and that are not easily matched by competitors
may increase the price without any negative repercussions. For example, in 1998
when inflation was merely 2.1%, some industries, such as airlines, mutual-fundhouses, sellers of mainframe software, and entertainment companies, boosted
their prices far faster.17
Hewlett-Packard Company operates in the highly competitive pocket calculator industry, where the practice of price cutting is quite common. Nonetheless,
Hewlett-Packard thrives by offering high-priced products to a select segment of
the market. It seems to appeal to a market segment that is highly inelastic withrespect to price but highly elastic with respect to quality. The company equips its
calculators with special features and then offers them at a price that is muchhigher than the industry average. In other words, rather than running the business on the basis of overall volume, Hewlett-Packard realizes high prices by beinga specialist that serves a narrow segment. In cosmetics or automobiles, for example, there may be a tenfold cost difference between mass market products andthose designed, produced, packaged, distributed, and promoted for small highquality niches. Up-market products are often produced by specialists, companies
such as Daimler-Benz or BMW, that can compete successfully around much larger
producers of standard products.
Many airlines have successfully used price structure to differentiate market
segments and objectives based on customer price sensitivity. Business travelers

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are relatively price insensitive, whereas tourists are very sensitive to the priceof tickets. In order to increase the volume of tourist traffic without forgoingbread-and-butter revenues from business customers, airlines have developed
price structures based on characteristics that differentiate these two customer
segments.
For example, tourists generally spend a weekend at their destination; business travelers do not. By changing the structure from pricing flights to pricing
itineraries, the airlines can discount itineraries that include a Saturday night stay.
Most business customers cannot take advantage of such discounts without incurring substantial inconvenience. This enables the airline to increase tourist volume
while maintaining high prices among the business customer segment. Such pricing policies have led to as much as 10 times the difference in fares paid for thesame seat. Thus, a flexible pricing strategy permits a company to realize highprices from customers who are willing to pay them without sacrificing volume
from customers who are not.18
Increase in price is seductive in nature. After all, improvements in price typically have three to four times the effect on profitability as proportionate
increases in volume. But the increase should be considered for its effect on longterm profitability, demand elasticity, and competitive moves. Although a higher
price may mean higher profits in the short run, the long-run effect of a priceincrease may be disastrous. The increase may encourage new entrants to flock to
the industry and competition from substitutes. Thus, before a price increasestrategy is implemented, its long-term effect should be thoroughly examined.
Further, an increase in price may lead to shifts in demand that could be detrimental. Likewise, the increase may negatively affect market share if the competition decides not to seek similar increases in price. Thus, competitive posturemust be studied and predicted. In addition, a company should review its own
ability to live with higher prices. A price increase may mean a decline in revenues but an increase in profits. Whether such a situation will create any problem needs to be looked into. Will laying off people or reassigning sales territories
be problematic? Is a limit to price increases called for as a matter of social responsibility? In 1979, President Carter asked businesses to adhere to 7 percent
increases in prices and wages voluntarily. In a similar situation, should a company that otherwise finds a 10 percent increase in price strategically sound goahead with it? Finally, the price increase should be duly reinforced by other factors in the marketing mix. A Chevy cannot be sold at a Cadillac price. A man’s
suit bearing a Kmart label cannot be sold on a par with one manufactured by
Brooks Brothers. Chanel No. 5 cannot be promoted by placing an ad in TV Guide.
The increased price must be evaluated before being finalized to see whether the
posture of other market mix variables will substantiate it.
Finally, the timing of a price increase can be nearly as important as theincrease itself. For example, a simple tactic of lagging competitors in announcing price increases can produce the perception among customers that you
are the most customer-responsive supplier. The extent of the lag can also be
important.

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PRICE-FLEXIBILITY STRATEGY
A price-flexibility strategy usually consists of two alternatives: a one-price policy
and a flexible-pricing policy. Influenced by a variety of changes in the environment, such as saturation of markets, slow growth, global competition, and theconsumer movement, more and more companies have been adhering in recent
years to flexibility in pricing of different forms. Pricing flexibility may consist ofsetting different prices in different markets based on geographic location, varying
prices depending on the time of delivery, or customizing prices based on the complexity of the product desired.
One-Price Strategy

A one-price strategy means that the same price is set for all customers who purchase goods under essentially the same conditions and in the same quantities.
The one-price strategy is fairly typical in situations where mass distribution andmass selling are employed. There are several advantages and disadvantages that
may be attributed to a one-price strategy. One advantage of this pricing strategy
is administrative convenience. It also makes the pricing process easier and contributes to the maintenance of goodwill among customers because no single customer receives special pricing favors over another.
A general disadvantage of a one-price strategy is that the firm usually ends up
broadcasting its prices to competitors who may be capable of undercutting theprice. Total inflexibility in pricing may undermine the product in the marketplace.
Total inflexibility in pricing may also have highly adverse effects on corporate
growth and profits in certain situations. It is very important that a company remain
responsive to general trends in economic, social, technological, political/legal, andcompetitive environments. Realistically, then, a pricing strategy should be periodically reviewed to incorporate environmental changes as they become pronounced.
Any review of this type would need to include a close look at a company’s position
relative to the actions of other firms operating within its industry. As an example, itis generally believed that one reason for the success of discount houses is that conventional retailers have rigidly held to traditional prices and margins.

Flexible-Pricing
Strategy

A flexible-pricing strategy refers to situations where the same products or quantities are offered to different customers at different prices. A flexible-pricing strategy
is more common in industrial markets than in consumer markets. An advantage ofa flexible-pricing strategy is the freedom allowed to sales representatives to makeadjustments for competitive conditions rather than refuse an order. Also, a firm isable to charge a higher price to customers who are willing to pay it and a lower
price to those who are unwilling, although legal difficulties may be encountered if
price discrimination becomes an issue. Besides, other customers may become
upset upon learning that they have been charged more than their competitors. In
addition, bargaining tends to increase the cost of selling, and some sales representatives may let price cutting become a habit.
Recently, many large U.S. companies have added new dimensions of flexibility to their pricing strategies. Although companies have always shown some

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willingness to adjust prices or profit margins on specific products when market
conditions have varied, this kind of flexibility is now being carried to the state ofhigh art. As a matter of fact, electronic commerce is further likely to accelerate
the flexible-pricing trend. The Internet, corporate networks, and wireless setups
are linking people, machines, and companies around the globe and connecting
sellers and buyers as never before. This is enabling buyers to quickly and easily
compare products and prices, putting them in a better bargaining position. At
the same time, the technology allows sellers to know customers’ buying habits,
preferences, and spending limits, enabling them to tailor products and prices.19
The concept of price flexibility can be implemented in four different ways: bymarket, by product, by timing, and by technology.
Price flexibility with reference to the market can be achieved either fromone geographic area to another or from one segment to another. Both Ford andGeneral Motors charge less for their compact cars marketed on the West Coast
than for those marketed anywhere else in the country. Different segments makedifferent uses of a product: many companies, therefore, consider customer
usage in setting price. For example, a plastic sold to industry might command
only 30 cents a pound; sold to a dentist, it might bring $25 a pound. Here again,
the flexible-pricing strategy calls for different prices in the two segments.
Price flexibility with reference to the product is implemented by considering
the value that a product provides to the customer. Careful analysis may show thatsome products are underpriced and can stand an upgrading in the marketplace.
Others, competitively priced to begin with, may not support any additional margin because the matchup between value and cost would be lost.
Costs of all transactions from raw material to delivery may be analyzed, andif some costs are unnecessary in a particular case, adjustments may be made in
pricing a product to sell to a particular customer. Such cost optimization is very
effective from the customer’s point of view because he or she does not pay for
those costs for which no value is received.
Price flexibility can also be practiced by adding to the price an escalation
clause based on cost fluctuations. Escalation clauses are especially relevant in situations where there is a substantial time gap between confirmation of an orderand delivery of the finished product. In the case of products susceptible to technological obsolescence, price is set to recover all sunken costs within a reasonable
period.
The flexible-pricing strategy has two main characteristics: an emphasis on
profit or margins rather than simply on volume and a willingness to change pricewith reference to the existing climate. Caution is in order here. In many instances,building market share may be essential to cutting costs and, hence, to increasing
profits. Thus, where the experience curve concept makes sense, companies may
find it advantageous to reduce prices to hold or increase market share. However,a reduction in price simply as a reactionary measure to win a contract is discounted. Implementation of this strategy requires that the pricing decision be
instituted by someone high up in the organization away from salespeople in thefield. In some companies, the pricing executive may report directly to the CEO.

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In addition, a systematic procedure for reviewing price at quarterly or semiannual intervals must be established. Finally, an adequate information system isrequired to help the pricing executive examine different pricing factors.

PRODUCT LINE-PRICING STRATEGY
A modern business enterprise manufactures and markets a number of productitems in a line with differences in quality, design, size, and style. Products in a line
may be complementary to or competitive with each other. The relationships
among products in a given product line influence the cross-elasticities of demand
between competing products and the package-deal buying of products complementary to each other. For example, instant coffee prices must bear some relationship to the prices of a company’s regular coffee because these items aresubstitutes for one another; therefore, this represents a case of cross-elasticity.
Similarly, the price of a pesticide must be related to that of a fertilizer if customers
are to use both. In other words, a multiproduct company cannot afford to priceone product without giving due consideration to the effect its price produces onother products in its line.
The pricing strategy of a multiproduct firm should be developed to maximize
the profits of the entire organization rather than the profitability of a single product. For products already in the line, pricing strategy may be formulated by classifying them according to their contribution as follows:
1. Products that contribute more than their pro rata share toward overhead after
direct costs are covered.
2. Products that just cover their pro rata share.
3. Products that contribute more than incremental costs but do not cover their pro
rata share.
4. Products that fail to cover the costs savable by their elimination.

With such a classification in mind, management is in a better position to
study ways of strengthening the performance of its total product line. Pricing
decisions on individual products in the four categories listed here are made in thelight of demand and competitive conditions facing each product in the line.
Consequently, some products (new products) may be priced to yield a very highmargin of profit; others (highly competitive standard products) may need toshow an actual loss. By retaining these marginal products to “keep the machines
running” and to help absorb fixed overhead costs, management may be able tomaximize total profit from all of its lines combined. A few items that make no contribution may need to be kept to round out the line offered.
General Motors’s pricing structure provides a good illustration of this procedure. To offset lower profit margins on lower-priced small cars, the company
raises the prices of its large cars. The prices of its luxury cars are raised much
more than those of its standard cars. For example, in 1998 a Cadillac Seville soldfor more than $60,000, four times the price of the company’s lowest-priced car.
Ten years ago, the top of the line was three times as costly as the lowest-priced

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CHAPTER 15 Pricing Strategies431car. The gap is widening, however, because the growing market for small cars
with low markups makes it necessary for the company to generate high profits on
luxury cars to meet its profit goals. Thus, at the beginning of the next century,
General Motors might sell a Cadillac for $80,000.
For a new product being considered for addition to the line, strategy development proceeds with an evaluation of the role assigned to it. The following
questions could be asked:
1. What would the effect be on the company’s competing products at different
prices?
2. What would be the best new-product price (or range), considering its impact on
the total company offerings as a whole? Should other prices be adjusted? What,
therefore, would be the incremental gain or loss (volumes and profits of existinglines plus volumes and profits of the new line at different prices)?
3. Is the new product necessary for staying ahead of or catching up with the competition?
4. Can it enhance the corporate image, and if so, how much is the enhancement
worth?

If product/market strategy has been adequately worked out, it will be obvious whether the new product can profitably cater to a particular segment. If so,
the pricing decision will be considerably easier to make; costs, profit goals, marketing goals, experience, and external competition will be the factors aroundwhich price will be determined.
Where there is no specific product/market match, pricing strategy for a new
product considered for the line will vary depending on whether the product iscomplementary or competitive vis-à-vis other products in the line. For the complementary product, examination of the industry price schedule, which is the primary guide for the bottom price, top price, and conventional spread between
product prices in a given industry, may be necessary. There are three particularly
significant factors in product line-pricing strategy. The lowest price in the market
is always the most remembered and unquestionably generates the most interest, if
not the most traffic; the top market price implies the ability to manufacture quality products; and a well-planned schedule structure (one that optimizes profit and,at the same time, is logical to customers) is usually carefully studied and eventually followed by the competition regardless of who initiated it. In addition, however, there can be a product in the line with the objective of pricing to obtain theprincipal profit from a product’s supplies or supplementary components.
If the anticipated product is competitive, a start will need to be made with thefollowing market analysis:
1. Knowledge of the industry’s pricing history and characteristics regarding theline.
2. Comparison of company and competitor products and volumes, showing gaps
and areas of popularity.
3. Volume and profit potentials of the company line as is.
4. Volume and profit potentials with the new internally competitive product.

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5. Effect on company volume and profit if competition introduced the proposed
product and the company did not.
6. Impact of a possible introduction delay or speedup.

With this information on hand, computations for cost-plus markup should
be undertaken. Thereafter, the pricer has three alternatives to set price: (a) add a
uniform or individual markup rate to the total cost of the product, (b) add amarkup rate that covers all the constant costs of the line, and (c) add the rate necessary for achieving the profit goal. These three alternatives have different characteristics. The first one hides the contribution margin opportunities. The second
alternative, although revealing the minimum feasible price, tends to spread constant-cost coverage in such a manner that the product absorbing the most overhead is made the most price attractive. The third alternative assigns the burden
to the product with the highest material cost, an action that may be competitively
necessary. No matter which alternative is pursued, however, the final priceshould be arrived at only after it has been duly examined with reference to themarket and the competition.

LEASING STRATEGY
The major emphasis of a pricing strategy is on buying a product outright rather
than leasing it. Except in housing, leasing is more common in the marketing ofindustrial goods than among consumer goods, though in recent years there has
been a growing trend toward the leasing of consumer goods. For example, somepeople lease cars. Usually, by paying a specified sum of money every month, similar to a rental on an apartment, one can lease a new car. Again, as in the case of
housing, a lease is binding for a minimum period, such as two years. Thus, theconsumer can lease a new car every other year. Because repairs in the first two
years of a car’s life may not amount to much, one is saved the bother of suchproblems.
At the same time, overall the lease may cost slightly more than what a customer would pay by buying the car on loan. The net price of a fully equipped 1995
Ford Windstar with a sticker price of $23,650, after negotiations and a $1,000 manufacturer’s rebate, would be $20,494. Payments on a two-year lease from Ford
Motor Credit Co. would be $457.43 a month, or total payout of $10,520, assumingthat the rebate is used for the first payment and a security deposit. At the end of
the lease, the car would have a residual value—the value after depreciation—of$14,663. That is what the customer would have to pay if he/she decides to buy it,
bringing the total cost to $25,183. On the other hand, monthly payments on afour-year loan at 9.9% would be $518.79. The total paid over the term of the loan
would be $24,901, and the customer would have a vehicle valued at more than
$7,000 at the end.20
Although there may be different alternatives for setting the lease price, thelessor usually likes to recover the investment within a few years. Thereafter, avery large portion of the lease price (or rent) is profit. A lessor may set the435

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monthly rental on a car so that within a few months, say 30, the entire cost of the
car can be recovered. For example, the monthly rental on a Toyota Corolla, basedon its 1998 price (assuming no extras), may be about $239 a month (the sticker
price is $15,985). With the term set at 36 months, the dealer gets all his or her
money back in about 32 months. (It should be noted that a dealer gets a car at thewholesale price, not the sticker price, which is the suggested retail price.) The
important thing is to set the monthly lease rate and the minimum period forwhich the lease is binding in such proportions that the total amount that thelessee pays for the duration of the lease is less than what he or she would pay inmonthly installments on a new car. As a matter of fact, the lease rate must be substantially less than that in order for the buyer to opt to lease.
Automobile renting is transforming the market perspectives of the industry.
One-fourth of all cars and trucks sold in 1998 went out under lease. By the year
2005, it is predicted, half of all cars and trucks will be leased. The reason for thisshift in automobile buying is easy to understand. About 75 percent of car buyers
need some sort of financing, and with interest on car loans no longer deductible,
leasing’s relatively low monthly payments are enticing. For the auto companies,
leasing camouflages price increases, and restores brand loyalty. It offers companies an opportunity to strike up a relationship with the customers. Further, it
attracts younger buyers to luxury brands and smoothes industry sales throughout the year.21
Leasing works out to be a viable strategy for other products as well. For
example, furniture renting may be attractive to young adults, people of highmobility (e.g., executives, airline stewards), and senior citizens who may needappropriate furnishings only temporarily when their children’s families come tovisit. In addition, apartment owners may rent furniture to provide furnishedunits to tenants.
In industrial markets, the leasing strategy is employed by essentially all capital goods and equipment manufacturers. Traditionally, shoe machinery, postage
meters, packaging machinery, textile machinery, and other heavy equipment havebeen leased. Recent applications of the strategy include the leasing of computers,
copiers, cars, and trucks. As a matter of fact, just about any item of capital machinery and equipment can be leased. From the customer’s point of view, the leasing
strategy makes sense for a variety of reasons. First, it reduces the capital required
to enter a business. Second, it protects the customer against technological obsolescence. Third, the entire lease price, or rental, may be written off as an expense
for income tax purposes. This advantage, of course, may or may not be relevant
depending on the source of funds the customer would have used for the outrightpurchase (i.e., his or her own money or borrowed funds). Finally, leasing gives thecustomer the freedom not to get stuck with a product that may later prove not to
be useful.
From the viewpoint of the manufacturer, the leasing strategy is advantageous in many ways. First, income is smoothed out over a period of years, which
is very helpful in the case of equipment of high unit value in a cyclical business.
Second, market growth can be boosted because more customers can afford to436

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lease a product than can afford to buy. Third, revenues are usually higher whena product is leased than when it is sold.

BUNDLING-PRICING STRATEGY
Bundling, also called iceberg pricing, refers to the inclusion of an extra margin(for support services) in the price over and above the price of the product as such.
This type of pricing strategy has been popular with companies that lease rather
than sell their products. Thus, the rental price, when using a bundling strategy,
includes an extra charge to cover a variety of support functions and services
needed to maintain the product throughout its useful life. Because unit profit
increases sharply after a product completes its planned amortization, it is desirable for firms that lease their products to keep the product in good condition, thus
enhancing its working life for high resale or re-leasing value. The bundling strategy permits a company to do so because a charge for upkeep, or iceberg, services
is included in the price.
IBM once followed a bundling strategy, whereby it charged one fee for hardware, service, software, and consultancy. In 1969, however, the Justice Department charged IBM with monopolizing the computer market. Subsequently, thecompany unbundled its price and started selling computers, software, service,and technical input separately.
Under the bundling strategy, not only are costs of hardware and profits covered, anticipated expenses for extra technical sales assistance, design and engineering of the system concept, software and applications to be used on thesystem, training of personnel, and maintenance are also included. Although thebundling strategy can be criticized for tending to discourage competition, onemust consider the complexities involved in delivering and maintaining a faultfree sophisticated system. Without the manufacturer taking the lead in adequately keeping the system in working condition, customers would have to deal
with a variety of people to make use of such products as computers. At least in
the initial stages of a technologically oriented product, a bundling strategy ishighly useful from the customer’s point of view.
For the company, this strategy (a) covers the anticipated expenses of providing services and maintaining the product, (b) provides revenues for supporting
after-sales service personnel, (c) provides contingency funds to meet unanticipated happenings, and (d) ensures the proper care and maintenance of the leased
products. The bundling strategy also permits an ongoing relationship with thecustomer. In this way the company gains firsthand knowledge of the customer’s
needs that may help to shift the customer to a new generation of the product.
Needless to say, the very nature of the bundling strategy makes it most relevant
to technologically sophisticated products, particularly those marked by rapid
technological obsolescence.
On the negative side, the bundling strategy tends to inflate costs and distortprices and profitability. For this reason, during unfavorable economic conditions,
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instance, may pass through a straight invoice cost and then charge separately fordelivery, packaging, and so on. A growing number of department stores now
charge extra for home delivery, gift wrapping, and shopping bags. Thus, people
who don’t want a service need not pay for it.

PRICE-LEADERSHIP STRATEGY
The price-leadership strategy prevails in oligopolistic situations. One member of
an industry, because of its size or command over the market, emerges as theleader of an entire industry. The leading firm then makes pricing moves that are
duly acknowledged by other members of the industry. Thus, this strategy places
the burden of making critical pricing decisions on the leading firm; others simply follow the leader. The leader is expected to be careful in making pricing decisions. A faulty decision could cost the firm its leadership because other membersof the industry would then stop following in its footsteps. For example, if, inincreasing prices, the leader is motivated only by self-interest, its price leadership will not be emulated. Ultimately the leader will be forced to withdraw theincrease in price.
The price-leadership strategy is a static concept. In an environment where
growth opportunities are adequate, companies would rather maintain stability
than fight each other by means of price wars. Thus, the leadership concept works
out well in this case. In the auto industry, General Motors is the leader, based onmarket share. The other two domestic members of the industry adjust their prices
to come very close to any price increase by General Motors.
Usually, the leader is the company with the largest market share. The leadership strategy is designed to stave off price wars and “predatory” competition that
tend to force down prices and hurt all parties. Companies that deviate from thisform are chastised through discounting or shaving by the leaders. Price deviationis quickly disciplined.
Successful price leaders are characterized by the following:
1. Large share of the industry’s production capacity.
2. Large market share.
3. Commitment to a particular product class or grade.
4. New cost-efficient plants.
5. Strong distribution system, perhaps including captive wholesale outlets.
6. Good customer relations, such as technical assistance for industrial buyers, programs directed at end users, and special attention to important customers during shortages.
7. An effective market information system that provides analysis of the realities ofsupply and demand.
8. Sensitivity to the price and profit needs of the rest of the industry.
9. A sense of timing to know when price changes should be made.
10. Sound management organization for pricing.
11. Effective product line financial controls, which are needed to make sound priceleadership decisions.
12. Attention to legal issues.22

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In an unfavorable business environment, it may not be feasible to implementa leadership strategy because firms may be placed differently to interact with theenvironment. Thus, the leader hesitates to make decisions on behalf of an entire
industry because other firms may not always find its decisions to their advantage.
For this reason, the price leader/follower pattern may be violated.
In order to survive during unfavorable conditions, even smaller firms may
take the initiative to undercut the price leader. For example, during 1988 when thelist prices of steel were similar, companies freely discounted their prices. In thechemical industry, with increasing competition from overseas, the price-leadership strategy does not work. Companies thus plan a variety of temporary
allowances to generate business. The following quote highlights the erosion of theleadership strategy in the glass container industry:
Traditional patterns of price leadership also are breaking down in the glass container
industry, with smaller companies moving to the fore in pricing. Last year, for example, Owens-Illinois, Inc.—which is larger than its next five competitors combined—
increased its list prices by 4½ percent. Fearing that the increase would hurt sales tobrewing companies that were just beginning to switch to glass bottles, the smaller
companies broke ranks and offered huge discounts. The action not only negated O-I’s

increase but served notice that the smaller companies were after O-I’s market
share.23
An automatic response to a leader’s price adjustment assumes that all firms
are more or less similarly positioned vis-à-vis different price variables (i.e., cost,competition, and demand) and that different firms have common pricing objectives. Such an assumption, however, is far from being justified. The leadershipstrategy is an artificial way to enforce similar pricing responses throughout anindustry. Strategically, it is a mistake for a company to price in a manner identical to that of its competitors. It should price either above or below the competition to set itself apart.

PRICING STRATEGY TO BUILD MARKET SHARE
Recent work in the area of marketing strategy has delineated the importance ofmarket share as a key variable in strategy formulation. Although market sharehas been discussed earlier with reference to other matters, this section examines
the impact of market share on pricing strategy.
Time and again it has been noted that higher market share and experience
lead to lower costs. Thus, a new product should be priced to improve experienceand market share. The combination of enhanced market share and experiencegives a company such a cost advantage that it cannot ever profitably be overcome
by any competitor of normal performance. Competitors are prevented from entering the market and must learn to live in a subordinate position.
Assuming the market is price sensitive, it is desirable to develop the market
as early as possible. One way of achieving this is to reduce price. Unit costs arenecessarily very high in the early stages of any product; if price is set to recover439

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all costs, there may be no market for the product at its initial price in competition
with existing alternatives. Following the impact of market share and experienceon prices, it may be worthwhile to set price at a level that will move the product.
During the early stages of a product introduction, operations may need to be conducted even at a loss. As volume is gained, costs go down, and even at an initial
low price the company makes money, implying that future competitive cost differentials should be of greater concern than current profitability. Of course, sucha strategic posture makes sense only in a competitive situation. In the absence ofcompetition there is every reason to set prices as high as possible, to be lowered
only when total revenue will not be affected by such an action.
The lower the initial price set by the first producer, the more rapidly that producer builds up volume and a differential cost advantage over succeeding competitors and the faster the market develops. In a sense, employing a pricing
strategy that builds market share is a purchase of time advantage. However, thelower the initial price, the greater the investment required before the progressive
reduction of cost results in a profit. This in turn means that the comparative
investment resources of competitors can become a significant or even the critical
determinant of competitive survival.
Two limitations, however, make the implementation of this type of strategy
difficult. First, the resources required to institute this strategy are more than thosenormally available to a firm. Second, the price, once set, must not be raised andshould be maintained until costs fall below price; therefore, the lower the price,
the longer the time needed to realize any returns and the larger the investment
required. When a future return is discounted to present value, there is obviously
a limit.
It is these difficulties that lead many firms to set initial price to cover all costs.
This policy is particularly likely to be adopted when there is no clear competitive
threat. As volume builds and costs decline, visible profitability results, which inturn induces new competitors to enter the field. As competitors make theirmoves, the innovating firm has the problem of choosing between current profitability and market share. Strategically, however, the pricing of a new product,
following the relationship between market share and cost, should be dictated bya product’s projected future growth.

SUMMARY

Pricing strategy is of interest to the very highest management levels of a company.
Yet few management decisions are more subject to intuition than pricing. There isa reason for this. Pricing decisions are primarily affected by factors, such as pricing objectives, cost, competition, and demand, that are difficult to articulate andanalyze. For example, assumptions must be made about what a competitor will
do under certain hypothetical circumstances. There is no way to know that for
certain; hence the characteristic reliance on intuition.
This chapter reviewed the pricing factors mentioned above and examined
important strategies that a pricer may pursue. The following strategies werediscussed:

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1. Pricing strategies for new products.
2. Pricing strategies for established products.
3. Price-flexibility strategy.
4. Product line-pricing strategy.
5. Leasing strategy.
6. Bundling-pricing strategy.
7. Price-leadership strategy.
8. Pricing strategy to build market share.

There are two principal pricing strategies for new products, skimming andpenetration. Skimming is a high-price strategy; penetration strategy sets a low
initial price to generate volume. Three strategies for established products werediscussed: maintaining the price, reducing the price, and increasing the price. A
flexible-pricing strategy provides leverage to the pricer in terms of duration ofcommitment both from market to market and from product to product. Productline-pricing strategy is directed toward maintaining a balance among different
products offered by a company. The leasing strategy constitutes an alternative
to outright sale of the product. The bundling strategy is concerned with packaging products and associated services together for the purposes of pricing.
Price-leadership strategy is a characteristic of an oligopoly, where one firm in anindustry emerges as a leader and sets the pricing strategy to build market share.
Setting price to build market share emphasizes the strategic significance of setting an initially low price to gain volume and market share, thereby enabling
the firm to achieve additional cost reductions in the future.

DISCUSSIONQUESTIONS

1. Is the maintenance of a stable price a viable objective? Why?
2. Is there a conflict between profit and volume objectives? Doesn’t one lead tothe other? Discuss.
3. What are the advantages of using incremental costs instead of full costs for
pricing? Are there any negative implications of using incremental costs that a
pricing strategist needs to be aware of?
4. What assumptions need to be made about competitive behavior for formulating pricing strategy?
5. “Short-term price increases tend to depress industry profits in the long run byaccelerating the introduction of new capacity and depressing market
demand.” Discuss.
6. Following the experience curve concept, the initial price of a new productshould be set rather low; as a matter of fact, it may be set below cost. Taking
into account the popularity of this thesis, discuss the relevance of the skimming strategy.
7. What factors are ascribed to the decline in popularity of the price-leadershipstrategy?

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NOTES

439

1 Thomas T. Nagle, The Strategy and Tactics of Pricing (Englewood Cliffs, NJ: Prentice-Hall, 1987): 8.
2 Heywood Klein, “Illinois Bell Faces New Environment as Era of Competitive Pricing

Nears,” The Wall Street Journal (31 December 1981): 9.
3 Mark I. Alpert, Pricing Decisions (Glenview, IL: Scott, Foresman, 1971): 96.
4 “Marketing in Britain: Elastic Brands,” The Economist (19 November 1994): 75.
5 Robert J. Dolan, “How Do You Know When the Price is Right?” Harvard Business

Review (September–October 1995): 174–183.
6 “Having an Ulcer is Getting a Lot Cheaper,” Business Week (9 May 1994): 30.
7 The Wall Street Journal (31 December 1981): 9.
8 “How T.I. Beat the Clock on Its $20 Digital Watch,” Business Week (31 May 1976): 62–63.

(For different reasons, T.I. quit the digital watch business itself a few years later. But
the point made here with reference to pricing is still relevant.)
9 Richard Gibson, "How Burger King Finally Became a Contender.” The Wall Street
Journal (27 February 1997): B1.
10 “Will Home Depot Be the 'Wal-Mart of the '90s?'” Business Week (19 March 1990): 124.
11 Ignatics Chitbebhen, “Clinical Case,” Forbes (20 May 1989): 178.
12 “Looking Downscale Without Looking Down,” Business Week (8 October 1990): 62.
13 “The Smoke Clears at Marlboro,” Business Week (31 January 1994): 76.
14 “Cereal Wars: A Tale of Bran, Oats, and Air,” Fortune (13 May 1996): 30.
15 Michael V. Marn and Robert L. Rosiello, “Managing Price, Gaining Profit,” Harvard
Business Review (September–October 1992): 48.
16 John B. Hinge, “Critics Call Cuts in Package Size Deceptive Move,” The Wall Street
Journal (5 February 1991): B1.
17 “The Power To Raise Prices,” Business Week (4 May 1998): 37.
18 Andrew A. Stern, “Pricing and Differentiation Strategies,” Planning Review(September–October 1989): 30–34.
19 Georgette Jason, “How to Save Big Bucks on a New Car,” The Wall Street Journal (5May 1995).
20 “Good-bye to Fixed Pricing,” Business Week (4 May 1998): 71. See also: Hermann Simonand Robert J. Dolan, “Price Customization,” Marketing Management (Fall 1998): 11–17.
21 ”Leasing Fever,” Business Week (7 February 1994): 92.
22 Stuart U. Rich, “Price Leaders: Large, Strong, but Cautious about Conspiracy,”
Marketing News (25 June 1982): 11.
23 “Flexible Pricing,” Business Week (12 December 1981): 81.

APPENDIXI.
Price Strategies for
New Products

Perspectives of Pricing Strategies
A. Skimming Pricing
Definition: Setting a relatively high price during the initial stage of a product’slife.
Objectives: (a) To serve customers who are not price conscious while the market is at the upper end of the demand curve and competition has not yet
entered the market. (b) To recover a significant portion of promotional andresearch and development costs through a high margin.

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Requirements: (a) Heavy promotional expenditure to introduce product, educate consumers, and induce early buying. (b) Relatively inelastic demandat the upper end of the demand curve. (c) Lack of direct competition andsubstitutes.
Expected Results: (a) Market segmented by price-conscious and not so priceconscious customers. (b) High margin on sales that will cover promotion
and research and development costs. (c) Opportunity for the firm to lower
its price and sell to the mass market before competition enters.
B. Penetration Pricing
Definition: Setting a relatively low price during the initial stages of a product’slife.
Objective: To discourage competition from entering the market by quickly taking a large market share and by gaining a cost advantage through realizing
economies of scale.
Requirements: (a) Product must appeal to a market large enough to support
the cost advantage. (b) Demand must be highly elastic in order for the firm
to guard its cost advantage.
Expected Results: (a) High sales volume and large market share. (b) Low margin on sales. (c) Lower unit costs relative to competition due to economies
of scale.
II.
Price Strategies
for Established
Products

A. Maintaining the Price
Objectives: (a) To maintain position in the marketplace (i.e., market share,
profitability, etc.). (b) To enhance public image.
Requirements: (a) Firm’s served market is not significantly affected by changes
in the environment. (b) Uncertainty exists concerning the need for or resultof a price change. (c) Firm’s public image could be enhanced by responding
to government requests or public opinion to maintain price.
Expected Results: (a) Status quo for the firm’s market position. (b) Enhancement of the firm’s public image.
B. Reducing the Price
Objectives: (a) To act defensively and cut price to meet the competition. (b) To
act offensively and attempt to beat the competition. (c) To respond to a customer need created by a change in the environment.
Requirements: (a) Firm must be financially and competitively strong to fight ina price war if that becomes necessary. (b) Must have a good understandingof the demand function of its product.
Expected Results: Lower profit margins (assuming costs are held constant).
Higher market share might be expected, but this will depend upon theprice change relative to competitive prices and upon price elasticity.

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C. Increasing the Price
Objectives: (a) To maintain profitability during an inflationary period. (b) To
take advantage of product differences, real or perceived. (c) To segment thecurrent served market.
Requirements: (a) Relatively low price elasticity but relatively high elasticity
with respect to some other factor such as quality or distribution. (b)Reinforcement from other ingredients of the marketing mix; for example, if
a firm decides to increase price and differentiate its product by quality, thenpromotion and distribution must address product quality.
Expected Results: (a) Higher sales margin. (b) Segmented market (price conscious, quality conscious, etc.). (c) Possibly higher unit sales, if differentiation is effective.
III.
Price-Flexibility
Strategy

A. One-Price Strategy
Definition: Charging the same price to all customers under similar conditions
and for the same quantities.
Objectives: (a) To simplify pricing decisions. (b) To maintain goodwill amongcustomers.
Requirements: (a) Detailed analysis of the firm’s position and cost structure ascompared with the rest of the industry. (b) Information concerning the costvariability of offering the same price to everyone. (c) Knowledge of theeconomies of scale available to the firm. (d) Information on competitive
prices; information on the price that customers are ready to pay.
Expected Results: (a) Decreased administrative and selling costs. (b) Constantprofit margins. (c) Favorable and fair image among customers. (d) Stable
market.
B. Flexible-Pricing Strategy
Definition: Charging different prices to different customers for the same product and quantity.
Objective: To maximize short-term profits and build traffic by allowing
upward and downward adjustments in price depending on competitive
conditions and how much the customer is willing to pay for the product.
Requirements: Have the information needed to implement the strategy.
Usually this strategy is implemented in one of four ways: (a) by market, (b)by product, (c) by timing, (d) by technology. Other requirements include (a)a customer-value analysis of the product, (b) an emphasis on profit margin
rather than just volume, and (c) a record of competitive reactions to pricemoves in the past.
Expected Results: (a) Increased sales, leading to greater market share. (b)Increased short-term profits. (c) Increased selling and administrative costs.
(d) Legal difficulties stemming from price discrimination.

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IV.
Product LinePricing Strategy

Definition: Pricing a product line according to each product’s effect on andrelationship with other products in that line, whether competitive or complementary.
Objective: To maximize profits from the whole line, not just certain membersof it.
Requirements: (a) For a product already in the line, strategy is developed
according to the product’s contributions to its pro rata share of overhead
and direct costs. (b) For a new product, a product/market analysis determines whether the product will be profitable. Pricing is then a function of
costs, profit goals, experience, and external competition.
Expected Results: (a) Well-balanced and consistent pricing schedule across the
product line. (b) Greater profits in the long term. (c) Better performance ofthe line as a whole.

V.
Leasing Strategy

Definition: An agreement by which an owner (lessor) of an asset rents that
asset to a second party (lessee). The lessee pays a specified sum of money,
which includes principal and interest, each month as a rental payment.
Objectives: (a) To enhance market growth by attracting customers who cannot
buy outright. (b) To realize greater long-term profits; once the production
costs are fully amortized, the rental fee is mainly profit. (c) To increase cash
flow. (d) To have a stable flow of earnings. (e) To have protection against
losing revenue because of technological obsolescence.
Requirements: (a) Necessary financial resources to continue production of subsequent products for future sales or leases. (b) Adequate computation oflease rate and minimum period for which lease is binding such that the
total amount the lessee pays for the duration of the lease is less than would
be paid in monthly installments on an outright purchase. (c) Customers
who are restrained by large capital requirements necessary for outrightpurchase or need write-offs for income tax purposes. (d) The capability tomatch competitors’ product improvements that may make the lessor’s
product obsolete.
Expected Results: (a) Increased market share because customers include those
who would have forgone purchase of product. (b) Consistent earnings overa period of years. (c) Greater cash flow due to lower income tax expensefrom depreciation write-offs. (d) Increased sales as customers exercise theirpurchase options.

VI.
Bundling-Pricing
Strategy

Definition: Inclusion of an extra margin in the price to cover a variety of support functions and services needed to sell and maintain the productthroughout its useful life.
Objectives: (a) In a leasing arrangement, to have assurance that the asset will beproperly maintained and kept in good working condition so that it can be
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expenses of providing services and maintaining the product. (c) To generate
revenues for supporting after-sales service personnel. (d) To establish a contingency fund for unanticipated happenings. (e) To develop an ongoing relationship with the customer. (f) To discourage competition with “free”
after-sales support and service.
Requirements: This strategy is ideally suited for technologically sophisticatedproducts that are susceptible to rapid technological obsolescence because
these products are generally sold in systems and usually require the following: (a) extra technical sales assistance, (b) custom design and engineering
concept for the customer, (c) peripheral equipment and applications, (d)training of the customer’s personnel, and (e) a strong service/maintenancedepartment offering prompt responses and solutions to customer problems.
Expected Results: (a) Asset is kept in an acceptable condition for resale or release. (b) Positive cash flow. (c) Instant information on changing customer
needs. (d) Increased sales due to “total package” concept of selling because
customers feel they are getting their money’s worth.
VII.
Price-Leadership
Strategy

Definition: This strategy is used by the leading firm in an industry in making
major pricing moves, which are followed by other firms in the industry.
Objective: To gain control of pricing decisions within an industry in order tosupport the leading firm’s own marketing strategy (i.e., create barriers toentry, increase profit margin, etc.).
Requirements: (a) An oligopolistic situation. (b) An industry in which all firms
are affected by the same price variables (i.e., cost, competition, demand). (c)An industry in which all firms have common pricing objectives. (d) Perfectknowledge of industry conditions; an error in pricing means losing control.
Expected Results: (a) Prevention of price wars, which are liable to hurt all parties involved. (b) Stable pricing moves. (c) Stable market share.

VIII.
Pricing Strategy to
Build Market ShareDefinition: Setting the lowest price possible for a new product.
Objective: To seek such a cost advantage that it cannot ever be profitably overcome by any competitor.
Requirements: (a) Enough resources to withstand initial operating losses thatwill be recovered later through economies of scale. (b) Price-sensitive market. (c) Large market. (d) High elasticity of demand.
Expected Results: (a) Start-up losses to build market share. (b) Creation of abarrier to entry to the industry. (c) Ultimately, cost leadership within theindustry.

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Distribution Strategies
The art of getting richconsists not in industry,
much less in saving,
but in a better order,
in timeliness, in beingat the right spot.
RALPH WALDO EMERSON

D

istribution strategies are concerned with the channels a firm may employ tomake its goods and services available to customers. Channels are organizedstructures of buyers and sellers that bridge the gap of time and space between the
manufacturer and the customer.
Marketing is defined as an exchange process. In relation to distribution,exchange poses two problems. First, goods must be moved to a central locationfrom the warehouses of producers who make heterogeneous goods and who are
geographically widespread. Second, the goods that are accumulated from diversified sources should represent a desired assortment from the viewpoint of customers. These two problems can be solved by the process of sorting, which
combines concentration (i.e., bringing the goods from different sources to a central location) and dispersion (i.e., picking an assortment of goods from different
points of concentration). Two basic questions need to be answered here. Whoshould perform the concentration and dispersion tasks—the manufacturer orintermediaries? Which intermediary should the manufacturer select to bringgoods close to the customer? These questions are central to distribution strategies.
Other strategy-related matters discussed in this chapter include scope of distribution (i.e., how widespread distribution may be), use of multiple channels toserve different segments, modification of channels to accommodate environmental shifts, resolution of conflict among channels, and use of vertical systems toinstitute control over channels. Each strategic issue is examined for its relevancein different circumstances. The application of each strategy is illustrated with
examples from marketing literature.

CHANNEL-STRUCTURE STRATEGY
The channel-structure strategy refers to the number of intermediaries that may
be employed in moving goods from manufacturers to customers. A company may
undertake to distribute its goods to customers or retailers without involving any
intermediary. This strategy constitutes the shortest channel and may be labeled a
direct distribution strategy. Alternatively, goods may pass through one or moreintermediaries, such as wholesalers or agents. This is an indirect distribution strategy. Exhibit 16-1 shows alternative channel structures for consumer and industrial
products.
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EXHIBIT 16-1
Typical Channel Structures
Manufacturers

Agent or
BrokerWholesaler

Retailer

Retailer

Agent or
BrokerWholesaler

Retailer

RetailerHousehold Consumers(a) Consumer Products
Manufacturers

Agent or
BrokerIndustrial
Distributor

Agent or
BrokerIndustrial
Distributor

Business Customers(b) Industrial Products

Decisions about channel structure are based on a variety of factors. To a significant extent, channel structure is determined by where inventories should bemaintained to offer adequate customer service, fulfill required sorting processes,
and still deliver a satisfactory return to channel members.
An underlying factor in determining channel-structure strategy is the use ofintermediaries. The importance of using intermediaries is illustrated with reference to an example of a primitive economy used by Alderson.1 In a primitive

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economy, five producers produce one type of item each: hats, hoes, knives, baskets, or pots. Because each producer needs all the other producers’ products, a
total of 10 exchanges are required to accomplish trade. However, with a market(or middlemen), once the economy reaches equilibrium (i.e., each producerconsumer has visited the market once), only five exchanges need to take place tomeet everyone’s needs. Let n denote the number of producer-consumers. Thenthe total number of transactions (T) without a market is given by:Twithout =n( n − 1)2

and the total number of transactions with a market is given by:Twith = n
The efficiency created in distribution by using an intermediary may beviewed using this equation:
Efficiency =Twithout n( n − 1) 1 n − 1
=
× =
Twith
2
n
2

In the example of five producer-consumers, the efficiency of having a middleman is 2. The efficiency increases as n increases. Thus, in many cases, intermediaries may perform the task of distribution more efficiently than manufacturers
alone.
PostponementSpeculation Theory

Conceptually, the selection of channel structure may be explained with reference
to Bucklin’s postponement-speculation framework.2 The framework is based onrisk, uncertainty, and costs involved in facilitating exchanges. Postponement
seeks to eliminate risk by matching production/distribution with actual customer
demand. Presumably, postponement should produce efficiency in marketing
channels. For example, the manufacturer may produce and ship goods only on
confirmed orders. Speculation, on the other hand, requires undertaking risk
through changes in form and movement of goods within channels. Speculation
leads to economies of scale in manufacturing, reduces costs of frequent ordering,and eliminates opportunity cost.
Exhibit 16-2 shows the behavior of variables involved in the postponementspeculation framework. The vertical axis shows the average cost of undertaking
a function for one unit of any given commodity; the horizontal axis shows thetime involved in delivering a confirmed order. Together, the average cost and thedelivery time measure the cost of marketing tasks performed in a channel withreference to delivery time. The nature of the three curves depicted in Exhibit 16-2
should be understood: C represents costs to the buyer for holding an inventory;AD´, costs involved in supplying goods directly from a manufacturer to a buyer;
and DB, costs involved in shipping and maintaining speculative inventories (i.e.,
in anticipation of demand).

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EXHIBIT 16-2
Using the Postponement-Speculation Concept to Determine Channel Structure

Source: Louis P. Bucklin and Leslie Halpert, “Exploring Channels of Distribution for Cement with
the Principle of Postponement-Speculation,” in Marketing and Economic Development, ed. Peter D.
Bennett (Chicago: American Marketing Association, 1965): 698. Reprinted by permission of theAmerican Marketing Association.

Following Bucklin’s framework, one determines the channel structure byexamining the behavior of the C, AD’, and DB curves:
1. The minimal cost of supplying the buyer for every possible delivery time isderived from curves AD’ and DB. As may be seen in Exhibit 16-2, especially fastdelivery service can be provided only by the indirect channel (i.e., by using a
stocking intermediary). However, at some delivery time, I’, the cost of serving theconsumer directly from the producer will intersect and fall below the cost of indirect shipment. The minimal costs derived from both curves are designated DD’.
From the perspective of channel cost, it will be cheaper to service the buyer froma speculative inventory if delivery times shorter than I’ are demanded. If the consumer is willing to accept delivery times longer than I’, then direct shipment willbe the least expensive.
2. The minimal total cost curve for the channel with respect to delivery time isderived by summing the cost of moving goods to the buyer, DD’, and the buyer’s
costs of holding inventory, C. The curve is represented in Exhibit 16-2 by DD’ +C. Total channel costs initially fall as delivery time lengthens because increased
buyer expenses are more than made up for by savings in other parts of the channel. Gradually, however, the savings from these sources diminish and buyer costs

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begin to rise more rapidly. A minimal cost point is reached, and expenses for thechannel rise thereafter. Channel structure is controlled by the location of this minimum point. If, as in the present case, it falls to the left of I’, then goods would be
expected to flow through the speculative inventory (i.e., an intermediary). If, on
the other hand, the savings of the buyer from postponement had not been as
great as those depicted, the minimum point would have fallen to the right of I’and shipments would have been made directly from the producer to the consumer.3

Benetton, an Italian apparel maker, offers an excellent example of a distribution strategy that combines speculation with postponement in an effort to optimize both service and cost. Speculation involves commitment by retailers tospecific inventory items months before the start of the selling season. It leads tosuch advantages for Benetton as low-cost production (via use of subcontractors)
and good quality control (via centralized warehousing and assembly of orders).
Postponement of orders requires last-minute dyeing of woolen items at an added
cost. The advantages of speculation are flexibility in meeting market needs andreduced inventory levels.4
Additional
Consideration in
Determining
Channel Structure

The postponement-speculation theory provides an economic explanation of theway the channels are structured. Examined in this section are a variety of environmental influences on channel-structure strategy formulation. These influences
may be technological, social and ethical, governmental, geographical, or cultural.
Many aspects of channel structure are affected by technological advances. For
example, mass retailing in food has become feasible because of the developmentof automobiles, highways, refrigerated cars, cash registers, packaging improvements, and mass communications (television). In the coming years, television
shopping with household computer terminals should have a far-reaching impact
on distribution structures.5 Technological advances permitted Sony to become
dominant in the U.S. market for low-priced CD players. Sony developed prepackaged players that could be sold through mass retailers so that even sales clerks
without technical know-how could handle customers.
How technology may be used to revamp the operations of a wholesaler, making it worthwhile to adopt indirect channels, is illustrated by the case of
Foremost-McKesson, the nation’s largest wholesale distributor. A few years ago,the company found itself in a precarious position. Distribution, though one of thecompany’s most pervasive business functions, did not pay. Foremost-McKesson
merely took manufacturers’ goods and resold them to small retailers through aroutine process of warehousing, transportation, and simple marketing thatoffered thin profits. As a matter of fact, at one time the company came close to
selling off drug wholesaling, its biggest business. Instead, however, its new chief
executive decided to add sophisticated technology to its operations in order tomake the company so efficient at distribution that manufacturers could not possibly do as well on their own. It virtually redefined the function of the intermediary. Having used the computer to make its own operations efficient, it devised
ways to make its data processing useful to suppliers and customers, in essence

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making Foremost part of their marketing teams. Since the company computerized its operations, Foremost has turned around dramatically. Here are the highlights of Foremost’s steps in reshaping its role:• Acting as middleman between drugstores and insurance offices by processing
medical insurance claims.
• Creating a massive “rack jobbing” service by providing crews to set up racks ofgoods inside retail stores, offering what amounts to a temporary labor force thatbrings both marketing know-how and Foremost merchandise along with it.
• Taking waste products as well as finished goods from chemical manufacturers,
and recycling the wastes through its own plants—-its first entry into chemical
waste management.
• Designing, as well as supplying, drugstores.
• Researching new uses for products it receives from manufacturers. Foremost
found new customers, for example, for a Monsanto Co. food preservative fromamong its contacts in the cosmetics industry.6

Another example of the use of technology to overhaul distribution is provided by Britain’s supermarket chain Tesco. The firm’s nine composite (variabletemperature) distribution centers use a just-in-time system (known as pick-byline or cross-docking). That means goods amounting to around 40% of total sales
go straight out to the stores within hours of arrival.7
Social taboos and ethical standards may also affect the channel-structure decision. For example, Mallen reports that Viva, a woman’s magazine, had achieved ahigh circulation in supermarkets and drugstores in Canada. When Viva
responded to readers’ insistence and to competition from Playgirl by introducing
nude male photos, most supermarkets banned the magazine. Because supermarkets accounted for more than half of Viva’s circulation, Viva dropped the photos
so that it could continue to be sold through this channel.
The channel-structure strategy can also be influenced by local, state, and federal laws in a variety of ways. For example, door-to-door selling of certain goods
may be prohibited by local laws. In many states (e.g., California and Ohio) wine
can be sold through supermarkets, but other states (e.g., Connecticut) do not permit this.
Geographic size, population patterns, and typology also influence the channel-structure strategy. In urban areas, direct distribution to large retailers may
make sense. Rural areas, however, may be covered only by wholesalers.
With the inception of large grocery chains, it may often appear that independent grocery stores are dying. The truth is, however, that independent grocery
stores as recently as 1992 accounted for 46 percent of all grocery sales in the country—over $175 billion. Thus, a manufacturer can ill afford not to deal with independents and to reach them it must go through wholesalers. Wetterau, forexample, is a grocery wholesale firm in Hazelwood, Missouri, which did over $6
billion worth of business serving almost 3,000 retail grocery stores. It does not do
any business with chain stores. But because of Wetterau’s determination to offer
its customers relatively low prices, a wide selection of brands, service programs
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their success, its customers are almost fanatically loyal. The company offers its
customers—small independent retail stores—a variety of services, including leasearrangements, store design, financing packages, training, and computerized
inventory systems. These services tend to enhance customers’ competitiveness by
reducing their operating costs and by simplifying their bookkeeping, which inturn helps Wetterau to earn profits.8 The Wetterau example shows that to reachsmaller retailers, particularly in areas far removed from large metropolises, theindirect distribution strategy is appropriate. The wholesaler provides services tosmall retailers that a large manufacturer can never match on its own.
Finally, cultural traits may require the adoption of a certain channel structure
in a setting that otherwise might seem an odd place for it. For example, in many
parts of Switzerland, fruits and vegetables are sold in a central marketplace in themorning by small vendors, even though there are modern supermarkets all over.
This practice continues because it gives customers a chance to socialize while
shopping. Similarly, changing lifestyles among average American consumers andtheir desire to have more discretionary income for life-fulfillment activities
appear to be making warehouse retailing (e.g., Sam’s Club) more popular. This isso because prices at warehouse outlets—grocery warehouses, for example—are
substantially lower than at traditional stores.
Channel Design
Model

Presented below is a channel design model that can be used to make thedirect/indirect distribution decision. The model involves six basic steps.
1. List the factors that could potentially influence the direct/indirect decision. Eachfactor must be evaluated carefully in terms of the firm’s industry position andcompetitive strategy.
2. Pick out the factors that will have the most impact on the channel design decision. No factor with a dominant impact should be left out. For example, assume
that the following four factors have been identified as having particular significance: market concentration, customer service level, asset specificity, and availability of working capital.
3. Decide how each factor identified is related to the attractiveness of a direct or an
indirect channel. For example, market concentration reflects the size distributionof the firm’s customers as well as their geographical dispersion. Therefore, themore concentrated the market, the more desirable the direct channel because of
the lower costs of serving that market (high = direct; low = indirect). Customer
service level is made up of at least three factors: delivery time, lot size, and product availability. The more customer service required by customers, the less desirable is the direct channel (high = indirect; low = direct). The direct channel ismore desirable, at least under conditions of high uncertainty in the environment,with a high level of asset specificity (high = direct; low = indirect). Finally, thegreater the availability of working capital, the more likely it is that a manufacturer can afford and consider a direct channel (high = direct; low = indirect). Notethat a high level on a factor does not always correspond to a direct channel.
4. Create a matrix based on the key factors to consider the interactions among key
factors. If only two factors are being considered, a two-by-two matrix of four cells
would result. For three factors, a three-by-three matrix of nine cells would result.

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For four factors, a four-by-four matrix of sixteen cells would result, and so on. If
more than five or six factors are involved, a series of smaller models could beconstructed to make this fourth step more manageable. Exhibit 16-3 presents afour-by-four matrix developed for this example.
5. Decide (for each cell in the matrix) whether a direct channel, an indirect channel,
or a combination of both a direct and an indirect channel is most appropriate,
considering the factors involved. Combination channels are becoming more common in business practice, especially in industrial markets.
For some cells in the matrix, deciding which channel design is best is rather
easy to do. For example, Cell 1 in Exhibit 16-3 has all four factors in agreementthat an indirect channel is best. This is also true for Cell 16: a direct channel is theobvious choice. For other cells, choosing between a direct channel and an indirectchannel is not as easy because factors conflict with each other to some extent. For
example, in Cell 14, asset specificity is low, suggesting that an indirect channel isbest. The other three factors suggest otherwise, however; the market is concentrated, customer service requirements are low, and the availability of capital tothe manufacturer is high. Taken together, the factors in Cell 14 reveal that a directchannel would be most attractive. In the cells that have factors that conflict with
one another, the strategist must make trade-offs among them to decide whether adirect channel, indirect channel, or combination of channels is best.

EXHIBIT 16-3
Designing a Distribution Channel Matrix
Asset Specificity
Low

Low

High

Capital Availability

Capital Availability

Low

High

Low

High

High

cell 1indirectcell 3indirectcell 2indirectcell 4
combinationLowcell 5indirectcell 7
combination

cell 6
combination

cell 8
directHighcell 9indirectcell 11
combination

cell 10
directcell 12
directLowcell 13
combination

cell 15
combination

cell 14
directcell 16
directCustomer
Service
Level

MarketConcentration

High

Customer
Service
Level

Source: Gary L. Frazier, “Designing Channels of Distribution,” The Channel for Communication (Seattle, Wash.: Center for Retail
Distribution Management, University of Washington, 1987): 3–7.

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6. For each product or service in question, locate the corresponding cell in the box
model. The prediction in this cell is the one that should be followed or at least theone that should be most seriously considered by the firm.

The accuracy of the model generated by this method depends totally on theexpertise and skills of the person who builds and uses it. If carefully constructed,
such a model can be invaluable in designing more efficient and effective channelsof distribution.9

DISTRIBUTION-SCOPE STRATEGY
For an efficient channel network, the manufacturer should clearly define the target customers it intends to reach. Implicit in the definition of target customers is
a decision about the scope of distribution the manufacturer wants to pursue. The
strategic alternatives here are exclusive distribution, selective distribution, andintensive distribution.
Exclusive
Distribution

Exclusive distribution means that one particular retailer serving a given area isgranted sole rights to carry a product. For example, Coach leather goods are distributed exclusively through select stores in an area. Several advantages may begained by the use of exclusive distribution. It promotes tremendous dealer loyalty, greater sales support, a higher degree of control over the retail market, better forecasting, and better inventory and merchandising control. The impact ofdealer loyalty can be helpful when a manufacturer has seasonal or other kinds offluctuating sales. An exclusive dealership is more willing to finance inventories
and thus bear a higher degree of risk than a more extensive dealership. Having asmaller number of dealers gives a manufacturer or wholesaler greater opportunity to provide each dealer with promotional support. And with fewer outlets, it
is easier to control such aspects as margin, price, and inventory. Dealers are also
more willing to provide data that may be used for marketing research and forecasts. Exclusive distribution is especially relevant for products that customers
seek out. Examples of such products include Rolex watches, Gucci bags, Regal
shoes, Celine neckties, and Mark Cross wallets.
On the other hand, there are several obvious disadvantages to exclusive distribution. First, sales volume may be lost. Second, the manufacturer places all its
fortunes in a geographic area in the hands of one dealer. Exclusive distribution
brings with it the characteristics of high price, high margin, and low volume. If
the product is highly price elastic in nature, this combination of characteristics canmean significantly less than optimal performance. Relying on one retailer canmean that if sales are depressed for any reason, the retailer is then likely to be ina position to dictate terms to other channel members (i.e., the retailer becomes thechannel captain).
For example, assume that a company manufacturing traditional toys deals
exclusively with Toys “R” Us. For a variety of reasons, its line of toys may not dowell. These reasons may be a continuing decline in the birthrate, an economic

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recession, the emerging popularity of electronic toys, higher prices of the company’s toys compared to competitive brands, a poor promotional effort by Toys
“R” Us, and so on. Because it is the exclusive distributor, however, Toys “R” Us
may put the blame on the manufacturer’s prices, and it may demand a reductionin prices from the manufacturer. Inasmuch as the manufacturer has no otherreasons to give that could explain its poor performance, it must depend on Toys
“R” Us’s analysis.
The last disadvantage of exclusive distribution is one that is easy to overlook.
In certain circumstances, exclusive distribution has been found to be in violation of
antitrust laws because of its restraint on trade. The legality of an exclusive contract
varies from case to case. As long as an exclusive contract does not undermine competition and create a monopoly, it is acceptable. The courts appear to use the following criteria to determine if indeed an exclusive distribution lessens competition:
1. Whether the volume of the product in question is a substantial part of the total
volume for that product type.
2. Whether the exclusive dealership excludes competitive products from a substantial share of the market.

Thus, a company considering an exclusive distribution strategy should
review its decision in the light of these two ground rules.
Intensive
Distribution

The inverse of exclusive distribution is intensive distribution. Intensive distribution makes a product available at all possible retail outlets. This may mean thatthe product is carried at a wide variety of different and also competing retail institutions in a given area. The distribution of convenience goods is most consistent
with this strategy. If the nature of a product is such that a consumer generally
does not bother to seek out the product but will buy it on sight if available, thenit is to the seller’s advantage to have the product visible in as many places as possible. The Bic Pen Corporation is an example of a firm that uses this type of strategy. Bic makes its products available in a wide variety of retail establishments,
ranging from drugstores, to “the corner grocery store,” to large supermarkets. In
all, Bic sells through 250,000 retail outlets, which represent competing as well as
noncompeting stores. The advantages to be gained from this strategy are
increased sales, wider customer recognition, and impulse buying. All of thesequalities are desirable for convenience goods.
There are two main disadvantages associated with intensive distribution. First,
intensively distributed goods are characteristically low-priced and low-margin
products that require a fast turnover. Second, it is difficult to provide any degreeof control over a large number of retailers. In the short run, uncontrolled distribution may not pose any problem if the intensive distribution leads to increased
sales. In the long run, however, it may have a variety of devastating effects. For
example, if durable products such as Sony television sets were to be intensively
distributed (i.e., through drugstores, discount stores, variety stores, etc.), Sony’s
sales would probably increase. But such intensive distribution could lead to the
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among traditional channels (e.g., department stores). Not only might these problems affect sales revenues in the long run, but the manufacturer might also lose
some of its established channels. For example, a department store might decide todrop the Sony line for another brand of television sets. In addition, Sony’s distinctive brand image could suffer. In other words, the advantages furnished by intensive distribution should be related carefully to product type to decide if this formof distribution is suitable. It is because of the problems outlined above that one
finds intensive distribution limited to such products as candy, newspapers, cigarettes, aspirin, and soft drinks. For these types of products, turnover is usually highand channel control is usually not as strategic as it would be, say, for television sets.
Selective
Distribution

Between exclusive and intensive distribution, there is selective distribution.
Selective distribution is the strategy in which several but not all retail outlets ina given area distribute a product. Shopping goods—goods that consumers seekon the basis of the most attractive price or quality characteristics—are frequently
distributed through selective distribution. Because of this, competition among
retailers is far greater for shopping goods than for convenience goods. Naturally,retailers wish to reduce competition as much as possible. This causes them topressure manufacturers to reduce the number of retail outlets in their area distributing a given product in order to reduce competition.
The number of retailers under a selective distribution strategy should be limited by criteria that allow the manufacturer to choose only those retailers who will
make a contribution to the firm’s overall distribution objectives. For example,
some firms may choose retail outlets that can provide acceptable repair and maintenance service to consumers who purchase their products. In the automotive
industry, selective criteria are used by manufacturers in granting dealerships.
These criteria consist of such considerations as showroom space, service facilities,
and inventory levels.
The point may be illustrated with reference to Pennsylvania House, a furniture company. The company used to have 800 retail accounts, but it cut this number to 500. This planned cut obviously limited the number of stores in which thecompany’s product line was exposed. More limited distribution provided thecompany with much stronger support among surviving dealers. Among these500 dealers, there was a higher average amount of floor space devoted to
Pennsylvania House merchandise, better customer service, better supplier relations, and most important for the company, substantially increased sales per
account.
Selective distribution is best applied under circumstances in which high sales
volume can be generated by a relatively small number of retailers or, in otherwords, in which the manufacturer would not appreciably increase its coverage byadding additional dealers. Selective distribution can also be used effectively insituations in which a manufacturer requires a high-caliber firm to carry a fullproduct line and provide necessary services. A dealer in this position is likely torequire promotional and technical assistance. The technical assistance is needed
not only in conjunction with the sale but also after the sale in the form of repair

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and maintenance service. Again, by limiting the number of retail outlets to a selectfew capable of covering the market, the manufacturer can avoid unnecessary
costs associated with signing on additional dealers.
Obviously, the greatest danger associated with a strategy of selective distribution is the risk of not adequately covering the market. The consequences of thiserror are greater than the consequences of initially having one or two extra dealers. Therefore, when in doubt, it is better to have too much coverage than notenough.
In selective distribution, it is extremely important for a manufacturer tochoose dealers (retailers) who most closely match the marketing goals and image
intended for the product. There can be segments within retail markets; therefore,
identifying the right retailers can be the key to penetrating a chosen market.
Every department store cannot be considered the same. Among them there can beprice, age, and image segmentation. One does not need to be very accurate in distinguishing among stores of the same type in the case of products that have no
special image (i.e., those that lend themselves to unsegmented market strategies
and mass distribution). But for products with any degree of fashion or style content or with highly segmented customer groups, a selective distribution strategy
requires a careful choice of outlets.
To appraise what type of product is suitable for what form of distribution,refer to Exhibit 16-4. This exhibit combines the traditional threefold classificationof consumer goods (convenience, shopping, and specialty goods) with a threefoldclassification of retail stores (convenience, shopping, and specialty stores) todetermine the appropriate form of distribution. This initial selection may then be
examined in the light of other considerations to make a final decision on the scopeof distribution.

MULTIPLE-CHANNEL STRATEGY
The multiple-channel strategy refers to a situation in which two or more different
channels are employed to distribute goods and services. The market must be
segmented so that each segment gets the services it needs and pays only for them,
not for services it does not need. This type of segmentation usually cannot bedone effectively by direct selling alone or by exclusive reliance upon distributors.
The Robinson-Patman Act makes the use of price for segmentation almost impossible when selling to the same kind of customer through the same distribution
channel. Market segmentation, however, may be possible when selling directly to
one class of customer and to another only through distributors, which usuallyrequires different services, prices, and support. Thus, a multiple-channel strategy
permits optimal access to each individual segment.
Basically, there are two types of multiple channels of distribution, complementary and competitive.
Complementary
Channels

Complementary channels exist when each channel handles a different noncompeting product or noncompeting market segment. An important reason to promote

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EXHIBIT 16-4
Selection of Suitable Distribution Policies Based on the Relationship between Type of
Product and Type of Store
Most Likely
Form ofDistribution

Classification

Consumer Behavior

Convenience store/
convenience good

The consumer prefers to buy the most
readily available brand of a product at
the most accessible store.

Intensive

Convenience store/shopping
good

The consumer selects his or her purchasefrom among the assortment carried by
the most accessible store.

Intensive

Convenience store/specialty
good

The consumer purchases his or her
favorite brand from the most accessible
store carrying the item in stock.

Selective/
exclusive

Shopping store/
convenience good

The consumer is indifferent to the brandof product he or she buys but shops
different stores to secure better retailservice and/or retail price.

Intensive

Shopping store/shopping
good

The consumer makes comparisonsamong both retail-controlled factors
and factors associated with the product(brand).

Intensive

Shopping store/specialty
good

The consumer has a strong preference as
to product brand but shops a number ofstores to secure the best retail service
and/or price for this brand.

Selective/
exclusive

Specialty store/convenience
good

The consumer prefers to trade at a
specific store but is indifferent to thebrand of product purchased.

Selective/
exclusive

Specialty store/shopping
good

The consumer prefers to trade at a
certain store but is uncertain as to which
product he or she wishes to buy andexamines the store’s assortment for thebest purchase.

Selective/
exclusive

Specialty store/specialty
good

The consumer has both a preference for aparticular store and for a specific brand.

Selective/
exclusive

Source: Louis P. Bucklin, “Retail Strategy and the Classification of Consumer Goods,” Journal ofMarketing (January 1963): 50–55; published by the American Marketing Association.

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complementary channels is to reach market segments that cannot otherwise be
served. For example, Avon Products, which had sold directly to consumers for 100
years, broke the tradition in 1986 and began selling some perfumes (e.g., Deneuve
fragrance, which sells for as much as $165 an ounce) through department stores.
The rationale behind this move was to serve customer segments that the company
could not reach through direct selling.10 Samsonite Corporation sells the same typeof luggage to discount stores that it distributes through department stores, withsome cosmetic changes in design. In this way the company is able to reach middleand low-income segments that may never shop for luggage in department stores.
Similarly, magazines use newsstand distribution as a complementary channel tosubscriptions. Catalogs serve as complementary channels for large retailers such as
J.C. Penney.
The simplest way to create complementary channels is through private
branding. This permits entry into markets that would otherwise be lost. The
Coca-Cola Company sells its Minute Maid frozen orange juice to A&P to be soldunder the A&P name. At the same time, the Minute Maid brand is available in
A&P stores. Presumably, there are customers who perceive the private brand to
be no different in quality from the manufacturer’s brand. Inasmuch as the private
brand is always a little less expensive than a manufacturer’s brand, such customers prefer the lower-priced private brand. Thus, private branding helps
broaden the market base.
There is another reason that may lead a manufacturer to choose this strategy.
In instances where other firms in an industry have saturated traditional distribution channels for a product, a new entry may be distributed through a different
channel. This new channel may then in turn be different from the traditional channel used for the rest of the manufacturer’s product line. Hanes, for example,
decided to develop a new channel for L’eggs (supermarkets and drugstores)
because traditional channels were already crowded with competing brands.
Likewise, R. Dakin developed nontraditional complementary channels to distribute its toys. Although most toy manufacturers sell their wares through toy shops
and department stores, Dakin distributes more than 60 percent of its products
through a variety of previously ignored outlets such as airports, hospital gift
shops, restaurants, amusement parks, stationery stores, and drugstores. This strategy lets Dakin avoid direct competition. In recent years, many companies havedeveloped new channels in the form of direct mail sales for such diverse products
as men’s suits, shoes, insurance, records, newly published books, and jewelry.
Still yet to come is electronic commerce. The Internet is going to change
where and how consumers shop and retailers sell. It will become the location tobuy almost anything a person wants—fast, easy, and whenever he/she wants it.
But that does not mean that traditional retail stores will become relics. For one
thing, it is going to be a long time before the majority of consumers do most of
their shopping on the Web. Further, the physical limits of buying on the Webmean that not every product is suited to online purchasing.11
U.S. consumers spent $5 billion on purchases on the Web in 1997. The number was likely to be $11 billion in 1998, and would soar to $95 billion in 2002. As

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personal computers and online services penetrate more and more households, thenumber of cybershoppers will grow. By 2002, 22% of U.S. households will use
Internet services, and 30% are expected to use the Internet to do a large part oftheir shopping.12
A company may also develop complementary channels to broaden the market when its traditional channel happens to be a large account. For example,
Easco Corporation, the nation’s second-largest maker of hand tools, had for years
tied itself to Sears, Roebuck and Company, supplying wrenches, sockets, andother tools for the retailer’s Craftsman line. Sears accounted for about 47 percent
of Easco’s sales and about 62 percent of its pretax earnings in the mid-1980s. But
as Sears’s growth slowed, Easco had a critical strategic dilemma: What do you dowhen one dominant customer stops growing and starts to slip? The company
decided to lessen its dependence on Sears by adding some 500 new hardware andhome-center stores for its hand tools.13
To broaden their markets in recent years, many clothing manufacturers,
including Ralph Lauren, Liz Claiborne, Calvin Klein, Anne Klein, and Adrienne
Vittadini, have opened their own stores to sell a full array of their clothes andaccessories.14 Again, to broaden the market, brand-name fast-food companies,
Pizza Hut, Subway Sandwiches, Salads Kiosk, and others, have started selling
their products in public school cafeterias.15
Complementary channels may also be necessitated by geography. Many
industrial companies undertake direct distribution of their products in such large
metropolitan areas as New York, Chicago, Detroit, and Cleveland. Because themarket is dense and because of the proximity of customers to each other, a salesperson can make more than 10 calls a day. The same company that sells directly
to its customers in urban environments, however, may use manufacturer’s representatives or some other type of intermediary in the hinterlands because the market there is too thin to support full-time salespeople.
Another reason to promote complementary channels is to enhance the distribution of noncompeting items. For example, many food processors package fruits
and vegetables for institutional customers in giant cans that have little market
among household customers. These products, therefore, are distributed throughdifferent channels. Procter & Gamble manufactures toiletries for hotels, motels,
hospitals, airlines, and so on, which are distributed through different channel
arrangements. The volume of business may also require the use of different channels. Many appliance manufacturers sell directly to builders but use distributors
and dealers for selling to household consumers.
The basis for employing complementary channels is to enlist customers andsegments that cannot be served when distribution is limited to a single channel.
Thus, the addition of a complementary channel may be the result of simple costbenefit analysis. If by employing an additional channel the overall business can beincreased without jeopardizing quality or service and without any negative impact
on long-term profitability, it may be worthwhile to do so. However, care is needed
to ensure that the enhancement of the market through multiple channels does notlead the Justice Department to charge the company with monopolizing the market.

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Competitive
Channels

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The second type of multiple-channel strategy is the competitive channel.
Competitive channels exist when the same product is sold through two different
and competing channels. This distribution posture may be illustrated with reference to a boat manufacturer, the Luhrs Company. Luhrs sells and ships boats
directly to dealers, using one franchise to sell Ulrichsen wood boats and Alura fiberglass boats and another franchise to sell Luhrs wood and fiberglass/wood boats.
The two franchises could be issued to the same dealer, but they are normally issued
to separate dealers. Competition between dealers holding separate franchises isboth possible and encouraged. The two dealers compete against each other to theextent that their products satisfy similar consumer needs in the same segment.
The reason for choosing this competitive strategy is the hope that it will
increase sales. It is thought that if dealers must compete against themselves as well
as against other manufacturers’ dealers, the extra effort will benefit overall sales.
The effectiveness of this strategy is debatable. It could be argued that a programusing different incentives, such as special discounts for attaining certain levels ofsales, could be just as effective as this type of competition. It could be even more
effective because the company would eliminate costs associated with developing
additional channels.
Sometimes a company may be forced into developing competing channels in
response to changing environments. For example, nonprescription drugs weretraditionally sold through drugstores. But as the merchandising perspectives ofsupermarkets underwent a change during the post-World War II period, grocery
stores became a viable channel for such products because shoppers expected tofind convenience drug products there. This made it necessary for drug companies
to deal with grocery wholesalers and retail grocery stores along with drug wholesalers and drugstores. In the 1980s, Capital Holding Corp. (a life insurance company located in Louisville, Kentucky) adopted a variety of marketing
innovations. For example, in 1985 it began selling life insurance in novel ways,
notably through supermarkets. Impressed by Capital Holding’s steady growthand strong financial performance, many other insurance companies were forced
to develop new channels to sell their insurance products.16
The argument behind the competitive channel strategy is that, although twobrands of the same manufacturer may be essentially the same, they may appeal todifferent sets of customers. Thus, General Motors engages different dealers for its
Buick, Cadillac, Chevrolet, Oldsmobile, and Pontiac cars. These dealers vigorouslycompete with one another. A more interesting example of competing multiple channels adopted by automobile manufacturers is provided by their dealings with car
rental companies. Carmakers sell cars directly to car rental agencies. Hertz, forexample, buys from an assembly plant and regularly resells some of its slightly
used cars in competition with new cars through its more than 100 offices across theUnited States. Many of these offices are located in close proximity to dealers of newcars. Despite such competition, a manufacturer undertakes distribution throughmultiple channels to come off, on the whole, with increased business.
In adopting multiple competing channels, a company needs to make sure thatit does not overextend itself; otherwise it may spread itself too thin and face com-

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petition to such an extent that ultimate results are disastrous. McCammon cites
the case of a wholesaler who adopted multiple channels and thus exposed itself
to a grave situation:
Consider, for example, the competitive milieu of Stratton & Terstegge, a large hardware wholesaler in Louisville. At the present time, the company sells to independent
retailers, sponsors a voluntary group program, and operates its own stores. In these
multiple capacities, it competes against conventional wholesalers (Belknap), cash andcarry wholesalers (Atlas), specialty wholesalers (Garcia), corporate chains (Wiches),
voluntary groups (Western Auto), cooperative groups (Colter), free-form corporations(Interco), and others. Given the complexity of its competitive environment, it is not
surprising to observe that Stratton & Terstegge generates a relatively modest rate of
return on net worth.17

One of the dangers involved in setting up multiple channels is dealer resentment. This is particularly true when competitive channels are established. When
this happens, it obviously means that an otherwise exclusive retailer will now
suffer a loss in sales. Such a policy can result in the retailer electing to carry a different manufacturer’s product line, if a comparable product line is available. For
example, if a major department store such as Lord & Taylor is upset with amanufacturer such as the Hathaway Shirt Company for doing business with discounters (i.e., for adopting competing channels), it can very easily give its business to another shirt manufacturer.
Consider the following examples.18 Hill’s Science Diet pet food lost a great
deal of support in pet shops and feed stores as a result of the company’s experiments with a “store within a store” pet shop concept in the competing grocerychannel. In the auto market, ATK, the dominant seller of replacement engines forJapanese cars, lost its virtual monopoly when it attempted to undercut distributors and sell direct to individual mechanics and installers.
Quaker Oats’s recent $1.4 billion write-off from the divestiture of its Snapple
business was caused in part by channel conflict. Quaker had planned to consolidate its highly efficient grocery channel supporting the Gatorade brand with
Snapple’s channels for reaching convenience stores. Snapple distributors were
supposed to focus on delivering small quantities of both brands to convenience
store accounts while Gatorade’s warehouse delivery channel handled larger
orders to grocery chains and major accounts, leveraging Quaker’s establishedstrength in this area.
However, the strategy backfired. As Quaker suggested moving larger
Snapple accounts to Gatorade’s delivery system, Snapple’s distributors revolted.
They saw the value of their Snapple business as an exclusive geographic franchisethat the split channel strategy would undermine. Several Snapple distributors
took legal action against Quaker. The company ultimately backed down, but the
dispute had created a considerable distraction at a time when competition from
Arizona and Nantucket Nectars was intensifying.
Multiple channels also create control problems. National Distillers andChemical Corporation had a wholly owned New York distributor, Peel Richards,

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that strictly enforced manufacturer-stipulated retail prices and refused to do business with price cutters. Since R.H. Macy discounted National Distiller’s products,
Peel Richards stopped selling to them. R.H. Macy retaliated by placing an orderwith an upstate New York distributor of National Distillers.19 National Distillers
had no legal recourse against either R.H. Macy or the upstate New York distributor,
who was an independent businessperson.
These problems do not diminish the importance of multiple distribution: they
only suggest the difficulties that may arise with multiple channels and the difficulties with which management must contend. A manufacturer’s failure to use multiple channels gives competitors an opportunity to segment the market byconcentrating on one or the other end of the market spectrum. This is particularly
disastrous for a leading manufacturer because it must automatically forgo access toa large portion of market potential for not being able to use the economies of multiple distribution. If a manufacturer determines that multiple channels could cause
problems, solutions must be found to resolve those problems. Exhibit 16-5 outlines
a variety of ways to tackle multiple channel conflicts at different stages in its development.20 For example, if conflict has recently arisen between channels focused on
the same segments, suppliers might respond by introducing separate products orbrands tailored to each channel.
EXHIBIT 16-5
Ten Ways to Manage Channel Conflict
Two or morechannels target
the same customer
segment
1. Differentiate
channel offer
2. Define exclusive
territories

Channel economics
deteriorate
4. Change the channel’s economic formula:• Grant rebates if an intermediary fulfills
certain program requirements• Adjust margins between products to
support different channel economics• Treat channels fairly to create levelplaying fieldThreatened channel
stops performing or
retaliates against
the supplier
8. Leverage power(e.g., a strong
brand) against
the channel toprevent retaliation

3. Enhance or
9. Migrate volume tochange thewinning channel
channel’s value 5. Create segment-specific programs (e.g., cer(e.g., to warehouseproposition
tain services not available via direct channels) clubs for pack(e.g., by building
aged goods)
skills in
6. Complement value proposition of thevalue chain)
existing channel by introducing a new
10. Back offchannel
7. Foster consolidation among intermediaries
in a declining channel
Source: Christine B. Bucklin, Pamela A. Thomas-Graham, and Elizabeth A. Webster, “Channel
Conflict: When Is It Dangerous?” The McKinsey Quarterly, No. 3, 1997, p. 38.

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CHANNEL-MODIFICATION STRATEGY
The channel-modification strategy is the introduction of a change in existing distribution arrangements based on evaluation and critical review. Channels shouldbe evaluated on an ongoing basis so that appropriate modification may be madeas necessary.21 A shift in existing channels may become desirable for any of thefollowing reasons:
1. Changes in consumer markets and buying habits.
2. Development of new needs in relation to service, parts, or technical help.
3. Changes in competitors’ perspectives.
4. Changes in relative importance of outlet types.
5. Changes in a manufacturer’s financial strength.
6. Changes in the sales volume level of existing products.
7. Changes in product (addition of new products), price (substantial reduction in
price to gain dominant position), or promotion (greater emphasis on advertising)strategies.

To illustrate the importance of modifying channel arrangements to keep up
with changing climate, consider GM’s efforts to remake its distribution system.
GM’s objective is to catch up with population shifts by moving stores out of small
towns and declining cities and into bustling retail zones along suburban highways.
At the same time, it is pushing dealers to reconfigure their holdings to match theway GM has realigned its divisions, and either to spiff up stores or build new ones.
The company’s ultimate goal: fewer but better dealers. Although the auto makerhas made progress in revamping the distribution, the going has been tough as
expected. GM launched a $1 billion project in 1990 to relocate some dealers, merge
others, and shrink its dealer count from 9,500 in 1990 to 7,000 by the end of 2000.22
ChannelEvaluation

Channels of distribution may be evaluated on such primary criteria as cost of distribution, coverage of market (penetration), customer service, communication
with the market, and control of distribution networks. Occasionally, such secondary factors as support of channels in the successful introduction of a new
product and cooperation with the company’s promotional effort also become
evaluative criteria. To arrive at a distribution channel that satisfies all these criteria requires simultaneous optimization of every facet of distribution, somethingthat is usually not operationally possible. Consequently, a piecemeal approach
may be followed.
Cost of Distribution. A detailed cost analysis of distribution is the first stepin evaluating various channel alternatives on a sales-cost basis. This requires classification of total distribution costs under various heads and subheads. Exhibit
16-6 illustrates such a cost classification based on general accounting practices;
information about each item should be conveniently available from the controller’s office.
The question of evaluation comes up only when the company has been following a particular channel strategy for a number of years. Presumably, the

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EXHIBIT 16-6
Representative List of Distribution Costs by Function
1.

Direct Selling

Salaries: administrative and supervisory
ClericalSalespeople
Commission
Travel and entertainment
Training
Insurance: real and property; liability; workmen’s compTaxes: personal property; social security; unemployment
insurance
Returned-goods expense chargeable to salespeople
PensionRent
Utilities
Repair and maintenance
Depreciation
Postage and office supplies
2.

Advertising and Sales Promotion

Salaries: administrative and supervisory; clerical; advertising production
Publication space: trade journals; newspapers
Product promotion: advertising supplier; advertising
agency fees; direct-mail expenses; contests; catalogs
and price list
Cooperative advertising: dealers; retail stores; billboards
3.

Product and Package Design

Salaries: administrative and supervisory
Wages
Materials
Depreciation
4.

Sales Discounts and Allowances

Cash discounts on sales
Quantity discounts
Sales allowances
5.

Credit Extension

Salaries: administrative and supervisory; credit representatives; clerical
Bad debt losses
Forms and postage
Credit rating services
Legal fees: collection efforts
TravelFinancial cost of accounts receivable
6.

Market Research

Salaries: administrative; clerical
Surveys: distributors; consumers
Industry trade data
Travel7.

Warehousing and Handling

Salaries: administrative
Wages: warehouse services
Depreciation: furniture; fixtures
Insurance
Taxes
Repair and maintenance
Unsalable merchandise
Warehouse responsibility
Supplies
Utilities
8.

Inventory Levels

Obsolescence markdown
Financial cost of carrying inventories
9.

Packing, Shipping, and Delivery

Salaries: administrative; clerical
Wages: truck drivers; truck maintenance persons; packers
Shipping clerks
Truck operators
Truck repairs
Depreciation: furniture; fixtures; trucks
Insurance
Taxes
Utilities
Packing supplies
Postage and forms
Freight: factory to warehouse; warehouse to customer;
factory to customer
Outside trucking service
10.

Order Processing

Order forms
Salaries: administrative
Wages: order review clerks; order processing clerks;
equipment operators
Depreciation: Order processing equipment

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EXHIBIT 16-6
Representative List of Distribution Costs by Function (continued)
11.

13.

Customer Service

Salaries: administrative; customer service representatives; clerical
Stationery and supplies
12.

Returned Merchandise

Freight
Salaries: administrative; clerical; returned-goods clerical
Returned-goods processing: material labor
Forms and supplies

Printing and Recording of Accounts Receivable

Sales invoice forms
Salaries: clerical; administrative; accounts receivableclerks; sales invoicing equipment operators
Depreciation: sales invoicing equipment

company has pertinent information to undertake distribution cost analysis bycustomer segment and product line. This sort of data allows the analyzer to findout how cost under each head varies with sales volume; for example, how warehousing expenses vary with sales volume, how packaging and delivery
expenses are related to sales, and so on. In other words, the purpose here is toestablish a relationship between annual sales and different types of cost. These
relationships are useful in predicting the future cost behavior for established
dollar-sales objectives, assuming present channel arrangements are continued.
To find out the cost of distribution for alternative channels, estimates should
be made of all relevant costs under various sales estimates. Cost information canbe obtained from published sources and interviews with selected informants. For
example, assume that a company has been selling through wholesalers for a number of years and is now considering distribution through its own branches. To follow the latter course, the company needs to rent a number of offices in important
markets. Estimates of the cost of renting or purchasing an office can be furnishedby real estate agents. Similarly, the cost of recruiting and hiring additional help tostaff the offices should be available through the personnel office. With the relevant information gathered, simple break-even analysis can be used to computethe attractiveness of the alternative channel.
Assume that a company has 20,000 potential customers and, on an average,that each of them must be contacted every two weeks. A salesperson who makes
10 calls a day and who works five days a week can contact 100 customers every
two weeks. Thus, the company needs 20,000 ÷ 100 = 200 salespeople. If eachsalesperson receives $30,000 in salary and $20,000 in expenses, the annual cost of
its salespeople is $10,000,000. Further, assume that 10 sales managers are
required for control and supervision and that each one is paid, say, $50,000 ayear. The cost of supervision would then be $500,000. Let $9,500,000 be the costof other overhead, such as office and warehouse expenses. The total cost of direct
distribution will then be $10,000,000 + $500,000 + $9,500,000, or $20 million.

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Assume that distribution through wholesalers (the arrangement currently being
pursued) costs the company 25 percent of sales. Assuming sales to be $x, we canset up an equation, 0.25x + $20 million, and solve for x (x + $80 million). If thecompany decides to go to direct distribution, it must generate a sales volume of$80 million before it can break even on costs. Thus, if sales potential is well above
the $80 million mark, direct distribution is worth considering.
One problem with break-even analysis is that distribution alternatives thatare considered equally effective may not always be so. It is a pervasive belief thatthe choice of a distribution channel affects total sales revenue just as the selectionof an advertising strategy does. For example, a retailer may receive the same
number of calls under either of two channel alternatives: from the company’ssalesperson or from a wholesaler’s salesperson. The question, however, iswhether the effect of these calls is the same. The best way to handle this problem
is to calculate the changes that would be necessary in order to make channel alternatives equally effective. To an extent, this can be achieved either intuitively or byusing one of the mathematical models reported in the marketing literature.
Coverage of the Market. An important aspect of predicting future sales
response is the penetration that will eventually be achieved in the market. For
example, in the case of a drug company, customers can be divided into threegroups: (a) drugstores, (b) doctors, and (c) hospitals.
One measure of the coverage of the market (or penetration of the market) is
the number of customers in a group contacted or sold, divided by the total number of customers in that group. Another measure may be penetration in terms ofgeographical coverage of territory. But these measures are too general. Using justthe ratio of customers contacted to the total number of customers does not give aproper indication of coverage because not all types of customers are equallyimportant. Therefore, customers may be further classified, as shown in the accompanying display:
CustomerGroup
Drugstores
Hospitals
Doctors

Classification
Large, medium, and small
Large, medium, and small
Large, medium, and small

Basis of Classification
Annual turnover
Number of beds
Number of patients attended

Then the desired level of penetration for each subgroup should be specified(e.g., penetrate 90 percent of the large, 75 percent of the medium, and 50 percentof the small drugstores). These percentages can be used for examining the effectiveness of an alternative channel.
An advanced analysis is possible, however, by building a penetration model.
The basis of the model is that increments in penetration for equal periods are proportional to the remaining distance to the aimed penetration. The increments inpenetration in a period t will be: t = rp(1 – r)t – 1, where p = targeted or aimed penetration and r = penetration ratio. This ratio signifies how rapidly the cumulative
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80 percent and if r = 0.3, then first-year penetration is 80 × 0.3 = 24 percent. Next
year, the increment in penetration will be 80 × 0.3 × 0.7 = 16.8 percent. Hence,cumulative penetration at the end of the second year will be 24 + 16.8 = 40.8. The
value of p for each subgroup is a matter of policy decision on the part of the company. The value of r depends on the period during which aimed penetration is tobe achieved and on sales efforts in terms of the number of medical representatives/salespeople and their call pattern for each subgroup. For the existing channel (selling through the wholesalers), the value of r can be determined from pastrecords. For the alternate channel (direct distribution), the approximate value of r
can be computed in one of two ways:
1. Company executives should know how many salespeople would be kept on therolls if the alternate channel were used. The executives can also estimate the average number of calls a day a salesperson can make and hence the average numberof customers in a subgroup he or she can contact. With this information, the valueof r can be determined as follows:
Number of customers inValue of r fora subgroup contacted
existing channel
under existing channel=
Value of r for
Number of customers inalternate channel
a subgroup that would
be contacted inalternate channel
2. A second approach may be to find out (or estimate) the penetration that would bepossible after one year if the alternate channel is used, then to substitute this in
the penetration equation to find r when p and t are known.

The penetration model makes it easier to predict the exact coverage in eachsubgroup of customers over a planning period (say, five years hence). The marketing strategist should determine the ultimate desired penetration p and the time
period in which it is to be achieved. Then the model would be able to predict
which channel would take the penetration closer to the objective.
Customer Service. The level of customer service differs from customer to customer for each business. Generally speaking, the sales department, with feedback
from the field force, should be able to designate the various services that the company should offer to different consumer segments. If this is not feasible, a sample
survey may be planned to find out which services customers expect and which services are currently being offered by competitors. This information can be used todevelop a viable service package. Then the capability and willingness of each channel alternative to provide these services may be matched to single out the mostdesirable channel. This can be done intuitively. A more scientific approach would be
to list and assign weights to each type of service, then rate different channels according to their ability to handle these services. Cumulative scores can be used for theservice ranking of channel alternatives. Conjoint measurement can be used to determine which services are most important to a particular segment of customers.

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Communication and Control. Control may be defined as the process of taking steps to bring actual results and desired results closer together. Communication refers to the information flow between the company and its customers. To
evaluate alternate channels on these two criteria, communication and control
objectives should be defined. With reference to communication, for example,
information may be desired on the activities of competitors, new products fromcompetitors, the special promotional efforts of competitors, the attitudes of customers toward the company’s and toward competitors’ services, and the reasonsfor success of a particular product line of the company. Each channel alternative
may then be evaluated in terms of its willingness, capabilities, and interest in providing the required information. In the case of wholesalers, the communication
perspective may also depend on the terms of the contract. But the mere fact thatthey are legally bound by a contract may not motivate wholesalers to cooperate
willingly. Finally, the information should be judged for accuracy, timeliness, andrelevance.
ChannelModification

Environmental shifts, internal or external, may require a company to modify
existing channel arrangements. A shift in trade practice, for instance, may render
distribution through a manufacturer’s representative obsolete. Similarly, technological changes in product design may require frequent service calls on customers
that wholesalers may not be able to make, thus leading the company to opt for
direct distribution.
To illustrate the point, consider jewelry distribution. For centuries, jewelry
was distributed through jewelry shops that relied on uniqueness, craftsmanship,and mystique to reap fat margins on very small volumes. Traditionally, big retailers shunned jewelry as a highly specialized, slow-moving business that tied up
too much money in inventory. But this attitude has changed in the last few years.
For example, between 1978 and 1982, jewelry stores’ share of the jewelry market
declined from 65 percent to less than 50 percent. On the other hand, relying on
hefty advertising and deep discounting, mass merchandisers (e.g., J.C. Penney,
Sears, Montgomery Ward, Target, and others) have been making fast inroads into
the jewelry business. For example, in 1983 J.C. Penney became the fourth-largest
retail jewelry merchant in the United States behind Zale, Gordon Jewelry, andBest Products, the catalog showroom chain. Such a shift in trade practice requiresthat jewelry manufacturers modify their distribution arrangements.23
Similarly, as computer makers try to reach ever-broadening audiences withlower-priced machines, they need new distribution channels. Many of them, IBM
and Apple, for example, have turned to retail stores. In the 1970s, people would
have laughed at the idea of selling computers over the counter; now it is a preferred way of doing business. The tantalizing opportunity to sell computers to
consumers has also given birth to specialty chains specializing in computer andrelated items.
Ben & Jerry’s Homemade Inc. had to change their distribution arrangements
for a different reason. Dreyer’s Grand Ice Cream controlled 70 percent of its distribution, and the relationship was regarded as a cornerstone of Ben & Jerry’s success.

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Then, Dreyer made an unwanted takeover offer which Ben & Jerry’s resented.
The company decided to end the relationship with Dreyer and forged a newalliance with Diage PLC’s Haagen-Dazs, until now regarded as an arch competitor, to deliver its products.24
Generally speaking, a new company in the market starts distribution throughintermediaries. This is necessary because, during the initial period, technical andmanufacturing problems are big enough to keep management busy. Besides, atthis stage, the company has neither the insight nor the capabilities needed to deal
successfully with the vagaries of the market. Therefore, intermediaries are used.
With their knowledge of the market, they play an important role in establishing ademand for a company’s product. But once the company establishes a foothold in
the market, it may discover that it does not have the control of distribution it needs
to make further headway. At this time, channel modification becomes necessary.
Managerial astuteness requires that the company do a thorough study before
deciding to change existing channel arrangements. Taking a few halfhearted measures could create insurmountable problems resulting in loose control and poor
communication. Further, the intermediaries affected should be duly taken into
confidence about a company’s plans and compensated for any breach of terms.
Any modification of channels should match the perspectives of the total marketing strategy. This means that the effect of a modified plan on other ingredients ofthe marketing mix (such as product, price, and promotion) should be considered.
The managers of different departments (as well as the customers) should be
informed so that the change does not come as a surprise. In other words, careneeds to be taken to ensure that a modification in channel arrangements does notcause any distortion in the overall distribution system.
The point may be illustrated with reference to Caterpillar.25 A decade ago,
many observers predicted Caterpillar’s demise. Yet today the company’s overall
share of the world market for construction and mining equipment is the highest
in its history. And the biggest reason for the turnaround, has been the company’ssystem of distribution and product support and the close customer relationships
it fosters. The backbone of that system is Caterpillar’s 186 independent dealers
around the world. They have played a central role in helping the company build
close relationships with customers and gain insights into how it can improve
products and services. The company’s success may be attributed to several factors. For one thing, the company stands by its dealers in goods times and in bad.
In addition, it gives them extraordinary support, helps ensure that the dealerships
are well run, and emphasizes full and honest two-way communication. Finally, it
stresses the emotional ties that have developed between the company and its
dealers over time.

CHANNEL-CONTROL STRATEGY
Channel arrangements traditionally consisted of loosely aligned manufacturers,
wholesalers, and retailers, all of whom were trying to serve their own ends regardless of what went on elsewhere in the channel structure. In such arrangements,

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channel control was generally missing. Each member of the channel negotiatedaggressively with others and performed a conventionally defined set of marketing
functions.
Importance ofChannel Control

For a variety of reasons, control is a necessary ingredient in running a successful
system. Having control is likely to have a positive impact on profits because inefficiencies are caught and corrected in time. This is evidenced by the success ofvoluntary and cooperative chains, corporate chains, franchise alignments, manufacturers’ dealer organizations, and sales branches and offices. Control also helps
to realize cost effectiveness vis-à-vis experience curves. For example, centralizedorganization of warehousing, data processing, and other facilities provide scaleefficiencies. Through a planned perspective of the total system, effort is directedto achieving common goals in an integrated fashion.

Channel Controller

The focus of channel control may be on any member of a channel system: themanufacturer, wholesaler, or retailer. Unfortunately, there is no established theory
to indicate whether any one of them makes a better channel controller than theothers. For example, one appliance retailer in Philadelphia with a 10 percent market share, Silo Incorporated, served as the channel controller there. This firm hadno special relationship with any manufacturer, but if a supplier’s line did not dowell, Silo immediately contacted the supplier to ask that something be done about
it. Wal-Mart (in addition to KMart and Target) can be expected to be the channel
controller for a variety of products. Among manufacturers, Kraft ought to be thechannel controller for refrigerated goods in supermarkets. Likewise, Procter &Gamble is a channel controller for detergents and related items. Ethan Allen
decided to control the distribution channels for its line of Early American furniture by establishing a network of 200 dealer outlets. Sherwin-Williams decided totake over channel control to guide its own destiny because traditional channels
were not showing enough aggressiveness. The company established its own
chain of 2,000 retail outlets.
These examples underscore the importance of someone taking over channel
leadership in order to establish control. Conventionally, market leadership andthe size of a firm determine its suitability for channel control. Strategically, a firmshould attempt to control the channel for a product if it can make a commitment
to fulfill its leadership obligations and if such a move is likely to be economicallybeneficial in the long run for the entire channel system. For example, the thoughtof winning a contract to supply a mass retailer may lead a company to modify
existing channel arrangements. After all, Toys “R” Us accounted for a fifth of the
U.S. toy market in 1996. The Home Depot sold more home improvement products
than all hardware stores combined, and the quarter of the underwear purchasedby Americans came from Wal-Mart (an estimated 23 percent of the U.S. population shops in Wal-Mart on an average day).26 Landing an account with one ofthese mass retailers can double or even triple a supplier’s annual sales. However,rapid revenue growth is not always accompanied by a surge in profits. The strainof coping with high volumes and the service needs of powerful customers can put

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tremendous pressure on suppliers’ profit margins if they attempt to conduct business as usual. Some manufacturers that supply mass retailers even find that
although their sales rise faster than those of other manufacturers, their earnings
growth is slower.
Vertical Marketing
Systems

Vertical marketing systems may be defined as:
professionally managed and centrally programmed networks [that] are preengineered to achieve operating economies and maximum market impact. Statedalternatively, vertical marketing systems are rationalized and capital-intensive networks designed to achieve technological, managerial, and promotional economies
through the integration, coordination, and synchronization of marketing flows frompoints of production to points of ultimate use.27

The vertical marketing system is an emerging trend in the American economy. It seems to be replacing all conventional marketing channels as the mainstay
of distribution. As a matter of fact, according to one estimate, vertical marketingsystems in the consumer-goods sector account for about 70 to 80 percent of theavailable market.28 In brief, vertical marketing systems (sometimes also referred
to as centrally coordinated systems) have emerged as the dominant ingredient in
the competitive process and thus play a strategic role in the formulation of distribution strategy.
Vertical marketing systems may be classified into three types: corporate,
administered, and contractual. Under the corporate vertical marketing system,
successive stages of production and distribution are owned by a single entity.
This is achieved through forward and backward integration. Sherwin-Williams
owns and operates its 2,000 retail outlets in a corporate vertical marketing system (a case of forward integration). Other examples of such systems are Hart,
Schaffner, and Marx (operating more than 275 stores), International Harvester,Goodyear, and Sohio. Not only a manufacturer but also a corporate vertical system might be owned and operated by a retailer (a case of backward integration).
Sears, like many other large retailers, has financial interests in many of its suppliers’ businesses. For example, about one-third of DeSoto (a furniture and homefurnishings manufacturer) stock is owned by Sears. Finally, W. W. Grainger provides an example of a wholesaler-run vertical marketing system. This firm, anelectrical distributor with 1998 sales of $900 million, has nine manufacturing
facilities.
Another outstanding example of a vertical marketing system is provided by
Gallo, the wine company.
The [Gallo] brothers own Fairbanks Trucking company, one of the largest intrastate
truckers in California. Its 200 semis and 500 trailers are constantly hauling wine out ofModesto and raw materials back in including . . . lime from Gallo’s quarry east of
Sacramento. Alone among wine producers, Gallo makes bottles—two million a day—and its Midcal Aluminum Co. spews out screw tops as fast as the bottles are filled. Mostof the country’s 1,300 or so wineries concentrate on production to the neglect of marketing. Gallo, by contrast, participates in every aspect of selling short of whispering in

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the ear of each imbiber. The company owns its distributors in about a dozen markets
and probably would buy many . . . more . . . if the laws in most states did not prohibit
doing so.29

In an administered vertical marketing system, a dominant firm within thechannel system, such as the manufacturer, wholesaler, or retailer, coordinates theflow of goods by virtue of its market power. For example, the firm may exert
influence to achieve economies in transportation, order processing, warehousing,advertising, or merchandising. As can be expected, it is large organizations like
Wal-Mart, Safeway, J.C. Penney, General Motors, Kraft, GE, Procter & Gamble,
Lever Brothers, Nabisco, and General Foods that emerge as channel captains toguide their channel networks, while not actually owning them, to achieve
economies and efficiencies.
In a contractual vertical marketing system, independent firms within thechannel structure integrate their programs on a contractual basis to realize
economies and market impact. Primarily, there are three types of contractual vertical marketing systems: wholesaler-sponsored voluntary groups, retailer-sponsored cooperative groups, and franchise systems. Independent Grocers Alliance(IGA) is an example of a wholesaler-sponsored voluntary group. At the initiativeof the wholesaler, small grocery stores agree to form a chain to achieve
economies with which to compete against corporate chains. The joining members agree to adhere to a variety of contractual terms, such as the use of a common name, to help realize economies on large order. Except for these terms, eachstore continues to operate independently. A retailer-sponsored cooperative
group is essentially the same. Retailers form their own association (cooperative)
to compete against corporate chains by undertaking wholesaler functions (andpossibly even a limited amount of production); that is, they operate their own
wholesale companies to serve member retailers. This type of contractual verticalmarketing system is operated primarily, though not exclusively, in the food line.
Associated Grocers Co-op and Certified Grocers are examples of retailer-sponsored food cooperative groups. Value-Rite, a group of 2,298 stores, is a drugstore
cooperative.30
A franchise system is an arrangement whereby a firm licenses others to market a product or service using its trade name in a defined geographic area under
specified terms and conditions. In 1994, there were more than 2,800 franchisers in
the United States, twice as many as in 1984. Practically any business that can betaught to someone is being franchised. In 1995, sales of goods and services by all
franchising companies (manufacturing, wholesaling, and retailing) exceeded$600 billion. Approximately one-third of all U.S. retail sales flow through franchise and company-owned units in franchise chains.
In addition to traditional franchising businesses (e.g., fast-food), banks are
doing it, as are accountants, dating services, skin care centers, tub and tile refinishers, tutors, funeral homes, bookkeepers, dentists, nurses, bird seed shops, gift
wrappers, wedding consultants, cookie bakers, popcorn poppers, beauty shops,
baby-sitters, and suppliers of maid service, lawn care, and solar greenhouses.

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The Commerce Department forecasts that by the year 2000 franchising willaccount for half of all retail sales. Four different types of franchise systems canbe distinguished:
1. The manufacturer-retailer franchise is exemplified by franchised automobile dealers and franchised service stations.
2. The manufacturer-wholesaler franchise is exemplified by Coca-Cola and PepsiCo,
who sell the soft drink syrups they manufacture to franchised wholesalers who,
in turn, bottle and distribute soft drinks to retailers.
3. The wholesaler-retailer franchise is exemplified by Rexall Drug Stores, Sentry
Drug Centers, and CompUSA.
4. The service sponsor-retailer franchise is exemplified by Avis, Hertz, and Nationalin the car rental business; McDonald’s, Chicken Delight, Kentucky Fried Chicken,
and Taco Bell in the prepared foods industry; Comfort Inn and Holiday Inn in thelodging and food industry; Midas and AAMCO in the auto repair business; andKelly Girl and Manpower in the employment service business.

Vertical marketing systems help achieve economies that cannot be realized
through the use of conventional marketing channels. In strategic terms, verticalmarketing systems provide opportunities for building experience, thus allowing
even small firms to derive the benefits of market power. If present trends are any
indication, by the year 2000 vertical marketing systems should account for almost
90 percent of total retail sales. Considering their growing importance, conventional channels will need to adopt new distribution strategies to compete against
vertical marketing systems. For example, they may
1. Develop programs to strengthen customers’ competitive capabilities. This alternative involves manufacturers and wholesalers in such activities as sponsoring centralized accounting and management reporting services, formulating cooperative
promotional programs, and cosigning shopping center leases.
2. Enter new markets. For example, building supply distributors have initiatedcash-and-carry outlets. Steel warehouses have added glass and plastic productlines to their traditional product lines. Industrial distributors have initiated stockless buying plans and blanket order contracts so that they may compete effectively for customers who buy on a direct basis.
3. Effect economies of operation by developing management information systems.
For example, some middlemen in conventional channels have installed the IBM
IMPACT program to improve their control over inventory.
4. Determine through research the focus of power in the channel and urge the channel member designated to undertake a reorganization of marketing flows.31

Despite the growing trend toward vertical integration, it would be naive toconsider it an unmixed blessing. Vertical integration has both pluses andminuses—more of the latter, according to one empirical study on the subject.32
For example, vertical integration requires a huge commitment of resources: in
mid-1981, Du Pont acquired Conoco in a $7.3 billion transaction. The strategy
may not be worthwhile unless the company gains needed insurance as well as
cost savings. As a matter of fact, some observers have blamed the U.S. automobile industry’s woes, in part, on excessive vertical integration: “In deciding to

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integrate backward because of apparent short-term rewards, managers often
restrict their ability to strike out in innovative directions in the future.”33

CONFLICT-MANAGEMENT STRATEGY
It is quite conceivable that the independent firms that constitute a channel of distribution (i.e., manufacturer, wholesaler, retailer) may sometimes find themselvesin conflict with each other. The underlying causes of conflict are the divergent
goals that different firms may pursue. If the goals of one firm are being challenged because of the strategies followed by another channel member, conflict isthe natural outcome. Thus, channel conflict may be defined as a situation inwhich one channel member perceives another channel member or members to beengaged in behavior that is preventing or impeding it from achieving its goals.
Disagreement between channel members may arise from incompatible
desires and needs. Weigand and Wasson give four examples of the kinds of conflict that may arise:
A manufacturer promises an exclusive territory to a retailer in return for the retailer’s“majority effort” to generate business in the area. Sales increase nicely, but the manufacturer believes it is due more to population growth in the area than to the effort ofthe store owner, who is spending too much time on the golf course.
A fast-food franchiser promises “expert promotional assistance” to his retailers as
partial explanation for the franchise fee. One of the retailers believes that the help heis getting is anything but expert and that the benefits do not correspond with what he
was promised.
Another franchiser agrees to furnish accounting services and financial analysis asa regular part of his service. The franchisee believes that the accountant is nothing
more than a “glorified bookkeeper” and that the financial analysis consists of several
pages of ratios that are incomprehensible.
A third franchiser insists that his franchisees should maintain a minimum stock of
certain items that are regularly promoted throughout the area. Arguments arise as towhether the franchiser’s recommendations constitute a threat, while the franchisee isparticularly concerned about protecting his trade name.34

The four strategic alternatives available for resolving conflicts between channel members are bargaining, boundary, interpenetration, and superorganizational
strategies.35 Under the bargaining strategy, one member of the channel takes thelead in activating the bargaining process by being willing to concede something,with the expectation that the other party will reciprocate. For example, a manufacturer may agree to provide interest-free loans for up to 90 days to a distributor
if the distributor will carry twice the level of inventory that it previously did andwill furnish warehousing for the purpose. Or a retailer may propose to continue
to carry the television line of a manufacturer if the manufacturer will supply television sets under the retailer’s own name (i.e., the retailer’s private brand). The
bargaining strategy works out only if both parties are willing to adopt the attitudeof give-and-take and if bottom-line results for both are favorable enough to
induce them to accept the terms of the bargain.

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The boundary strategy handles the conflict through diplomacy; that is, by
nominating the employee most familiar with the perspectives of the other party
to take up the matter with his or her counterpart. For example, a manufacturer
may nominate a veteran salesperson to communicate with the purchasing agentof the customer to see if some basis can be established to resolve the conflict. For
example, North Face, the manufacturer of high-performance outdoor clothes, isexpanding beyond the $5 billion specialty outdoor market to the broader $30billion casual sportswear market. To implement the strategy, it plans to increase
the number of stores selling North Face after 2001, from 1,500 specialty stores up
to 4,000 retailers.36
This has upset the specialty stores since they fear that the expansion will
undercut the brand, putting pressure on their margins. To resolve the conflict, theNorth Face salesperson may meet the specialty store buyers to talk over businessin general. In between the talks, he or she may indicate in a subtle way that thecompany’s decision to broaden the distribution would be mutually beneficial. In
the end, the specialty stores will reap the benefits of the brand name popularity
triggered by the mass distribution. Besides, the salesperson may be authorized topropose that his or her company will agree not to sell the top of the line to “newretailers,” thus ensuring that it will continue to be available only through the specialty stores. In order for this strategy to succeed, it is necessary that the diplomat(the salesperson in the example) be fully briefed on the situation and provided
leverage with which to negotiate.
The interpenetration strategy is directed toward resolving conflict throughfrequent informal interactions with the other party to gain a proper appreciationof each other’s perspectives. One of the easiest ways to develop interaction is for
one party to invite the other to join its trade association. For example, several
years ago television dealers were concerned because they felt that the manufacturers of television sets did not understand their problems. To help correct the situation, the dealers invited the manufacturers to become members of the National
Appliance and Radio-TV Dealers Association (NARDA). Currently, manufacturers take an active interest in NARDA conventions and seminars.
Finally, the focus of superorganizational strategy is to employ conciliation,
mediation, and arbitration to resolve conflict. Essentially, a neutral third party isbrought into the conflict to resolve the matter. Conciliation is an informal attempt
by a third party to bring two conflicting organizations together and make themcome to an agreement amicably. For example, an independent wholesaler may
serve as a conciliator between a manufacturer and its customers. Under mediation, the third party plays a more active role. If the parties in conflict fail to cometo an agreement, they may be willing to consider the procedural or substantive
recommendations of the mediator.
Arbitration may also be applied to resolve channel conflict. Arbitration may
be compulsory or voluntary. Under compulsory arbitration, the dispute must by
law be submitted to a third party, the decision being final and binding on both conflicting parties. For example, the courts may arbitrate between two parties in dispute. Years ago, when automobile manufacturers and their dealers had problems

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relative to distribution policies, the court arbitrated. Voluntary arbitration is aprocess whereby the parties in conflict submit their disputes for resolution to athird party on their own. For example, in 1955 the Federal Trade Commission arbitrated between television set manufacturers, distributors, and dealers by setting
up 32 industry rules to protect the consumer and to reduce conflicts over distribution. The conflict areas involved were tie-in sales; price fixing; mass shipments
used to clog outlets and foreclose competitors; discriminatory billing; and special
rebates, bribes, refunds, and discounts.37
Of all the methods of resolving conflict, arbitration is the fastest.36 In addition, under arbitration, secrecy is preserved and less expense is incurred.
Inasmuch as industry experts serve as arbitrators, one can expect a fairer decision. Thus, as a matter of strategy, arbitration may be more desirable than othermethods for managing conflict. Exhibit 16-5 lists different ways of managing
channel conflict.

SUMMARY

Distribution strategies are concerned with the flow of goods and services frommanufacturers to customers. The discussion in this chapter was conducted fromthe manufacturer’s viewpoint. Six major distribution strategies were distinguished: channel-structure strategy, distribution-scope strategy, multiple-channel
strategy, channel-modification strategy, channel-control strategy, and conflictmanagement strategy.
Channel-structure strategy determines whether the goods should be distributed directly from manufacturer to customer or indirectly through one or moreintermediaries. Formulation of this strategy was discussed with reference to
Bucklin’s postponement-speculation theory. Distribution-scope strategy specifies
whether exclusive, selective, or intensive distribution should be pursued. The
question of simultaneously employing more than one channel was discussed
under multiple-channel strategy. Channel-modification strategy involves evaluating current channels and making necessary changes in distribution perspectives
to accommodate environmental shifts. Channel-control strategy focuses on vertical marketing systems to institute control. Finally, resolution of conflict amongchannel members was examined under conflict-management strategy.
The merits and drawbacks of each strategy were discussed. Examples frommarketing literature were given to illustrate the practical applications of different
strategies.

DISCUSSIONQUESTIONS

1. What factors may a manufacturer consider to determine whether to distributeproducts directly to customers? Can automobiles be distributed directly to customers?
2. Is intensive distribution a prerequisite for gaining experience? Discuss.
3. What precautions are necessary to ensure that exclusive distribution is notliable to challenge as a restraint of trade?

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4. What strategic factor makes the multiple-channel strategy a necessity for a
multiproduct company?
5. What criteria may a food processor adopt to evaluate its channels of distribution?
6. What kinds of environmental shifts require a change in channel arrangements?
7. What reasons may be ascribed to the emergence of vertical marketing systems?
8. What strategies may conventional channels adopt to meet the threat of vertical marketing systems?
9. What are the underlying sources of conflict in distribution channel relations?
Give examples.
10. What is the most appropriate strategy for resolving a channel conflict?

NOTES

Wroe Alderson, “Factors Governing the Development of Marketing Channels,” inMarketing Channels for Manufactured Products, ed. Richard M. Clewett (Homewood,
IL: Richard D. Irwin, 1964): 7.
2 Louis P. Bucklin, A Theory of Distribution Channel Structure (Berkeley: IBER Special
Publications, University of California, 1966); and “Postponement, Speculation and
Structure of Distribution Channels,” in The Marketing Channel: A Conceptual
Viewpoint, ed. Bruce E. Mallen (New York: John Wiley & Sons, 1967): 67–74.
3 Louis P. Bucklin and Leslie Halpert, “Exploring Channel of Distribution for Cementwith the Principle of Postponement-Speculation,” in Marketing and Economic
Development, ed. Peter D. Bennett (Chicago: American Marketing Association, 1965):
699.
4 See “Benetton,” in Robert D. Buzzell and John A. Quelch, Multinational Marketing
Management (Reading, MA: Addison-Wesley Publishing Co., 1988): 47–76.
5 See Louis W. Stern and Patrick J. Kaufmann, “Electronic Data Interchange in Selected
Consumer Goods Industries: An Interorganizational Perspective,” in Marketing in an
Electronic Age, ed. Robert D. Buzzell (Boston: Harvard Business School Press, 1985):
52–73.
6 Leslie Easton, “Distributing Value: A Revamped McKesson Corporation Is Producing
Surprises,” Barron’s (3 August 1987): 13, 41–42.
7 ”Tesco’s New Tricks,” The Economist (15 April 1995): 61.
8 Wetterau, Inc., Annual Report for 1998.
9 V. Kasturi Rangan, Melvyn A. J. Menezes, and E.P. Maier, “Channel Selection for New
Industrial products: A Framework, Method and Application,” Journal of Marketing(July 1992): 69–82.
10 “Avon Will Offer Perfumes through Department Stores.” The Wall Street Journal (21August 1986): 16.
11 “Home Alone?” The Economist (12 October 1996): 67.
12 Christina Lourosa, “Change in Store,” The Wall Street Journal (16 November 1998): R28.
13 “Easco: Turning to New Customers While Helping Sears Promote Tools,” BusinessWeek (6 October 1980): 62.
14 Terry Agins, “Clothing Makers Don Retailers’ Garb,” The Wall Street Journal (13 July1989): B1.
1

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15 Louise Lee, “School’s Back, and So Are the Marketers,” The Wall Street Journal(1 September 1997): B1.
16 “Even Star Insurers Are Feeling the Heat,” Business Week (14 January 1985): 119.
17 Bert C. McCammon, Jr., “Future Shock and the Practice of Management” (Paper pre-sented at the Fifth Annual Research Conference of the American Marketing
Association, Madrid, Spain, 1973): 9.
18 Christine B. Bucklin, Pamela A. Thomas-Graham, and Elizabeth A. Webster, “Channel
Conflict: When Is It Dangerous?” The McKinsey Quarterly, 3 (1997): 36–43.
19 Robert E. Weigand, “Fit Products and Channels to Your Market,” Harvard Business
Review (January–February 1977): 95–105.
20 Christine B. Bucklin, et al, “Channel Conflict.”
21 Glenn A. Mercer, “Don’t Just Optimize—Unbundle,” The McKinsey Quarterly 3 (1994):
103–116.
22 “GM Brings Its Dealers Up to Speed,” Business Week (23 February 1998): 82.
23 “Chain Stores Strike Gold in Jewelry Sales,” Business Week (6 February 1984): 56.
24 Laura Johannes, “Ben & Jerry’s Plans to End Ties With Dreyer’s,” The Wall Street
Journal (1 September 1998): A4.
25 Donald V. Fifties, “Make Your Dealers Your Partners,” Harvard Business Review(March–April 1996): 84–96.
26 William H. Bolen, Jr. and Robert J. Davis, “Overreaching for Mass Retailers,” The
McKinsey Quarterly, 4 (1997): 40–53.
27 Bert C. McCammon, Jr., “Perspectives for Distribution Programming,” in VerticalMarketing Systems, ed. Louis P. Bucklin (Glenview, IL: Scott, Foresman, 1970): 43.
28 Philip Kotler, Marketing Management, 7th ed. (Englewood Cliffs, NJ: Prentice-Hall,
1994): 519.
29 Jaclyn Fireman, “How Gallo Crushes the Competition,” Fortune (1 September 1986): 27.
30 The Wall Street Journal (2 October 1986): 1.
31 Louis W. Stern, Adel I. El-Ansary, and James R. Brown, Management in Marketing
Channels (Englewood Cliffs, NJ: Prentice-Hall, 1989): 299.
32 Robert D. Buzzell, “Is Vertical Integration Profitable?” Harvard Business Review(January–February 1983): 92–102.
33 Robert H. Hayes and William J. Abernathy, “Managing Our Way to Economic
Decline,” Harvard Business Review (July–August 1980): 72.
34 Robert Weigand and Hilda C. Wasson, “Arbitration in the Marketing Channel,”
Business Horizons (October 1974): 40.
35 See Louis W. Stern and Adel I. El-Ansary, Marketing Channels, 3rd ed. (Englewood
Cliffs, NJ: Prentice-Hall, 1988), 290–298.
36 “A Slippery Slope For North Face,” Business Week (7 December 1998): 66.
37 Stern and El-Ansary, Marketing Channels.

APPENDIXI.
Channel-Structure
Strategy

Perspectives on Distribution Strategies
Definition: Using perspectives of intermediaries in the flow of goods from manufacturers to customers. Distribution may be either direct (from manufacturer toretailer or from manufacturer to customer) or indirect (involving the use of one
or more intermediaries, such as wholesalers or agents, to reach the customer).

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Objective: To reach the optimal number of customers in a timely manner at thelowest possible cost while maintaining the desired degree of control.
Requirements: Comparison of direct versus indirect distribution on the basis of (a)cost, (b) product characteristics, (c) degree of control, and (d) other factors.
Costs: (a) Distribution costs. (b) Opportunity costs incurred because product notavailable. (c) Inventory holding and shipping costs.
Product Characteristics: (a) Replacement rate. (b) Gross margin. (c) Service requirements. (d) Search time.
Degree of Control: Greater when direct distribution used.
Other Factors: (a) Adaptability. (b) Technological changes (e.g., computer technology). (c) Social/cultural values.
Expected Results: (a) Direct distribution: (i) high marketing costs, (ii) large degreeof control, (iii) informed customers, and (iv) strong image. (b) Indirect distribution: (i) lower marketing costs, (ii) less control, and (iii) reduced channel management responsibilities.
II.
Distribution-Scope
Strategy

Definition: Establishing the scope of distribution, that is, the target customers.
Choices are exclusive distribution (one retailer is granted sole rights in serving
a given area), intensive distribution (a product is made available at all possible
retail outlets), and selective distribution (many but not all retail outlets in agiven area distribute a product).
Objective: To serve chosen markets at a minimal cost while maintaining desired
product image.
Requirements: Assessment of (a) customer buying habits, (b) gross margin/
turnover rate, (c) capability of dealer to provide service, (d) capability of dealer
to carry full product line, and (e) product styling.
Expected Results: (a) Exclusive distribution: (i) strong dealer loyalty, (ii) highdegree of control, (iii) good forecasting capability, (iv) sales promotion assistance from manufacturer, (v) possible loss in sales volume, and (vi) possible
antitrust violation. (b) Selective distribution: (i) extreme competition in marketplace, (ii) price discounting, and (iii) pressure from channel members to
reduce number of outlets. (c) Intensive distribution: (i) low degree of control,(ii) higher sales volume, (iii) wide customer recognition, (iv) high turnover,and (v) price discounting.

III.
Multiple-Channel
Strategy

Definition: Employing two or more different channels for distribution of goods andservices. Multiple-channel distribution is of two basic types: complementary(each channel handles a different noncompeting product or market segment)
and competitive (two different and competing channels sell the same product).
Objective: To achieve optimal access to each individual market segment toincrease business. Complementary channels are used to reach market segments otherwise left unserved; competitive channels are used with the hope ofincreasing sales.

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Requirements: (a) Market segmentation. (b) Cost/benefit analysis. Use of complementary channels prompted by (i) geographic considerations, (ii) volume ofbusiness, (iii) need to distribute noncompeting items, and (iv) saturation of traditional distribution channels. Use of competitive channels can be a response
to environmental changes.
Expected Results: (a) Different services, prices, and support provided to different
segments. (b) Broader market base. (c) Increased sales. (d) Possible dealer
resentment. (e) Control problems. (f) Possible over-extension. Over-extension
can result in (i) decrease in quality/service and (ii) negative effects on long-run
profitability.
IV.
ChannelModification
Strategy

Definition: Introducing a change in the existing distribution arrangements on thebasis of evaluation and critical review.
Objective: To maintain an optimal distribution system given a changing environment.
Requirements: (a) Evaluation of internal/external environmental shifts: (i)changes in consumer markets and buying habits, (ii) changes in the retail life
cycle, (iii) changes in the manufacturer’s financial strength, and (iv) changes in
the product life cycle. (b) Continuous evaluation of existing channels. (c)Cost/benefit analysis. (d) Consideration of the effect of the modified channels
on other aspects of the marketing mix. (e) Ability of management to adapt tomodified plan.
Expected Results: (a) Maintenance of an optimal distribution system given environmental changes. (b) Disgruntled dealers and customers (in the short run).

V.
Channel-Control
Strategy

Definition: Takeover by a member of the channel structure in order to establish
control of the channel and provide a centrally organized effort to achieve common goals.
Objectives: (a) To increase control. (b) To correct inefficiencies. (c) To realize costeffectiveness through experience curves. (d) To gain efficiencies of scale.
Requirements: Commitment and resources to fulfill leadership obligations.
Typically, though not always, the channel controller is a large firm with market
leadership/influence.
Expected Results (Vertical Marketing System): (a) Increased control. (b) Professional
management. (c) Central programming. (d) Achievement of operating
economies. (e) Maximum market impact. (f) Increased profitability. (g)Elimination of inefficiencies.

VI.
ConflictManagement
Strategy

Definition: Resolving conflict among channel members.
Objective: To devise a solution acceptable to the conflicting members so that they
will cooperate to make it work.
Requirements: Choice of a strategy for solving the conflict. (a) Bargaining: (i) bothparties adopt give-and-take attitude and (ii) bottom line is favorable enough toDistribution Strategies

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both parties to induce them to accept the terms of the bargain. (b) Boundary:(i) nomination of an employee to act as diplomat, (ii) diplomat is fully briefed
on the situation and provided with leverages with which to negotiate, and (iii)both parties are willing to negotiate. (c) Interpenetration: (i) frequent formalinteractions with the other party to develop an appreciation of each other’s
perspectives and (ii) willingness to interact to solve problems. (d)Superorganizational: A neutral third party is brought into the conflict toresolve the matter by means of (i) conciliation, (ii) mediation, or (iii) arbitration(compulsory or voluntary).
Expected Results: (a) Elimination of snags in the channel. (b) Results that are
mutually beneficial to the parties involved. (c) Need for management timeand effort. (d) Increased costs. (e) Costs incurred by both parties in the formof concessions.

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CHAPTER SEVENTEEN

Promotion Strategies
Advertisements
contain the only
truths to be relied
on in a newspaper.

Promotion strategies are concerned with the planning, implementation, andcontrol of persuasive communication with customers. These strategies may
be designed around advertising, personal selling, sales promotion, or any combination of these. The first strategic issue involved here is how much money may
be spent on the promotion of a specific product/market. The distribution of thetotal promotional budget among advertising, personal selling, and sales promotion is another strategic matter. The formulation of strategies dealing with these
two issues determines the role that each type of promotion plays in a particularsituation.
Clear-cut objectives and a sharp focus on target customers are necessary for
an effective promotional program. In other words, merely undertaking an advertising campaign or hiring a few salespeople to call on customers may not suffice.
Rather, an integrated communication plan consisting of various promotion methods should be designed to ensure that customers in a product/market cluster get
the right message and maintain a long-term cordial relationship with the company. Promotional perspectives must also be properly matched with product,
price, and distribution perspectives.
In addition to the strategic issues mentioned above, this chapter discusses
strategies in advertising and personal selling. The advertising strategies examined are media strategy and copy strategy. Strategic matters explored in the areaof personal selling are those concerned with designing a selling program andsupervising salespeople. The formulation of each strategy is illustrated with reference to examples from the literature.

THOMAS JEFFERSONSTRATEGIES FOR DEVELOPING PROMOTIONAL PERSPECTIVES
The amount that a company may spend on its total promotional effort, which consists of advertising, personal selling, and sales promotion, is not easy to determine. There are no unvarying standards to indicate how much should be spent on
promotion in a given product/market situation. This is so because decisions
about promotion expenditure are influenced by a complex set of circumstances.
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PromotionExpenditure Strategy

Promotion expenditure makes up one part of the total marketing budget. Thus,
the allocation of funds to one department, such as advertising, affects the level of
expenditure elsewhere within the marketing function. For example, a company
may need to choose between additional expenditures on advertising or a new
package design. In addition, the perspectives of promotion expenditure must be
examined in the context of pricing strategy. A higher price obviously provides
more funds for promotion than does a lower price. The amount set aside for promotion is also affected by the sales response to the product, which is very difficult to estimate accurately. A related matter is the question of the cumulative
effect of promotion. The major emphasis of research in this area, even where theissue is far from being resolved, has been on the duration of advertising effects.
Although it is generally accepted that the effects of advertising and maybe theeffects of other forms of promotion as well may last over a long period, there isno certainty about the duration of these benefits. The cumulative effect depends
on the loyalty of customers, frequency of purchase, and competitive efforts, eachof which may be influenced in turn by a different set of variables.
Promotion expenditures vary from one product/market situation to another.
Consider the case of McDonald’s. It spent $330.8 million on television advertisingin 1997, over twice as much as its rival Burger King. Yet the research showed thatviewers remembered and liked Burger King’s ads better than McDonald’s. Thereis no way to be sure if McDonald’s advertising budget was more than optimum.
Similarly, the best-known and best-liked television ad in 1997 was for Miller Lite,a commercial showing people arguing whether Miller tasted great or was less filling. This campaign performed better than all other beer commercials even thoughseveral companies spent more money on their campaigns than Miller did.1 Again,
despite the ad’s success, it is difficult to say if Miller’s budget was optimum.
Promotion, however, is the key to success in many businesses. To illustrate thispoint, take the case of Isordil, a brand of nitrate prescribed to heart patients to prevent severe chest pains. Made by the Ives Laboratories division of the American
Home Products Corporation, it was introduced in 1959 and has since grown toclaim almost 50 percent of a $200-million-a-year market. Ives claims that Isordil islonger acting and in certain ways more effective than other nitrate drugs on themarket. No matter that the Food and Drug Administration has not yet approved
all of the manufacturer’s claims, nor that some doctors think that Isordil differs little from competing drugs—Ives has promoted its nitrate so aggressively for solong that many doctors think only of Isordil when they think of nitrates. The success of Isordil illustrates the key importance of promotion: Indeed, the very survival of a drug in today’s highly competitive marketplace often depends as muchon a company’s promotion talents as it does on the quality of its medicine.
Promotion induces competitors to react, but there is no way to anticipate
competitive response accurately, thus making it difficult to decide on a budget.
For example, during the decade from 1980 to 1990, the promotional costs ofAnheuser-Busch rose by $6 a barrel of beer (from $3 in 1980 to $9 in 1990).2
Although the company has been able to prevent Miller’s inroads into its markets,
the question remains if continuing to increase ad budgets is the best strategy.

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Despite the difficulties involved, practitioners have developed rules of thumbfor determining promotion expenditures that are strategically sound. These rulesof thumb are of two types: they either take the form of a breakdown method or
they employ the buildup method.
Breakdown Methods. There are a number of breakdown methods that can be
helpful in determining promotion expenditures. Under the percentage-of-sales
approach, promotion expenditure is a specified percentage of the previous year’sor predicted future sales. Initially, this percentage is arrived at by hunch. Later,
historical information is used to decide what percentage of sales should be allocated for promotion expenditure. The rationale behind the use of this approach isthat expenditure on promotion must be justified by sales. This approach is followed by many companies because it is simple, it is easy to understand, and it
gives managers the flexibility to cut corners during periods of economic slowdown. Among its flaws is the fact that basing promotion appropriation on sales
puts the cart before the horse. Further, the logic of this approach fails to consider
the cumulative effect of promotion. In brief, this approach considers promotion anecessary expenditure that must be apportioned from sales revenue without considering the relationship of promotion to competitor’s activities or its influenceon sales revenues.
Another approach for allocating promotion expenditure is to spend as muchas can be afforded. In this approach, the availability of funds or liquid resources
is the main consideration in making a decision about promotion expenditure. In
other words, even if a company’s sales expectations are high, the level of promotion is kept low if its cash position is tight. This approach can be questioned on
several grounds. It makes promotion expenditures dependent on a company’s
liquid resources when the best move for a cash-short company may be to spend
more on promotion with the hope of improving sales. Further, this approach
involves an element of risk. At a time when the market is tight and sales are slow,
a company may spend more on promotion if it happens to have resources available. This approach does, however, consider the fact that promotion outlays havelong-term value; that is, advertising has a cumulative effect. Also, under conditions of complete uncertainty, this approach is a cautious one.
Under the return-on-investment approach, promotion expenditures are considered as an investment, the benefits of which are derived over the years. Thus, asin the case of any other investment, the appropriate level of promotion expenditure is determined by comparing the expected return with the desired return. The
expected return on promotion may be computed by using present values of
future returns. Inasmuch as some promotion is likely to produce immediate
results, the total promotion expenditure may be partitioned between current
expense and investment. Alternatively, the entire promotion expenditure can beconsidered an investment, in which case the immediate effect of promotion canbe conceived as a return in period zero. The basic validity and soundness of
the return-on-investment approach cannot be disputed. But there are several
problems in its application. First, it may be difficult to determine the outcomes of488

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different forms of promotion over time. Second, what is the appropriate return to
be expected from an advertising investment? These limitations put severe constraints on the practical use of this approach.
The competitive-parity approach assumes that promotion expenditure is directly
related to market share. The promotion expenditure of a firm should, therefore,
be in proportion to that of competitors in order to maintain its position in the market. Thus, if the leader in the industry allocates two percent of its sales revenue
for advertising, other members of the industry should spend about the same percentage of their sales on advertising. Considering the competitive nature of oureconomy, this seems a reasonable approach. It has, however, a number of limitations. First, the approach requires a knowledge of competitors’ perspectives on
promotion, and this information may not always be available. For example, themarket leader may have decided to put its emphasis not on promotion per se but
on reducing prices. Following this firm’s lead in advertising expenditures without reference to its prices would be an unreliable guide. Second, one firm may get
more for its promotion dollar through judicious selection of media, timing ofadvertising, skillful preparation of ads, a good sales supervision program, and soon. Thus, it could realize the same results as another firm that has twice as muchto spend. Because promotion is just one of the variables affecting market performance, simply maintaining promotional parity with competitors may not beenough for a firm to preserve its market share.
Buildup Method. Many companies have advertising, sales, and sales promotion (merchandising) managers who report to the marketing manager. The marketing manager specifies the objectives of promotion separately for theadvertising, personal selling, and sales promotion of each product line. Ideally,
the spadework of defining objectives should be done by a committee consistingof executives concerned with product development, pricing distribution, and promotion. Committee work helps incorporate inputs from different areas; thus, adecision about promotion expenditure is made in the context of the total marketing mix. For example, the committee may decide that promotion should beundertaken to expose at least 100,000 households to the product; institutional customers may be sought through reductions in price.
In practice, it may not always be easy to pinpoint the separate roles of advertising, personal selling, and sales promotion because these three methods of promotion usually overlap to some degree. Each company must work out its own
rules for a promotion mix. Once the tasks to be performed by each method of promotion have been designated, they may be defined formally as objectives andcommunicated to the respective managers. On the basis of these objectives, eachpromotion manager probably redefines his or her own goals in more operationalterms. These redefined objectives then become the modus operandi of eachdepartment.
Once departmental objectives have been defined, each area works out adetailed budget, costing each item required to accomplish the objectives of the
program. As each department prepares its own budget, the marketing manager

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may also prepare a summary budget for each of them, simply listing the major
expenditures in light of the overall marketing strategy. A marketing manager’s
budget is primarily a control device.
When individual departments have arrived at their estimates of necessary
allocation, the marketing manager meets with each of them to approve budgets.
At that time, the marketing manager’s own estimates help assess department
budgets. Finally, an appropriation is made to each department. Needless to say,the emphasis on different tasks is revised and the total budget refigured several
times before an acceptable program emerges. A committee instead of just the marketing manager may approve the final appropriation for each department.
The buildup method forces managers to analyze scientifically the role they
expect promotion to play and the contribution it can make toward achieving marketing objectives. It also helps maintain control over promotion expenditure andavoid the frustrations often faced by promotion managers as a result of cuts inpromotion appropriations due to economic slowdown. On the other hand, thisapproach can become overly scientific. Sometimes profit opportunities that
require additional promotion expenditure may appear unannounced. Involvement with the objective and task exercise to decide how much more should bespent on promotion takes time, perhaps leading to the loss of an unexpected
opportunity.
Promotion Mix
StrategyAnother strategic decision in the area of promotion concerns the allocation ofeffort among the three different methods of promotion. Advertising refers to nonpersonal communication transmitted through the mass media (radio, television,
print, outdoors, and mail). The communication is identified with a sponsor whocompensates the media for the transmission. Personal selling refers to face-toface interaction with the customer. Unlike advertising, personal selling involves
communication in both directions, from the source to the destination and back.
All other forms of communication with the customer other than those included inadvertising and personal selling constitute sales promotion. Thus, coupons, samples, demonstrations, exhibits, premiums, sweepstakes, trade allowances, sales
and dealer incentives, cents-off packs, rebates, and point-of-purchase material are
all sales promotion devices.
A variety of new ways have been developed to communicate with customers.
These include telemarketing (i.e., telephone selling) and demonstration centers (i.e.,
specially designed showrooms to allow customers to observe and try out complex
industrial equipment). The discussion in this chapter will be limited to the three traditional methods of promotion. In some cases, the three types of promotion may belargely interchangeable; however, they should be blended judiciously to complement each other for a balanced promotional perspective. Illustrated below is themanner in which a chemical company mixed advertising with personal selling andsales promotion to achieve optimum promotional performance:
An advertising campaign aimed at customer industries, employees, and plant communities carried the theme, “The little chemical giant.” It appeared in Adhesive Age,

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American Paint & Coating Journal, Chemical & Engineering News, Chemical Marketing
Reporter, Chemical Purchasing, Chemical Week, Modern Plastics, and Plastics World.
Sales promotion and personal selling were supported by publicity. Editorial toursof the company’s new plants, programs to develop employee understanding andinvolvement in the expansion, and briefings for local people in towns and cities where
USIC [the company] had facilities provided a catalyst for publicity.
Personal selling was aggressive and provided direct communication about thefirm’s continued service. USIC reassured producers of ethyl alcohol, vinyl acetatemonomer, and polyethylene that “we will not lose personal touch with our customers.”3

Development of an optimum promotion mix is by no means easy. Companies
often use haphazard, seat-of-the-pants procedures to determine the respectiveroles of advertising, personal selling, and sales promotion in a product/market
situation.
Decisions about the promotional mix are often diffused among many decision makers, impeding the formation of a unified promotion strategy. Personalselling plans are sometimes divorced from the planning of advertising and sales
promotion. Frequently, decision makers are not adequately aware of the objectives and broad strategies of the overall product program that the promotion planis designed to implement. Sales and market share goals tend to be constant,regardless of decreases or increases in promotional expenditures. Thus they are
unrealistic as guides and directives for planning, as criteria for promotional effectiveness, or even as a fair basis for application of the judgment of decision makers. Briefly, the present state of the art in the administration of the promotionfunction is such that cause-and-effect relationships as well as other basic insights
are not sufficiently understood to permit knowledgeable forecasts of what toexpect from alternate courses of action. Even identifying feasible alternatives canprove difficult.
A variety of factors should be considered to determine the appropriate promotion mix in a particular product/market situation. These factors may be categorized as product factors, market factors, customer factors, budget factors, andmarketing mix factors, as outlined in Exhibit 17-1.
Product Factors. Factors in this category relate principally to the way inwhich a product is bought, consumed, and perceived by the customer. For industrial goods, especially technical products, personal selling is more significant thanadvertising because these goods usually need to be inspected and compared
before being bought. Salespeople can explain the workings of a product and provide on-the-spot answers to customer queries. For customer goods such as cosmetics and processed foods, advertising is of primary importance. In addition,
advertising plays a dominant role for products that provide an opportunity for
differentiation and for those being purchased with emotional motives.
The perceived risk of a purchase decision is another variable here. Generally
speaking, the more risk a buyer perceives to be associated with buying a particular product, the higher the importance of personal selling over advertising. A
buyer generally desires specific information on a product when the perceived risk

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EXHIBIT 17-1
Criteria for Determining Promotion Mix
Product Factors
1. Nature of product2. Perceived risk
3. Durable versus nondurable
4. Typical purchase amountMarket Factors
1. Position in its life cycle
2. Market share
3. Industry concentration
4. Intensity of competition
5. Demand perspectives
Customer Factors
1. Household versus business customers
2. Number of customers
3. Concentration of customers
Budget Factors
1. Financial resources of the organization
2. Traditional promotional perspectives
Marketing Mix Factors
1. Relative price/relative quality
2. Distribution strategy
3. Brand life cycle
4. Geographic scope of market

is high. This necessitates an emphasis on personal selling. Durable goods arebought less frequently than nondurables and usually require a heavy commitment of resources. These characteristics make personal selling of greater significance for durable goods than advertising. However, because many durable goods
are sold through franchised dealerships, the influence of each type of promotion
should be determined in light of the additional push it would provide in moving
the product. Finally, products purchased in small quantities are presumably purchased frequently and require routine decision making. For these products,
advertising should be preferable to personal selling. Such products are often of
low value; therefore, a profitable business in these products can only be conducted on volume. This underlines the importance of advertising in this case.
Market Factors. The first market factor is the position of a product in its life
cycle. The creation of primary demand, hitherto nonexistent, is the primary task
during the introductory stage; therefore, a great promotion effort is needed to
explain a new product to potential customers. For consumer goods in the introductory stage, the major thrust is on heavy advertising supported by missionary

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selling to help distributors move the product. In addition, different devices ofsales promotion (e.g., sampling, couponing, free demonstrations) are employed
to entice the customer to try the product. In the case of industrial products, personal selling alone is useful during this period. During the growth phase, there isincreasing demand, which means enough business for all competitors. In the caseof consumer goods, however, the promotional effort shifts to reliance on advertising. Industrial goods, on the other hand, begin to be advertised as the market
broadens. However, they continue to require a personal selling effort. In thematurity phase, competition becomes intense, and advertising, along with sales
promotion, is required to differentiate the product (a consumer good) from competitive brands and to provide an incentive to the customer to buy a particular
product. Industrial goods during maturity call for intensive personal selling.
During the decline phase, the promotional effort does not vary much initiallyfrom that during the maturity phase except that the intensity of promotion
declines. Later, as price competition becomes keen and demand continues todecline, overall promotional perspectives are reduced.
For a given product class, if market share is high, both advertising and personal selling are used. If the market share is low, the emphasis is placed on either
personal selling or advertising. This is because high market share seems to indicate that the company does business in more than one segment and uses multiple
channels of distribution. Thus, both personal selling and advertising are used topromote the product. Where market share is low, the perspectives of the businessare limited, and either advertising or personal selling will suffice, depending on
the nature of the product.
If the industry is concentrated among a few firms, advertising has additionalsignificance for two reasons: (a) heavy advertising may help discourage otherfirms from entering the field, and (b) heavy advertising sustains a desired position for the product in the market. Heavy advertising constitutes an implied warranty of product performance and perhaps decreases the uncertainty consumers
associate with new products. In this way, new competition is discouraged andexisting positions are reinforced.
Intensity of competition tends to affect promotional blending in the same waythat market share does. When competition is keen, all three types of promotion
are needed to sustain a product’s position in the market. This is because promotion is needed to inform, remind, and persuade customers to buy the product. On
the other hand, if competitive activity is limited, the major function of promotion
is to inform and perhaps remind customers about the product. Thus, either advertising or personal selling is emphasized.
Hypothetically, advertising is more suited for products that have relatively
latent demand. This is because advertising investment should open up newopportunities in the long run, and if the carryover effect is counted, expenditure
per sales dollar would be more beneficial. If demand is limited and new
demand is not expected to be created, advertising outlay would be uneconomical. Thus, future potential becomes a significant factor in determining the roleof advertising.

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Customer Factors. One of the major dimensions used to differentiate businesses is whether products are marketed for household consumption or for organizational use. There are several significant differences in the way products aremarketed to these two customer groups, and these differences exert considerable
influence on the type of promotion that should be used. In the case of household
customers, it is relatively easy to identify the decision maker for a particular product; therefore, advertising is more desirable. Also, the self-service nature of many
consumer-product sales makes personal selling relatively unimportant. Finally,
household customers do not ordinarily go through a formal buying process using
objective criteria as organizational customers do. This again makes advertisingmore useful for reaching household customers. Essentially the same reasons
make personal selling more relevant in promoting a product among organizational customers.
The number of customers and their geographic concentration also influence
promotional blending. For a small customer base, especially if it is geographicallyconcentrated, advertising does not make as much sense as it does in cases where
customers are widely scattered and represent a significant mass. Caution isneeded here because some advertising may always be necessary for consumer
goods, no matter what the market perspectives are. Thus, these statements provide only a conceptual framework and should not be interpreted as exact yes/nocriteria.
Budget Factors. Ideally, the budget should be based on the promotional tasks
to be performed. However, intuitively and traditionally, companies place anupper limit on the amount that they spend on promotion. Such limits may influence the type of promotion that may be undertaken in two ways. First, a financially weak company is constrained in undertaking certain types of promotion.
For example, television advertising necessitates a heavy commitment of
resources. Second, in many companies the advertising budget is, by tradition,linked to revenues as a percentage. This method of allocation continues to be used
so that expected revenues indicate how much may be spent on advertising in the
future. The allocated funds, then, automatically determine the role of advertising.
Marketing Mix Factors. The promotion decision should be made in the context of other aspects of the marketing mix. The price and quality of a product relative to competition affect the nature of its promotional perspectives. Higher
prices must be justified to the consumer by actual or presumed product superiority. Thus, in the case of a product that is priced substantially higher than competing goods, advertising achieves significance in communicating andestablishing the product’s superior quality in the minds of customers.
The promotion mix is also influenced by the distribution structure employed
for the product. If the product is distributed directly, the sales force can largely be
counted on to promote the product. Indirect distribution, on the other hand,requires greater emphasis on advertising because the push of a sales force is limited. As a matter of fact, the further the manufacturer is from the ultimate user,
the greater the need for the advertising effort to stimulate and maintain demand.

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The influence of the distribution strategy may be illustrated with reference to two
cosmetics companies that deal in similar products, Revlon and Avon. Revlon distributes its products through different types of intermediaries and advertises
them heavily. Avon, on the other hand, distributes primarily directly to end users
in their homes and spends less on advertising relative to Revlon.
Earlier we examined the effect on the promotion mix of a product’s position
in its life cycle. The position of a brand in its life cycle also influences promotional
perspectives. Positioning a new brand in the desired slot in the market during its
introduction phase requires a higher degree of advertising. As a product enters
the growth phase, advertising should be blended with personal selling. In thegrowth phase, the overall level of promotion declines in scope. When an existing
brand reaches the maturity phase in its life cycle, the marketer has three options:to employ life-extension strategies, to harvest the brand for profits, and/or to
introduce a new brand that may be targeted at a more specific segment of themarket. The first two options were discussed in Chapter 13. As far as the third
option is concerned, for promotional purposes, the new brand will need to betreated like a new product.
Finally, the geographic scope of the market to be served is another consideration. Advertising, relatively speaking, is more significant for products marketednationally than for those marketed locally or regionally. When the market is geographically limited, one study showed that even spot television advertisingproved to be more expensive vis-à-vis the target group exposures gained.4 Thus,
because advertising is an expensive proposition, regional marketers should rely
less on advertising and more on other forms of promotion, or they should substitute another element of the marketing mix for it. For example, a regional marketer
may manufacture private label brands.
Conclusion

Although these factors are helpful in establishing roles for different methods ofpromotion, actual appropriation among them should take into consideration theeffect of any changes in the environment. For example, in the 1980s soft drink
companies frequently used sales promotion (mainly cents off) to vie for customers. In the 1990s, however, the markers of soft drinks changed their promotion mix strategy to concentrate more on advertising. This is evidenced by the factthat the five largest soft drink makers spent about $500 million on advertising in
1994, 40 percent more than they spent in 1984. One reason for this change in promotional perspective was the realization that price discounting hurt brand loyalties; because Coke and Pepsi had turned their colas into commodities by meansof cents-off promotion, the consumer now shopped for price.
An empirical study on this topic has shown that consumers prefer incentives
other than price. Price cuts also appear to have little lasting effect on sales volumes. For example, consumers exposed to repeated price cuts learn to ignore the“usual” price. Instead, they wait for the next discount and then stockpile theproduct. They also tend to become discount junkies, stimulated into buying only
by ever-steeper discounts.5 In brief, price promotions not only cut margins, butalso leave manufacturers to cope with costly fluctuations in stocks.

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In addition, the promotion mix may also be affected by a desire to be innovative. For example, Puritan Fashions Corporation, an apparel company, traditionally spent little on advertising. In the late 1970s, the company was continuallylosing money. Then, in the 1980s, the company introduced a new product, bodyhugging jeans, and employed an unconventional promotion strategy. It placed
Calvin Klein’s label on its jeans, sold them as a prestige trouser priced at $35 (double the price of nonlabeled styles), and advertised them heavily. This promotion
mix provided the company with instant success. Another example of promotion
innovation is provided by Kellogg, which, instead of plastic toys and other gimmicks, now featured Microsoft Corp. software for children and adults. Althoughpromotional innovation may not last long because competitors may soon copy it,it does provide the innovator with a head start.
Promotional blending requires consideration of a large number of variables,
as outlined above. Unfortunately, it is difficult to assign quantitative values to theeffect that these variables have on promotion. Thus, decisions about promotional
blending must necessarily be made subjectively. These factors, however, provide
a checklist for reviewing the soundness and viability of subjective decisions.
Recent research conducted by the Strategic Planning Institute for Cahners
Publishing Co. identified the following decision rules that can be used in formulating ad budgets. These rules may be helpful in finalizing promotion mix
decisions.6
1. Market share—A company that has a higher market share must generally
spend more on advertising to maintain its share.
2. Sales from new products—If a company has a high percentage of its sales
resulting from new products, it must spend more on advertising compared tocompanies that have well-established products.
3. Market growth—Companies competing in fast-growing markets should spendcomparatively more on advertising.
4. Plant capacity—If a company has a lot of unused plant capacity, it should
spend more on advertising to stimulate sales and production.
5. Unit price (per sales transaction)—The lower the unit price of a company’s
products, the more it should spend on advertising because of the greater likelihood of brand switching.
6. Importance of product to customers (in relation to their total purchases)—
Products that constitute a lower proportion of customers’ purchases generally
require higher advertising expenditures.
7. Product price—Both very high-priced (or premium) products and very lowpriced (or discount) products require higher ad expenditures because, in bothcases, price is an important factor in the buying decision and the buyer must be
convinced (through advertising) that the product is a good value.
8. Product quality—Higher-quality products require a greater advertising effort
because of the need to convince the consumer that the product is unique.
9. Breadth of product line—Companies with a broad line of products must spend
more on advertising compared to companies with specialized product lines.
10. Degree of standardization—Standardized products produced in large quantities should be backed by higher advertising outlays because they are likely tohave more competition in the market.

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ADVERTISING STRATEGIES
Companies typically plan and execute their advertising through five stages:
developing the budget, planning the advertising, copy development andapproval, execution, and monitoring response.7 Exhibit 17-2 summarizes who
participates in each stage and the end product.
Media-Selection
Strategy

Media may be defined as those channels through which messages concerning a
product or service are transmitted to targets. The following media are available toadvertisers: newspapers, magazines, television, radio, outdoor advertising, transit advertising, direct mail, and the Internet.
Selection of an advertising medium is influenced by such factors as the
product or service itself, the target market, the extent and type of distribution,
the type of message to be communicated, the budget, and competitors’ advertising strategies. Except for the advertising perspectives employed by the competition, information on most of these factors is presumably available inside thecompany. It may be necessary to undertake a marketing research project to findout what sorts of advertising strategies competitors have used in the past andwhat might be expected of them in the future. In addition, selection of a

EXHIBIT 17-2
The Advertising Planning Process
Stage

Preliminary players

End productDeveloping themarketing planand budget

Product manager

BudgetSpending guidelines
Profit projections

Planning theadvertising

Product manager
Advertising manager
Ad agency
Corporate advertising
department

Identification of the target market
Allocating of spending
Statement of advertising strategy
and message

Copy development Ad agency
and approval
Copy research company
Product manager
Advertising manager
Senior management

Finished copy
Media plan (with reach and frequency projections)Execution

Ad agency or media buying
company

Actual placement

Monitoring
response

Market research manager
Product manager
Ad agency (research)

Awareness, recognition, and perception tracking
Perceptual maps
Sales/share tracking

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medium also depends on the advertising objectives for the product/market
concerned. With this information in place, different methods may be used to
select a medium.
Mention must be made here of an emerging medium, i.e., Internet advertising. Online advertising is booming and had reached about $2 billion in 1998.8
Internet advertising offers a variety of advantages. It offers an exceptional ability
to target specific customers. Besides, it blurs the division between content andadvertising, which the traditional media regard as sacred. If the money is right,
many online publishers are willing to strike whatever sort of partnerships anadvertiser might want.
However, ad rates on the Net are steep enough to justify the cost. Most advertisers pay at least as much to reach an Internet audience, typically $10 to $40 per1000 viewers, as they would for TV or magazine ads.9 Further, the emotion-ladenvignettes that work so well on TV simply don’t woo viewers in cyberspace.
Presently, most marketers see Internet advertising as little more than a complement to traditional media.
Despite the above problems, Internet advertising will account for a growing
proportion of overall advertising expenditure. As the technology improves, theimpact of Internet advertising will increase and become easier to measure, andthe gap between this new precise, interactive marketing capability and conventional “fuzzy” passive media will widen. The following reasons are advanced forthe growing popularity of Internet advertising:10(a) The Web presents great advertising opportunities for marketers because of its
continuing growth, its user demographics, its effectiveness, and its costcompetitiveness.
(b) The overall Web population is reaching critical mass. Recent surveys show there
are 25 to 40 million adult Web users in the United States—between one-eighthand one-fifth of the population. Twenty-five million Americans use the Web atleast once a week, according to one source, and 8.4 million are daily users. The
average user spends 8.6 hours a month on line.
(c) The demographics of Internet users are broadening, but remain attractive. Morewomen are now using the Internet: one survey puts the figure at 47 percent,another at 38 percent. In financial terms, 91 percent of those who used the Web
in the past six months have household incomes above $60,000—almost double
the average U.S. household income of $31,000. Marketers pursuing certain segments of the population are finding the Internet increasingly useful. For thoseinterested in, say, American men aged 35 to 44 with incomes over $75,000, theWeb can provide access to about 2 million—over 40 percent of the target demographic segment, and a critical mass in itself.
(d) Studies have shown that the Internet is reasonably good at achieving standard
advertising objectives, such as shaping attitudes. However, it also has capabilities that traditional media cannot match. Features that make the Internet a superior medium include its addressability, its interactivity, and its scope forcustomization. Advertisers can do things on the Internet that are impossible intraditional media: identify individual users, target and talk to them one at atime, and engage in a genuine two-way dialogue.

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PART 6 Marketing Strategies(e) In terms of advertising economics, the Internet can already compete with existing media, both in response as measured by click-throughs and in exposure asmeasured by cost per thousand. Moreover, the Internet’s economics look betterand better the more precisely a target consumer segment is defined. The cost to
an Internet advertiser of reaching families that earn over $70,000 and own a foreign car, for instance, can be less than a quarter the cost of using a specialty
magazine such as Car and Driver.
(f) Like traditional media, the Internet needs consistent metrics and auditing inorder to gain broad acceptance from marketers. Both are emerging slowly, driven by old players such as Nielsen and new ones such as Web Track.
(g) Advertisers and agencies cannot afford to produce a different ad and negotiate
a different price for every site. Standards for size, position, content, and pricing
are badly needed and are now being developed; an example is CASIE, theCoalition for Advertising Supported Information and Entertainment, a joint project of the Association of National Advertisers and the American Association ofAdvertising Agencies.
(h) Unless they place their ads on one of the few highly trafficked sites, advertisers
find it difficult to ensure that sufficient people see them. Responding to advertisers’ need for scale, placement networks such as DoubleClick do the aggregating for them, making sure that a specified number of people will be exposed totheir ads.

Advertising Objectives. To build a good advertising program, it is necessary
first to pinpoint the objectives of the ad campaign. It would be wrong to assume
that all advertising leads directly to sales. A sale is a multiphase phenomenon,
and advertising can be used to transfer the customer from one phase to the next:
from unawareness of a product or service, to awareness, to comprehension, toconviction, to action. Thus, the advertiser must specify at what stage or stages heor she wants advertising to work. The objectives of advertising may be defined byany one of the following approaches: inventory approach, hierarchy approach, or
attitudinal approach.
Inventory Approach. A number of scholars have articulated inventories of functions performed by advertising. The objectives of an ad campaign may be definedfrom an inventory based on a firm’s overall marketing perspective. For example,
the following inventory may be used to develop a firm’s advertising objectives:
A. Increase sales by
1. Encouraging potential purchasers to visit the company or its dealers.
2. Obtaining leads for salespeople or dealers.
3. Inducing professional people (e.g., doctors, architects) to recommend the product.
4. Securing new distributors.
5. Prompting immediate purchases through announcements of special sales andcontests.
B. Create an awareness about a company’s product or service by
1. Informing potential customers about product features.
2 Announcing new models.
3. Highlighting the unique features of the product.

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4. Informing customers as to where the product may be bought.
5. Announcing price changes.
6. Demonstrating the product in use.

The inventory approach is helpful in highlighting the fact that different objectives can be emphasized in advertising and that these objectives cannot be
selected without reference to the overall marketing plan. Thus, this approachhelps the advertiser avoid operating in a vacuum. However, inherent in thisapproach is the danger that the decision maker may choose nonfeasible and conflicting objectives if everything listed in an inventory seems worth pursuing.
Hierarchy Approach. Following this approach, the objectives of advertisingshould be stated in an action-oriented psychological form. Thus, the objectives ofadvertising may be defined as (a) gaining customers’ initial attention, perception,
continued favorable attention, and interest; or (b) affecting customers’ comprehension, feeling, emotion, motivation, belief, intentions, decision, imagery, association, recall, and recognition. The thesis behind this approach is that customers
move from one psychological state to another before actually buying a product.
Thus, the purpose of advertising should be to move customers from state to state
and ultimately toward purchasing the product. Although it makes sense to define
the purpose of an individual ad in hierarchical terms, it may be difficult to relate
the purpose so defined to marketing goals. Besides, measurement of psychological states that form the basis of this approach is difficult and subjective comparedto the measurement of goals such as market share.
Attitudinal Approach. According to this approach, advertising is instrumental
in producing changes in attitudes; therefore, advertising goals should be defined
to influence attitudinal structures. Thus, advertising may be undertaken toaccomplish any of the following goals:
1. Affect those forces that influence strongly the choice of criteria used for evaluating brands belonging to the product class.
2. Add characteristic(s) to those considered salient for the product class.
3. Increase/decrease the rating for a salient product class characteristic.
4. Change the perception of the company’s brand with regard to some particularsalient product characteristic.
5. Change the perception of competitive brands with regard to some particularsalient product characteristic.

The attitudinal approach is an improvement over the hierarchical approach
because it attempts to relate advertising objectives to product/market objectives.
This approach indicates not only the functions advertising performs, it also targets the specific results it can achieve.
Advertising objectives should be defined by a person completely familiar
with all product/market perspectives. A good definition of objectives aids in thewriting of appropriate ad copy and in selecting the right media. It should be recognized that different ad campaigns for the same product can have varied objectives. But all ad campaigns should be complementary to each other to maximize
total advertising impact.

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Product/market advertising objectives may be used to derive media objectives. Media objectives should be defined so as to answer such questions as: Are
we trying to reach everybody? Are we aiming to be selective? If housewives
under 30 with children under 10 are really our target, what media objectives
should we develop? Are we national or regional? Do we need to concentrate inselected counties? Do we need reach or frequency or both? Are there creative considerations to control our thinking? Do we need color or permanence (whichmight mean magazines and supplements), personalities and demonstration(which might mean television), the best reminder for the least money (whichmight mean radio or outdoor), superselectivity (which might mean direct mail),or going all the way up and down in the market (which could mean newspapers)?
The following is a list of sample media objectives based on these questions:
1. We need a national audience of women.
2. We want them between 18 and 34.
3. Because the product is a considered purchase, we need room to explain it thoroughly.
4. We need color to show the product to best advantage.
5. We must keep after these women more than once, so we need frequency.
6. There’s no way to demonstrate the product except in a store.

Media-Selection Procedure. Media selection calls for two decisions: (a) which
particular medium to use and (b) which specific vehicles to choose within a given
medium. For example, if magazines are to be used, in which particular magazines
should ads be placed? The following two approaches can be used in media selection: cost-per-thousand-contacts comparison and matching of audience andmedium characteristics.
Cost-per-Thousand-Contacts Comparison. The cost-per-thousand-contacts comparison has traditionally been the most popular method of media selection.
Although simple to apply, the cost-per-thousand method leaves much to be
desired. Basing media selection entirely on the number of contacts to be reachedignores the quality of contacts made. For example, an advertisement for a
women’s dress line appearing in Vogue would make a greater impact on those
exposed to it than would the same ad appearing in True Confessions. Similarly,
Esquire would perhaps be more appropriate than many less-specialized magazines for introducing men’s fashions.
Further, the cost-per-thousand method can be highly misleading if one considers the way in which advertisers define the term exposure. According to themedia definition, exposure occurs as soon as an ad is inserted in the magazine.
Whether the exposure actually occurs is never considered. This method also fails
to consider editorial images and the impact power of different channels of a
medium.
Matching of Audience and Media Characteristics. An alternative approach tomedia selection is to specify the target audience and match its characteristics to aparticular medium. A step-by-step procedure for using this method is describedas follows:501

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1. Build a profile of customers, detailing who they are, where they are located,when they can be reached, and what their demographic characteristics are.
Setting media objectives (discussed earlier) is helpful in building customer
profiles.
2. Study media profiles in terms of audience coverage. Implicit in this step is thestudy of the audience’s media habits (i.e., an examination of who constitutes aparticular medium’s audience).
3. Match customer profiles to media profiles. The customer characteristics for a
product should be matched to the audience characteristics of different media.
This comparison should lead to the preliminary selection of a medium, based primarily on the grounds of coverage.
4. The preliminary selection should be examined further in regard to product andcost considerations. For some products, other things being equal, one medium issuperior to another. For example, in the case of beauty aids, a product demonstration is helpful; hence, television would be a better choice than radio. Cost is
another concern in media selection; information on cost is available from themedia themselves. Cost should be balanced against the benefit expected from thecampaign under consideration.
5. Finally, the total budget should be allocated to different media and to various
media vehicles. The final selection of a medium should maximize the achievement of media objectives. For example, if the objective is to make people awareof a product, then the medium selected should be the one that reaches a wide
audience.

Basically, two types of information are required for media selection: customer
profile and media characteristics. The advertiser should build a customer profilefor his or her product/market. Information about various media is usually available from media owners. Practically all media owners have complete information
available to them concerning their audiences (demographics and circulation figures). Each medium, however, presents the information in a way that makes it
look best. It is desirable, therefore, to validate the audience information suppliedby media owners with data from bureaus that audit various media. The Audit
Bureau of Circulations, the Traffic Audit Bureau, and the Business Publications
Audit of Circulation are examples of such audit bureaus.
Evaluation Criteria. Before money is committed to a selected medium, it isdesirable to review the medium’s viability against evaluation criteria. Is the decision maker being thorough, progressive (imaginative), measure-minded, practical, and optimistic? Thoroughness requires that all aspects of media selection be
given full consideration. For maximum impact, the chosen medium should be
progressive: it should have a unique way of doing the job. An example of progressiveness is putting a sample envelope of Maxwell House coffee in millions ofcopies of TV Guide. Because of postal regulations, this sampling could not bedone in a magazine that is purchased primarily through subscriptions. But TV
Guide is mainly a newsstand magazine. Measure-mindedness refers to more thanjust the number of exposures. It refers not only to frequency and timing in reaching the target audience but also to the quality of the audience; that is, to the proportion of heavy to light television viewers reached, proportion of men to502

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women, working to nonworking women, and so on. Practicality requires choosing a medium on factual, not emotional, grounds. For example, it is not desirable
to substitute a weak newspaper for a strong one just because the top managementof the company does not agree with the editorial policy of the latter. Finally, theoverall media plan should be optimistic in that it takes advantage of lessons
learned from experience.
Advertising-Copy
Strategy

Copy refers to the content of an advertisement. In the advertising industry, theterm is sometimes used in a broad sense to include the words, pictures, symbols,
colors, layout, and other ingredients of an ad. Copywriting is a creative job, andits quality depends to a large extent on the creative ability of writers in the advertising agency or in the company. However, creativity alone may not produce goodad copy. A marketing strategist needs to have his or her own perspectives incorporated in the copy (what to say, how to say it, and to whom to say it) and needs
to furnish information on ad objectives, product, target customers, competitive
activity, and ethical and legal considerations. The creative person carries on fromthere. In brief, although copywriting may be the outcome of a flash of inspirationon the part of an advertising genius, it must rest on a systematic, logical, step-bystep presentation of ideas.
This point may be illustrated with reference to Perrier, a brand of bottled
water that comes from mineral springs located in southern France. In Europe, thisproduct has been quite popular for some years; in the United States, however, it
used to be available in gourmet shops only. In 1977, the company introduced the
product to the U.S. market as a soft drink by tapping the adult user market withheavy advertising. Perrier’s major product distinction is that its water is naturally
carbonated spring water. The product was aimed at the affluent adult population,
particularly those concerned with diet and health, as a status symbol and a signof maturity. Perrier faced competition from two sources: regular soft drink makers and potential makers of mineral water. The company took care of its soft drink
competition by segmenting the market on the basis of price (Perrier was priced 50
percent above the average soft drink) and thus avoided direct confrontation. In
regard to competition from new brands of mineral water, Perrier’s association
with France and the fact that it is constituted of naturally carbonated spring water
were expected to continue as viable strengths. This information was used todevelop ad copy for placement in high-fashion women’s magazines and in television commercials narrated by Orson Welles. The results were astonishing. In
less than five years, Perrier became a major liquid drink in the U.S. market.11
Take another example. Back in 1998, packs of Thomas’ English Muffins carried the following announcement: “Coming Soon . . . New Package, Same Great
Taste!” An illustration of the forthcoming design appeared along with the burst.12
This campaign set a new standard in postmodern promotion. Instead of simply
crowing about itself, this package was actually heralding its own replacement.
The new design showed up in stores about six weeks later.
Essentially, ad copy constitutes an advertiser’s message to the customer. To
ensure that the proper message gets across, it is important that there is no distortion

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of the message because of what in communication theory is called noise. Noise may
emerge from three sources: (a) dearth of facts (e.g., the company is unaware of theunique distinctions of its product), (b) competitors (e.g., competitors make changes
in their marketing mix to counter the company’s claims or position), and (c) behavior traits of the customers or audience. Failure to take into account the last sourceof noise is often the missing link in developing ad copy. It is not safe to assume thatone’s own perspectives on what appeals to the audience are accurate. It is desirable,
therefore, to gain, through some sort of marketing research, insights into behavior
patterns of the audience and to make this information available to the copywriter.
For example, a 1993 Research International Organization (RIO) study of teenagers
in 26 countries provides the following clues for making an effective appeal to young
customers.
1. Never talk down to a teenager. While “hip” phraseology and the generally flippant tone observed in the teenager’s conversation may be coin of the realm fromone youngster to another, it comes across as phony, foolish, and condescending
when directed at him or her by an advertiser. Sincerity is infinitely more effective
than cuteness. Entertainment and attention-getting approaches by themselves dolittle to attract a teenager to the merits of a product. In fact, they often dissuade
the youngster from making a purchase decision.
2. Be totally, absolutely, and unswervingly straightforward. Teenagers may act
cocky and confident in front of adults, but most of them are still rather unsure ofthemselves and are wary of being misled. They are not sure they know enough to
avoid being taken advantage of, and they do not like to risk looking foolish byfalling for a commercial gimmick. Moreover, teenagers as a group are far more
suspicious of things commercial than adults are. Advertising must not only be
noticed; it must be believed.
3. Give the teenager credit for being motivated by rational values. When making abuying selection, adults like to think they are doing so on the basis of the benefits
the product or service offers. Teenagers instinctively perceive what’s “really
there” in an offering. Advertising must clearly expose for their consideration thevalue a product or service claims to represent.
4. Be as personal as possible. Derived from the adult world of marketing, this rule
has an exaggerated importance with teenagers. In this automated age, with somany complaining of being reduced en masse to anonymity, people are becoming
progressively more aware of their own individuality. The desire to be personallyknown and recognized is particularly strong with young people, who areurgently searching for a clear sense of their own identity.13

Findings from communications research are helpful in further refining theattributes of ad copy that an advertising strategist needs to spell out for the copywriter.
Source Credibility. An ad may show a celebrity recommending the use of a
product. It is hoped that this endorsement will help give the ad additional credibility, credibility that will be reflected in higher sales.
Research on the subject has shown that an initially credible source, such as
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changing the opinion of an audience than if a similar claim is made by a lesserknown source, such as an unknown homemaker. However, as time passes, theaudience tends to forget the source or to dissociate the source from the message.14
Some consumers who might have been swayed in favor of a particular brandbecause it was recommended by Miss America may revert to their original choice,whereas those who did not initially accept the homemaker’s word may later
become favorably inclined toward the product she is recommending. The
decreasing importance of the source behind a message over time has been called
the sleeper effect.15
Several conclusions can be drawn from the sleeper effect. In some cases, it
may be helpful if the advertiser is disassociated as much as possible from the ad,particularly when the audience may perceive that a manufacturer is trying topush something.16 On the other hand, when source credibility is important,advertisements should be scheduled so that the source may reappear to reinforce
the message.
An example of source credibility is provided by Nike. It attracted popularsports heroes as credible sources to build new product lines and marketing campaigns around them. Consumers seemed to respond best to athletes who combined a passion to win with a maverick disregard for convention: “outlaws withmorals.”17
Balance of Argument. When preparing copy, there is a question of whether
only the good and distinctive features of a brand should be highlighted orwhether its demerits should be mentioned as well. Traditionally, the argument
has been, “Put your best foot forward.” In other words, messages should bedesigned to emphasize only the favorable aspects of a product. Recent research in
the field of communication has questioned the validity of indiscriminately detailing the favorable side. It has been found that
1. Presenting both sides of an issue is more effective than giving only one side
among individuals who are initially opposed to the point of view being presented.
2. Better-educated people are more favorably affected by presentation of both sides;
poorly educated persons are more favorably affected by communication thatgives only supporting arguments.
3. For those already convinced of the point of view presented, the presentation ofboth sides is less effective than a presentation featuring only those items favoring
the general position being advanced.
4. Presentation of both sides is least effective among the poorly educated who are
already convinced of the position advocated.
5. Leaving out a relevant argument is more noticeable and detracts more from effectiveness when both sides are presented than when only the side favorable to the
proposition is being advanced.18

These findings have important implications for developing copy. If one is trying to reach executive customers through an ad in the Harvard Business Review, it
probably is better to present both favorable and unfavorable qualities of a product.

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On the other hand, for such status products and services as Rolex diamond watches
and Chanel No. 5 perfume, emphasis on both pros and cons can distort the image.
Thus, when status is already established, a simple message is more desirable.
Message Repetition. Should the same message be repeated time and again?
According to learning theory, reinforcement over time from different directions
increases learning. It has been said that a good slogan never dies and that repetition is the surest way of getting the message across. However, some feel that,
although the central theme should be maintained, a message should be presented
with variations.
Communication research questions the value of wholesale repetition.
Repetition, it has been found, leads to increased learning up to a certain point.
Thereafter, learning levels off and may, in fact, change to boredom and loss ofattention. Continuous repetition may even counteract the good effect created earlier. Thus, advertisers must keep track of the shape of the learning curve anddevelop a new product theme when the curve appears to be flattening out. The
Coca-Cola Company, for example, regularly changes its message to maintainaudience interest.19
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Coca-Cola
Coca-Cola revives and sustains
The Great National Temperance Beverage
Thirst knows no season
Six million a day
Around the corner from everywhere
The pause that refreshes
The best friend thirst ever had
Where there’s Coke there’s hospitality
Along the highway to anywhere
What you want is a Coke
Makes good things taste better
Sign of good taste
The cold, crisp taste of Coke
Things go better with Coke
It’s the real thing
I’d like to buy the world a Coke
Look up, America
Coke adds life
Have a Coke and a smile
Coke is it
We’ve got a taste for you
Catch the wave
When Coca-Cola is a part of your life, you can’t beat the feeling
Can’t beat the feeling
Always new, always real
Always you, always Coke
Always spring, always Coke
Something should stay the same, like Coke

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Rational versus Emotional Appeals. Results of studies on the effect of rational and emotional appeals presented in advertisements are not conclusive. Somestudies show that emotional appeals have definite positive results.20 However,arousing emotions may not be sufficient unless the ad can rationally convince thesubject that the product in question will fulfill a need. It appears that emphasis on
one type of appeal—rational or emotional—is not enough. The advertiser must
strike a balance between emotional and rational appeals. For example, Procter &Gamble’s Crest toothpaste ad, “Crest has been recommended by the American
Dental Association,” has a rational content; but its reference to cavity prevention
also excites emotions. Similarly, a Close-up toothpaste ad produced for Lever
Brothers is primarily emotional in nature: “Put your money where your mouthis.” However, it also has an economic aspect: “Use Close-up both as a toothpaste
and mouthwash.”
An example of how emotional appeal complemented by service created amarket niche for an unknown company is provided by Singapore Airlines.
Singapore is a Southeast Asian nation barely larger than Cleveland. Many airlines
have tried to sell the notion that they have something unique to offer, but not
many have succeeded. Singapore Airlines, however, thrives mainly on the charmof its cabin attendants, who serve passengers with warm smiles and copious
attention. A gently persuasive advertising campaign glamorizes the attendants
and tries to convey the idea of in-flight pleasure of a lyrical quality. Most of theairline’s ads are essentially large, soft-focus color photographs of various attendants. A commercial announces: “Singapore girl, you look so good I want to stayup here with you forever.” Of course, its emotional appeals are duly supported
by excellent service (rational appeals to complement emotional ones). The airline
provides gifts, free cocktails, and free French wines and brandy even to economyclass passengers. Small wonder that it flies with an above-average load factor
higher than that of any other major international carrier. In brief, emotional
appeal can go a long way in the development of an effective ad campaign, but it
must have rational underpinnings to support it.
Comparison Advertising. Comparison advertising refers to the comparisonof one brand with one or more competitive brands by explicitly naming them ona variety of specific product or service attributes. Comparison advertising became
popular in the early 1970s; today one finds comparison ads for all forms of goods
and services. Although it is debatable whether comparative ads are more or lesseffective than individual ads, limited research on the subject indicates that insome cases comparative ads are more useful.
Many companies have successfully used comparison advertising. One thatstands out is Helene Curtis Industries. The company used comparison ads on
television for its Suave brand of shampoo. The ads said: “We do what theirs does
for less than half the price.” Competitors were either named or their labels wereclearly shown. The message that Suave is comparable to top-ranking shampoos
was designed to allay public suspicion that low-priced merchandise is somehow
shoddy. The campaign was so successful that within a few years Suave’s sales

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surpassed those of both Procter & Gamble’s Head & Shoulders and Johnson &Johnson’s Baby Shampoo in volume. The company continues to use the same
approach in its advertising today. Comparison advertising clearly provides anunderdog with the chance to catch up with the leader.21
In using comparison advertising, a company should make sure that its claimof superiority will hold up in a court of law. More businesses today are counterattacking by suing when rivals mention their products in ads or promotions. For
example, MCI has sought to stop an AT&T ad campaign (aimed at MCI) thatclaims that AT&T’s long-distance and other services are better and cheaper.
It will be appropriate to mention here that in recent years, companies havecome up with alternative promotional approaches that bypass the use of traditional media.22 For example, in the United Kingdom, Nestle’s Buitoni brand grewthrough programs that taught the English how to cook Italian food. The Body
Shop gathered loyalty with its support of environmental and social causes.
Cadbury funded a theme park tied to its history in the chocolate business.
Haagen-Dazs opened posh ice-cream parlors and got itself featured by a name on
the menus of fine restaurants. Hugo Boss and Swatch backed athletic or cultural
events that became associated with their brands. At a time when promotionalcosts are rising and markets have fragmented, novel approaches for promoting
the product in the ever more competitive world could be rewarding.

PERSONAL SELLING STRATEGIES
Selling Strategy

There was a time when the problems of selling were simpler than they are today.
Recent years have produced a variety of changes in the selling strategies of businesses. The complexities involved in selling as we approach the next century are
different from those in the past. As an example, today a high-principled style ofselling that favors a close, trusting, long-term relationship over a quick sell is recommended. The philosophy is to serve the customer as a consultant, not as a peddler. Discussed below are objectives and strategic matters pertaining to selling
strategies.
Objectives. Selling objectives should be derived from overall marketing
objectives and should be properly linked with promotional objectives. For example, if the marketing goal is to raise the current 35 percent market share in a product line to 40 percent, the sales manager may stipulate the objective to increase
sales of specific products by different percentage points in various sales regions
under his or her control.
Selling objectives are usually defined in terms of sales volume. Objectives,
however, may also be defined for (a) gross margin targets, (b) maximum expenditure levels, and (c) fulfillment of specific activities, such as converting a statednumber of competitors’ customers into company customers.
The sales strategist should also specify the role of selling in terms of personalselling push (vis-à-vis advertising pull). Selling strategies depend on the consumer decision process, the influence of different communication alternatives,

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and the cost of these alternatives. The flexibility associated with personal selling
allows sales presentations to be tailored to individual customers. Further, personal selling offers an opportunity to develop a tangible personal rapport withcustomers that can go far toward building long-term relationships. Finally, personal selling is the only method that secures immediate feedback. Feedback helps
in taking timely corrective action and in avoiding mistakes. The benefits of personal selling, however, must be considered in relation to its costs. For example,
according to the research department of the McGraw-Hill Publications Company,
per call personal selling expenditures for all types of personal selling in 1994 came
to $205.40, up 15.4 percent from 1991.23 Thus, the high impact of personal sellingshould be considered in light of its high cost.
Strategic Matters. As a part of selling strategy, several strategic mattersshould be resolved. A decision must be made on whether greater emphasisshould be put on maintaining existing accounts or on converting customers.
Retention and conversion of customers are related to the time salespeople spend
with them. Thus, before salespeople can make the best use of their efforts, theymust know how much importance is to be attached to each of these two functions.
The decision is influenced by such factors as the growth status of the industry, thecompany’s strengths and weaknesses, competitors’ strengths, and marketing
goals. For example, a manufacturer of laundry detergent will think twice before
attempting to convert customers from Tide (Procter & Gamble’s brand) to its own
brand. On the other hand, some factors may make a company challenge theleader. For example, Bic Pen Corporation aggressively promotes its disposable
razor to Gillette customers. The decision to maintain or convert customers cannot
be made in isolation and must be considered in the context of total marketingstrategy.24
An important strategic concern is how to make productive use of the sales
force. In recent years, high expenses (i.e., cost of keeping a salesperson on theroad), affordable technological advances (e.g., prices of technology used in telemarketing, teleconferencing, and computerized sales have gone down substantially), and innovative sales techniques (e.g., video presentations) have made it
feasible for marketers to turn to electronic marketing to make the most productive
use of sales force resources. For example, Gould’s medical products division in
Oxnard, California, uses video to support sales efforts for one of its new products,
a disposable transducer that translates blood pressure into readable electronic
impulses. Gould produced two videotapes—a six-minute sales presentation and anine-minute training film—costing $200,000. Salespeople were equipped withvideorecorders—an additional $75,000 investment—to take on calls. According to
Gould executives, video gives a concise, clear version of the intended communication and adds professionalism to their sales effort. Gould targeted its competitors’ customers and maintains that it captured 45 percent of the $75 million
transducer market in less than a year. At the end of nine months, the company had
achieved sales of more than 25,000 units per month, achieving significant penetration in markets that it had not been able to get into before.25

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Another aspect of selling strategy deals with the question of who should becontacted in the customer organization. The buying process may be divided into
four phases: consideration, acceptance, selection, and evaluation. Different executives in the customer organization may exert influence on any of the four phases.
The sales strategist may work out a plan specifying which salesperson should callupon various individuals in the customer organization and when. On occasion, aperson other than the salesperson may be asked to call on a customer. Sometimes,
as a matter of selling strategy, a team of people may visit the customer. For example, Northrop Corporation, an aerospace contractor, assigns aircraft designers andtechnicians—not salespeople—to call on potential customers. When Singapore
indicated interest in Northrop’s F-5 fighter, Northrop dispatched a team to
Singapore that included an engineer, a lawyer, a pricing expert, a test pilot, and amaintenance specialist.
A manufacturer of vinyl acetate latex (used as a base for latex paint) built its
sales volume by having its people call on the “right people” in the customer organization. The manufacturer recognized that its product was used by the customer
to produce paint sold through its marketing department, not the purchasing
agent or the manager of research. So the manufacturer planned for its people tomeet with the customer’s sales and marketing personnel to find out what theirproblems were, what kept them from selling more latex paint, and what role the
manufacturer could play in helping the customer. It was only after the marketing
personnel had been sold on the product that the purchasing department was contacted. Thus, a good selling strategy requires a careful analysis of the situation todetermine the key people to contact in the customer organization. A routine callon a purchasing agent may not suffice.
The selling strategy should also determine the size of the sales force needed
to perform an effective job. This decision is usually made intuitively. A company
starts with a few salespeople, adding more as it gains experience. Some companies may go a step beyond the intuitive approach to determine how many salespeople should be recruited. For instance, consideration may be given to factors
such as the number of customers who must be visited, the amount of market
potential in a territory, and so on. But all these factors are weighed subjectively.
This work load approach requires the following steps:
1. Customers are grouped into size classes according to their annual sales volume.
2. Desirable call frequencies (number of sales calls on an account per year) areestablished for each class.
3. The number of accounts in each size class is multiplied by the corresponding callfrequency to arrive at the total work load for the country in sales calls per year.
4. The average number of calls a sales representative can make per year is determined.
5. The number of sales representatives needed is determined by dividing the total
annual calls required by the average annual calls made by a sales representative.

Sales Motivationand Supervision
Strategy

To ensure that salespersons perform to their utmost capacity, they must be motivated adequately and properly supervised. It has often been found that salespeople fail to do well because management fails to carry out its part of the job,

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especially in the areas of motivation and supervision. Although motivation andsupervision may appear to be mundane day-to-day matters, they have far-reaching implications for marketing strategy. The purpose of this section is to provide
insights into the strategic aspects of motivation and supervision.
Motivation. Salespeople may be motivated through financial and nonfinancial means. Financial motivation is provided by monetary compensation.
Nonfinancial motivation is usually tied in with evaluation programs.26
Compensation. Most people work to earn a living; their motivation to work is
deeply affected by the remuneration they receive. A well-designed compensation
plan keeps turnover low and helps to increase an employee’s productivity. A compensation plan should be simple, understandable, flexible (cognizant of the differences between individuals), and economically equitable. It should also provide
incentive and build morale. It should not penalize salespeople for conditions
beyond their control, and it should help develop new business, provide stable
income, and meet the objectives of the corporation. Above all, compensation
should be in line with the market price for salespeople. Because some of theserequisites may conflict with each other, there can be no one perfect plan. All thatcan be done is to try to balance each variable properly and design a custom-madeplan for each sales force.
Different methods of compensating salespeople are the salary plan, the commission plan, and the combination plan. Exhibit 17-3 shows the relative advantages and disadvantages of each plan.
The greatest virtue of the straight-salary method is the guaranteed income andsecurity that it provides. However, it fails to provide any incentive for the ambitious salesperson and therefore may adversely affect productivity. Most companies work on a combination plan, which means that salespeople receive apercentage of sales as a commission for exceeding periodic quotas. Conceptually,
the first step in designing a compensation plan is to define the objective. Objectives
may focus on rewarding extraordinary performance, providing security, and soon. Every company probably prefers to grant some security to its people and, atthe same time, distinguish top employees through incentive schemes. In designing
such a plan, the company may first determine the going salary rate for the type ofsales staff it is interested in hiring. The company should match the market rate toretain people of caliber. The total wage should be fixed somewhere near the market rate after making adjustments for the company’s overall wage policy, environment, and fringe benefits. A study of the spending habits of those in the salaryrange of salespeople should be made. Based on this study, the percentage of
nondiscretionary spending may be linked to an incentive income scheme whereby
extra income could be paid as a commission on sales, as a bonus, or both. Caremust be taken in constructing a compensation plan. In addition to being equitable,
the plan should be simple enough to be comprehensible to the salespeople.
Once compensation has been established for an individual, it is difficult to
reduce it. It is desirable, therefore, for management to consider all the pros andcons of fixed compensation for a salesperson before finalizing a salary agreement.

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EXHIBIT 17-3
Advantages and Disadvantages of Various Sales Compensation Alternatives
Salary Plan
Advantages
1. Assures a regular income.
2. Develops a high degree of loyalty.
3. Makes it simple to switch territories or quotas or to reassign salespeople.
4. Ensures that nonselling activities will be performed.
5. Facilitates administration.
6. Provides relatively fixed sales costs.
Disadvantages
1. Fails to give balanced sales mix because salespeople would concentrate on productswith greatest customer appeal.
2. Provides little, if any, financial incentive for the salesperson.
3. Offers few reasons for putting forth extra effort.
4. Favors salespeople who are the least productive.
5. Tends to increase direct selling costs over other types of plans.
6. Creates the possibility of salary compression where new trainees may earn almost as
much as experienced salespeople.
Commission Plan
Advantages
1. Pay relates directly to performance and results achieved.
2. System is easy to understand and compute.
3. Salespeople have the greatest possible incentive.
4. Unit sales costs are proportional to net sales.
5. Company’s selling investment is reduced.
Disadvantages
1. Emphasis is more likely to be on volume than on profits.
2. Little or no loyalty to the company is generated.
3. Wide variances in income between salespeople may occur.
4. Salespeople are encouraged to neglect nonselling duties.
5. Some salespeople may be tempted to “skim” their territories.
6. Service aspect of selling may be slighted.
7. Problems arise in cutting territories or shifting people or accounts.
8. Pay is often excessive in boom times and very low in recession periods.
9. Salespeople may sell themselves rather than the company and stress short-term
rather than long-term relationships.
10. Highly paid salespeople may be reluctant to move into supervisory or managerial
positions.
11. Excessive turnover of sales personnel occurs when business turns bad.

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EXHIBIT 17-3
Advantages and Disadvantages of Various Sales Compensation Alternatives (continued)
Combination Plan
Advantages
1. Offers participants the advantage of both salary and commission.
2. Provides greater range of earnings possibilities.
3. Gives salespeople greater security because of steady base income.
4. Makes possible a favorable ratio of selling expense to sales.
5. Compensates salespeople for all activities.
6. Allows a greater latitude of motivation possibilities so that goals and objectives canbe achieved on schedule
Disadvantages
1. Is often complex and difficult to understand.
2. Can, where low salary and high bonus or commission exist, develop a bonus thatis too high a percentage of earnings; when sales fall, salary is too low to retain
salespeople.
3. Is sometimes costly to administer.
4. Unless a decreasing commission rate for increasing sales volume exists, can result ina “windfall” of new accounts and a runaway of earnings.
5. Has a tendency to offer too many objectives at one time so that really important ones
can be neglected, forgotten, or overlooked.

Evaluation. Evaluation is the measurement of a salesperson’s contribution tocorporate goals. For any evaluation, one needs standards. Establishment of standards, however, is a difficult task, particularly when salespeople are asked to perform different types of jobs. In pure selling jobs, quotas can be set for minimal
performance, and salespeople achieving these quotas can be considered as doing
satisfactory work. Achievement of quotas can be classified as follows: salespeople
exceeding quotas between 1 to 15 percent may be designated as average; thosebetween 16 and 30 percent as well-performing; finally, those over 30 percent canbe considered extraordinary salespeople. Sales contests and awards, both financial and nonfinancial, may be instituted to give recognition to salespeople in various categories.
Supervision. Despite the best efforts in selecting, training, and compensating
salespeople, they may not perform as expected. Supervision is important toensure that salespeople provide the services expected of them. Supervision ofsalespeople is defined in a broader sense to include the assignment of a territory
to a salesperson, control over his or her activities, and communication with thesalesperson in the field.
Salespeople are assigned to different geographic territories. An assignment
requires solving two problems: (a) forming territories so that they are as much

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alike as possible in business potential and (b) assigning territories so that eachsalesperson is able to realize his or her full potential. Territories may be formedby analyzing customers’ locations and the potential business they represent.
Customers can be categorized as having high, average, or low potential. Further,probabilities in terms of sales can be assigned to indicate how much potential isrealizable. Thus, a territory with a large number of high-potential customers witha high probability of buying may be smaller in size (geographically) than a territory with a large number of low-potential customers with a low probability ofbuying.
Matching salespeople to territories should not be difficult once the territories
have been laid out. Regional preferences and the individual affiliations of salespeople require that employees be placed where they will be happiest. It may bedifficult to attract salespeople to some territories, whereas other places may be ingreat demand. Living in big metropolitan areas is expensive and not always comfortable. Similarly, people may avoid places with poor weather. It may become
necessary to provide extra compensation to salespeople assigned to unpopularplaces.
Although salespeople are their own bosses in the field, the manager must
keep informed of their activities. To achieve an adequate level of control, a system
must be created for maintaining communication with employees in the field, for
guiding their work, and for employing remedial methods if performance slackens. Firms use different types of control devices. Some companies require salespeople to fill in a call form that gives all particulars about each visit to eachcustomer. Some require salespeople to submit weekly reports on work performed
during the previous week. Salespeople may be asked to complete several forms
about sales generated, special problems they face, market information collected,
and so on. Using a good reporting system to control the sales force should have apositive influence on performance. In recent years, more and more companies
have begun to use computer-assisted techniques to maintain control of the activities of their sales forces.
Management communicates with salespeople through periodic mailings,
regional and national conferences, and telephone calls. Two areas of communication in which management needs to be extra careful to maintain the morale ofgood salespeople are (a) in representing the problems of the field force to people
at headquarters and (b) in giving patient consideration to the salesperson’s complaints. A sales manager serves as the link between the people in the field and thecompany and must try to bring their problems and difficulties to the attention of
top management. Top management, not being fully aware of operations in thefield, may fail to appreciate problems. It is, therefore, the duty of the sales manager to keep top management fully posted about field activities and to secure forsalespeople its favor. For example, a salesperson in a mountainous area may not
be able to maintain his or her work tempo during the winter because of weather
conditions. Management must consider this factor in reviewing the salesperson’swork. It is the manager’s duty to stand by and help with occupational or personal
problems bothering salespeople.

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Close rapport with salespeople and patient listening can be very helpful inrecognizing and solving sales force problems. More often than not, a salesperson’s problem is something that the company can take care of with a little effort
and expenditure if it is only willing to accept such responsibility. The primarything, however, is to know the salesperson’s mind. This is where the role of thesupervisor comes in. It is said that the sales manager should be as much a therapist in solving the problems of his or her salespeople as the latter should be inhandling customers’ problems.

SUMMARY

Promotion strategies are directed toward establishing communication with customers. Three types of promotion strategies may be distinguished. Advertisingstrategies are concerned with communication transmitted through the mass
media. Personal selling strategies refer to face-to-face interactions with the customer. All other forms of communication, such as sampling, demonstration, cents
off, contests, etc., are known as sales promotion strategies. Two main promotion
strategies were examined in this chapter: promotion-expenditure strategy, which
deals with the question of how much may be spent on overall promotion, andpromotion mix strategy, which specifies the roles that the three ingredients of promotion (i.e., advertising, personal selling, and sales promotion) play in promoting a product.
Discussed also were two advertising strategies. The first, media-selection
strategy, focuses on the choice of different media to launch an ad campaign. The
second, advertising-copy strategy, deals with the development of appropriate ad
copy to convey intended messages. Two personal selling strategies were examined: selling strategy and sales motivation and supervision strategy. Selling strategy emphasizes the approach that is adopted to interact with the customer (i.e.,
who may call on the customer, whom to call on in the customer organization,
when, and how frequently). Sales motivation and supervision strategy is concerned with the management of the sales force and refers to such issues as sales
compensation, nonfinancial incentives, territory formation, territory assignments,
control, and communication.

DISCUSSIONQUESTIONS

1. Outline promotion objectives for a packaged food product in an assumed market segment.
2. Develop a promotion-expenditure strategy for a household computer to bemarketed through a large retail chain.
3. Will promotion-expenditure strategy for a product in the growth stage of the
product life cycle be different from that for a product in the maturity stage?
Discuss.
4. How may a promotion budget be allocated among advertising, personal selling, and sales promotion? Can a simulation model be developed to figure out
an optimum promotion mix?
5. Is comparison advertising socially desirable? Comment.

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6. Should the media decision be made before or after the copy is first developed?
7. Which is more effective, an emotional appeal or a rational appeal? Are emotional appeals relevant for all consumer products?

NOTES

1 James B. Arndorfer, “Brewers Fight for Hispanic Market,” Advertising Age (8 June 1998):

40.
2 Richard Gibson, “Marketers’ Mantra: Reap More with Less,” The Wall Street Journal (22March 1991): B1.
3 “USIC Chem. Ads Start to Support Effort to Double Sales in 5 Years,” Industrial

Marketing (June 1986): 1–4.
4 Michael E. Porter, “Interbrand Choice: Media Mix and Market Performance,” American

Economic Review (6 May 1976): 190–203.
5 “Market Makers,” The Economist (14 March 1998): 67.
6 See Workbook for Estimating Your Advertising Budget (Boston: Cahners Publishing Co.,

1984).
7 Naras V. Eechambadi, “Does Advertising Work?” The McKinsey Quarterly 3 (1994):

117–129.
8 “Branding on the Net,” Business Week (9 November 1998): 76.

.

9 George Anders, “Internet Advertising , Just Like Its Medium, Is Pushing Boundaries,”

The Wall Street Journal (30 November 1998): A1
10 Caroling Cartellieri, Andrew J. Parsons, Varsha Rao, and Michael P. Zeisser, “The RealImpact of Internet Advertising,” The McKinsey Quarterly 3 (1997): 44-63.
11 E. S. Browning, “Perrier’s Vincent Plans Wave of Change as a Fresh Regime Displaces

the Old?” The Wall Street Journal (14 February 1991): B1.
12 “New Headline, Same Great Column,” Fortune (16 February 1998): 42.
13 “The Generation Gap in Point Form: Some Recent Reflections on the Vital Signs andValues of the Youth Market,” Marketing (U.K.) (14 February 1994): 21. Also see Jeanne
Whalen, “Market Trends: Retailers Aim Straight at Teens,” Advertising Age(5 September 1994): 1.
14 See Stratford P. Sherman, “When You Wish upon a Star,” Fortune (19 August 1985): 66.
15 See Carl I. Hoveland, Irving L. Janis, and Harold H. Kelley, Communication and
Persuasion (New Haven: Yale University Press, 1953): 225.
16 Thomas R. King, “Credibility Gap: More Consumers Find Celebrity Ads
Unpersuasive,” The Wall Street Journal (5 July 1985): B5.
17 Kenneth Labich, “Nike vs. Reebok,” Fortune (18 September 1995): 90.
18 Carl I. Hoveland, Arthur A. Lumsdaine, and Fred D. Sheffield, “The Effect ofPresenting ‘One Side’ versus ‘Both Sides’ in Changing Opinions on a Controversial
Subject,” in The Process and Effect of Mass Communication, ed. Wilbur Schramm(Urbana: University of Illinois Press, 1960): 274.
19 Based on information supplied by the Coca-Cola Company.
20 Hoveland, Janis, and Kelley, Communication and Persuasion, 57.
21 Joanne Lipman, “Amex Card Takes on Visa Over Olympics,” The Wall Street Journal(3 February 1992): B1.
23 “Average Cost Shatters $200 Mark for Industrial Sales Calls, but Moderation Seen in
1984 Hikes,” Marketing News (17 August 1997): 16. The study also showed that thelarger the sales force, the lower the cost. For instance, companies with fewer than 10
salespeople spent more than $290.70 per call; companies with more than 100 spent$147.10. This underscores the significance of the experience effect (see Chapter 12).

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24 Jaclyn Fireman, “The Death and Rebirth of the Salesman,” Fortune (25 July 1994): 80.
25 “Rebirth of a Salesman: Willy Loman Goes Electronic,” Business Week (27 February1984): 103.
26 Alan Farnham, “Mary Kay’s Lessons in Leadership,” Fortune (20 September 1993): 68.

APPENDIX

Perspectives on Promotion Strategies

I.
PromotionExpenditure
Strategy

Definition: Determination of the amount that a company may spend on its total
promotional effort, which includes advertising, personal selling, and sales promotion.
Objective: To allocate enough funds to each promotional task so that each is utilized to its fullest potential.
Requirements: (a) Adequate resources to finance the promotion expenditure. (b)Understanding of the products/services sales response. (c) Estimate ofthe duration of the advertising effect. (d) Understanding of each product/
market situation relative to different forms of promotion. (e) Understanding ofcompetitive response to promotion.
Expected Results: Allocation of sufficient funds to the promotional tasks to accomplish overall marketing objectives.

II.
Promotion Mix
Strategy

Definition: Determination of a judicious mix of different types of promotion.
Objective: To adequately blend the three types of promotion to complement eachother for a balanced promotional perspective.
Requirements: (a) Product factors: (i) nature of product, (ii) perceived risk, (iii)
durable versus nondurable, and (iv) typical purchase amount. (b) Market factors: (i) position in the life cycle, (ii) market share, (iii) industry concentration,(iv) intensity of competition, and (v) demand perspectives. (c) Customers factors: (i) household versus business customers, (ii) number of customers, and(iii) concentration of customers. (d) Budget factors: (i) financial resources of theorganization and (ii) traditional promotional perspectives. (e) Marketing mix
factors: (i) relative price/relative quality, (ii) distribution strategy, (iii) brandlife cycle, and (iv) geographic scope of the market. (f) Environmental factors.
Expected Results: The three types of promotion are assigned roles in a way thatprovides the best communication.

III.
Media-Selection
Strategy

Definition: Choosing the channels (newspapers, magazines, television, radio, outdoor advertising, transit advertising, and direct mail) through which messages
concerning a product/service are transmitted to the targets.
Objective: To move customers from unawareness of a product/service, to awareness, to comprehension, to conviction, to the buying action.

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Requirements: (a) Relate media-selection objectives to product/market objectives. (b) Media chosen should have a unique way of promoting the business.
(c) Media should be measure-minded not only in frequency, in timing, and inreaching the target audience but also in evaluating the quality of the audience. (d) Base media selection on factual not connotational grounds. (e)Media plan should be optimistic in that it takes advantage of the lessons
learned from experience. (f) Seek information on customer profiles and audience characteristics.
Expected Results: Customers are moved along the desired path of the purchaseprocess.
IV.
Advertising-Copy
Strategy

Definition: Designing the content of an advertisement.
Objective: To transmit a particular product/service message to a particular target.
Requirements: (a) Eliminate “noise” for a clear transmission of message. (b)Consider importance of (i) source credibility, (ii) balance of argument, (iii) message repetition, (iv) rational versus emotional appeals, (v) humor appeals, (vi)presentation of model’s eyes in pictorial ads, and (vii) comparison advertising.
Expected Results: The intended message is adequately transmitted to the target
audience.

V.
Selling Strategy

Definition: Moving customers to the purchase phase of the decision-making
process through the use of face-to-face contact.
Objective: Achievement of stated sales volume and gross margin targets and thefulfillment of specific activities.
Requirements: (a) The selling strategy should be derived from overall marketing
objectives and properly linked with promotional objectives. (b) Decision on
maintenance of existing accounts versus lining up new customers. (c) Decisionon who should be contacted in customer’s organization. (d) Determine optimal
size of sales force.
Expected Results: (a) Sales and profit targets are met at minimum expense. (b)Overall marketing goals are achieved.

VI.
Sales Motivationand Supervision
Strategy

Definition: Achieving superior sales force performance.
Objective: To ensure optimal performance of the sales force.
Requirements: (a) Motivation financial and nonfinancial. (b) Adequate compensation package. (c) Evaluation standards. (d) Appropriate territory assignment,
activity control, and communication.
Expected Results: Business objectives are met adequately at minimum expense.

CHAPTER EIGHTEEN

18

Global Market
Strategies
Competition in the U.S.
marketplace is nolonger national, butinternational. Americanbusinesses that adapt tochanging circumstancesand recognize opportunities will prosper;
those that do not willat best survive
temporarily.
PRESIDENT’S TASK FORCEON INTERNATIONALPRIVATE ENTERPRISEO

ne of the most significant developments in recent years has been the emergence of global markets. Today’s market provides not only a multiplicity ofgoods but goods from many places. It would not be surprising to discover thatyour shirt comes from Taiwan, your jeans from Mexico, and your shoes from Italy.
You may drive a Japanese car equipped with tires manufactured in France, withnuts and bolts produced in India, and with paint from a U.S. company. Gucci
bags, Sony Walkmans, and McDonald’s golden arches are seen on the streets ofTokyo, London, Paris, and New York. Thai goods wind up on U.S. grocery shelves
as Dole canned pineapple and on French farms as livestock feed. Millions of consumers worldwide want all the things that they have heard about, seen, or experienced via new communication technologies. Firms today are enmeshed inworld competition to serve these consumers, no matter where they live.
A number of broad forces have led to growing globalization of markets.1
These include
1. Growing similarity of countries—Because of growing commonality of infrastructure, distribution channels, and marketing approaches, more and more products
and brands are available everywhere. Similar buyer needs thus manifest themselves in different countries. Large retail chains, television advertising, and credit
cards are just a few examples of once-isolated phenomena that are rapidly
becoming universal.
2. Falling tariff barriers—Successive rounds of bilateral and multilateral agreements have lowered tariffs markedly since World War II. At the same time,
regional economic agreements, such as the European Union (EU), have facilitatedtrade relations.
3. Strategic role of technology—Technology is not only reshaping industries but
contributing toward market homogenization. For example, electronic innovations
have permitted the development of more compact, lighter products that are lesscostly to ship. Transportation costs themselves have fallen with the use of containerization and larger-capacity ships. Increasing ease of communication anddata transfer make it feasible to link operations in different countries. At the sametime, technology leads to an easy flow of information among buyers, making
them aware of new and quality products and thus creating demand for them.

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The impact of these forces on the globalization of markets may be illustrated
with reference to a few examples. Kids everywhere play Nintendo and stroll
along the streets to the sound of Sony Walkmans. The videocassette recorder market took off simultaneously in Japan, Europe, and the United States, but the mostextensive use of videocassette recorders today is probably in places like Riyadh
and Caracas. Shopping centers from Dusseldorf to Rio sell Gucci shoes, Yves St.
Laurent suits, and Gloria Vanderbilt jeans. Siemens and ITT telephones can befound almost everywhere in the world. The Mercedes-Benz and the Toyota
Corolla are as much objects of passion in Manila as in California.
Just about every gas turbine sold in the world has some GE technology orcomponent in it, and what country doesn’t need gas turbines? How many airlines around the world could survive without Boeing or Airbus? Third World
markets for high-voltage transmission equipment and diesel-electric locomotives are bigger than those in developed countries. And today’s new industries—
robotics, videodisks, fiber optics, satellite networks, high-technology plastics,
artificial diamonds—seem global from birth.
Briefly, these forces have homogenized worldwide markets, triggering opportunities for firms to seek business across national borders. For U.S. corporations,the real impetus to overseas expansion occurred after World War II. Attempting
to reconstruct war-torn economies, the U.S. government, through the MarshallPlan, provided financial assistance to European countries. As the postwar
American economy emerged as the strongest in the world, its economic assistanceprograms, in the absence of competition, stimulated extensive corporate development of international strategies. Since then, many new players, not only from
Europe but from Southeast Asia as well, have entered the arena to serve global
markets. Asian competitors have been particularly quick to exploit new international competitive conditions as well as cross-cutting technologies to leapfrog
well-established rivals.
Global markets offer unlimited opportunities. But competition in these markets is intense. To be globally successful, companies must learn to operate andcompete as if the world were one large market, ignoring superficial regional andnational differences. Corporations geared to this new reality can benefit fromenormous economies of scale in production, distribution, marketing, and management. By translating these benefits into reduced world prices, they can dislodge competitors who still operate under the perspectives of the 1980s.
Companies willing to change their perspectives and become global can attain sustainable competitive advantage.

IDENTIFYING TARGET MARKETSThe World Bank lists 132 countries. Different countries represent varying market
potential due to economic, cultural, and political contrasts. These contrasts meanthat a global marketer cannot select target customers randomly but must employ
workable criteria to choose countries where the company’s product/service has
the best opportunity for success.

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Major Markets

The most basic information needed to identify markets concerns population
because people, of course, constitute a market. The population of the world
reached an estimated 6.0 billion in 1998. According to the latest estimates from theUnited Nations, this total is expected to increase to 6.2 billion by the year 2000 andto almost 8.5 billion by 2025. Current world population is growing at about 1.7
percent per year. This is a slight decline from the peak rate of 1.9 percent, but theabsolute number of people being added to the world’s population each year isstill increasing. This figure is expected to peak at the turn of the century at about
90 million additional people per year.
Population growth rates vary significantly by region. Europe has the lowest
rate of population growth at only about 0.3 percent per year. Several European
countries, including Austria, Denmark, West Germany, Luxembourg andSweden, are experiencing declining populations. Growth rates are also below 1
percent per year in North America.
The regions with the highest population growth rates are Africa (3 percent
per year), Latin America (2 percent per year), and South Asia (1.9 percent peryear). China, the world’s most populous country, is growing at only about 1.2 percent per year. Even so, it means that China’s population increases by over 12 million people each year. The world’s second most populous country, India, is
growing at over 1.7 percent per year. India’s population is expected to grow from
970 million today to 1 billion by about 2003.
One striking aspect of population growth in developing countries is the rapid
rate of urbanization. The urban population is growing at less than 1 percent inEurope and in North America, but it is growing at almost 3.5 percent in the developing world. Today 15 of the 20 largest urban agglomerations are in the developing world. By the year 2000, 17 of the 20 will be in the developing world. The only
cities in the top 20 located in developed countries will be Tokyo, New York, and
Los Angeles. The world’s largest cities will be Mexico City (27 million) and Sao
Paulo (25 million).
The above information shows that the total market in Europe and North
America will not be increasing; the population of these two continents will not
add much to total market size. Of course, these populations are growing older, so
certain segments will increase in number. For example, the total population ofEurope will increase only 2.8 percent from 1990 to 2000, but the over-65 population in Europe will increase by 14 percent during the same period.
In the developing world, the increase in numbers does not necessarily mean
increased markets for U.S. business. The fastest-growing region in the world,
Africa, is also experiencing low or negative rates of economic growth per capita.
Many Latin American countries, Brazil in particular, are hampered by huge external debts that force them to try to limit imports while using their resources to generate foreign exchange for debt service. In most of these cases, the problem of
foreign debt will need to be solved before the growing populations in the developing world will translate into large markets for U.S. business.
Obviously, population figures alone provide little information about market
potential because people must have the means in terms of income to become

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viable customers. In Exhibit 18-1, population combined with per capita GNP provides an estimate of consuming capacity. An index of consuming capacity depicts
absolute, or aggregate, consumption, both in the entire world and in individual
economies. Consumption rates can be satisfied either domestically or throughimports.
The information in Exhibit 18-1 should be interpreted cautiously because it
makes no allowances for difference in the purchasing power among different
countries. Two conclusions are obvious, however: (a) aggregate consuming
capacity depends upon total population as well as per capital income; and (b)advanced countries dominate as potential customers.

EXHIBIT 18-1
Consuming Capacities of Selected Countries

Country
United StatesJapan
Germany
FranceUnited Kingdom
Italy
BrazilCanadaNetherlands
Australia
India
MexicoSwitzerland
Belgium
TurkeyThailandDenmarkSouth Africa
Argentina
IsraelPhilippinesPeru
New Zealand
EcuadorParaguay
UgandaPopulation *(millions)

Per Capita GNP †(Dollars)

Index of Consuming
Capacity ‡

263
125
82
58
59
57
159
30
16
18
929
92
7
10
61
58
5
42
35
6
69
24
4
12
5
19

26,98039,64027,51024,99018,70019,0203,640
19,38024,00018,720340
3,320
40,63024,7102,780
2,740
29,8903,160
2,767
15,9201,050
2,310
14,340
1,390
1,690
240

7,098,438
4,962,928
2,253,069
1,451,919
1,093,950
1,087,944
579,488573,648
372,000
338,832
315,996
304,776
284,410249,571
169,858
159,468
155,428
131,140
96,01587,56072,03054,97851,624
15,985
8,112
4,608* World Bank Report, 1997. Figures in millions.
† Statistical Abstract of the United States: 1997 (Washington, D.C.: U.S. Department of Commerce).
Figures in U.S. dollars.
‡ Per capita GNP (gross national product) multiplied by total population in billions.

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Although population and income variables provide a snapshot of the market
opportunity in a given country, a variety of other factors must be considered to
identify viable markets. These factors are urbanization, consumption patterns,
infrastructure, and overall industrialization. Taking these factors into account,
Business International has identified twelve countries as major global markets (seeExhibit 18-2).2 Interestingly, three of these twelve countries—China, Brazil, andIndia—are developing countries.
Although these twelve countries have been identified as the principal global
markets by Business International, they may not all be viable markets from the viewpoint of U.S. firms. A variety of environmental factors (political, legal, cultural)

EXHIBIT 18-2
Size, Growth, and Intensity of World’s 12 Largest Markets

Major Markets
United States
China
Japan
India
Germany
RussiaFrance
Italy
United Kingdom
BrazilMexicoCanadaMarket Intensity(World = 1.00)

Cumulative
Market Size
Five-Year Market(% of World Market)
Growth (%)

1990

1995

1990

1995

1995

2.03
–0.81
1.74
–0.82
1.81
0.70
1.36
1.30
1.32
–0.10
–0.13
1.92

2.03
–0.70
1.89
–0.85
1.54
0.23
1.40
1.17
1.20
–0.09
0.09
1.73

18.79
10.08
8.47
6.12
4.33
7.06
3.28
3.28
3.05
2.69
1.60
2.07

18.41
12.30
8.27
6.35
4.54
4.06
3.17
2.86
2.75
2.70
2.01
1.99

5.88
37.03
3.80
12.68
14.10
–21.34
5.50
6.46
–1.39
11.09
82.18
14.77

Source: Crossborder Monitor (August 27 1997): 12.
Notes: Market Intensity measures the richness of the market, or the degree of concentrated purchasing power it represents. Taking the world’s market intensity as 1, the EIU has calculated the intensity of each country or region as it relates to this base. The intensity figure is derived from anaverage of per-capita ownership, production, and consumption indicators. Specifically, it is calculated by averaging per-capita figures for automobiles in use (double-weighted), telephones in use,
TVs in use, steel consumption, electricity production, private consumption expenditure (doubleweighted), and the percentage of population that is urban (double-weighted).
Market Size shows the relative dimension of each national or regional market as a percentage ofthe total world market. The percentages for each market are derived by averaging the corresponding data on total population (double-weighted), urban population, private consumption expenditure, steel consumption, electricity production, and ownership of telephones, passenger
automobiles, and televisions.
Market Growth is an average of cumulative growth in several key economic market indicators:
population, steel consumption, electricity production, and ownership of passenger automobiles, lorries, buses, and TVs.

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affect market opportunity in a nation. For example, Brazil is burdened with debt,
which limits the amount of export potential in that country; China’s political control limits freedom of choice; India’s regulations make it difficult for foreign corporations to conduct business there. Thus, many countries may not have large market
potential, yet they may constitute important markets for U.S. business.
Exhibit 18-3 lists the top 25 U.S. export markets. Also shown is the dollar
amount of exports to each country in 1997. It should be noted that, globally speaking, although Canada ranks as the 12th largest market in the world (see Exhibit18-2), it represents the single largest market for the United States, accounting forover one-fifth of its trade.
Emerging Markets

Traditionally, a major proportion of international business activities of U.S. corporations has been limited to developed countries. For example, at the end of
1997, total U.S. direct investment was estimated to be $794 billion, of which

EXHIBIT 18-3
Top 25 U.S. Markets: U.S. Domestic and Foreign Goods Exports, 1996 (F.a.s. Value)

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.

CanadaJapan
MexicoUnited Kingdom
South Korea
Germany
TaiwanSingapore
Netherlands
FranceHong Kong
Belgium-Luxembourg
BrazilAustralia
China
Italy
Malaysia
Switzerland
Saudi Arabia
ThailandPhilippines
IsraelSpain
Venezuela
Colombia

Source: Business America (March 1997): 27.

$ billions
133.7
67.5
56.8
30.9
26.6
23.5
18.4
16.7
16.6
14.4
14.0
12.8
12.7
12.0
12.0
8.8
8.5
8.4
7.3
7.2
6.1
6.0
5.5
4.7
4.7

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almost 70 percent was in developed countries. Slowly, however, new markets are
unfolding. Consider the newly industrializing countries. During the decade of the
1980s, South Korea, Singapore, Taiwan, and Hong Kong were the world’s fastestgrowing economies and consequently offered new opportunities for U.S. firms.
In recent years, even developing countries, at least the more politically stableones, have begun to show viable market potential. A number of developing countries are achieving higher and higher growth rates every year.3 Although an individual country may not provide adequate potential for U.S. corporations,developing countries as a group constitute a major market. In 1998, almost 30 percent of U.S. trade was with developing countries. In future years, the flow of U.S.
trade with developing countries should increase. An Organization of Economic
Cooperation and Development (OECD) study showed that, in 1970, OECD countries, with just 20 percent of the world’s people, had 83 percent of the world’s
trade in manufactures; whereas developing countries, with 70 percent of theworld’s people, captured just 11 percent of the trade. In the year 2000, however, it
is estimated that OECD countries, with 15 percent of the population, will have 63
percent of the world’s trade in manufactures; developing countries, with 78 percent of the population, will account for 28 percent of world trade.4 Interestingly,
although for cultural, political, and economic reasons, Western Europe, Canada,
and to a lesser extent Japan have always been predominantly important for business, many developing countries provide a better return on U.S. investment.5
The relevance of emerging markets for the United States can be illustrated
with reference to Pacific basin countries. Over the last quarter century, streams offood, fuels, textiles, cameras, cars, and videocassette recorders flowing fromcountries all across Asia exerted heavy pressure on Western economies. This outpouring of exports has increased the Asian/Pacific share of world trade from lessthan 10 percent in the 1970s to over 25 percent in 1997 and has pushed one Asian
economy after another out of the Dark Ages and into the global marketplace.
For U.S. marketers, rising Pacific power holds both a threat and a promise. The
threat is dramatically increased competition for sales and market share, both athome and abroad. In 1997 alone, Asian/Pacific countries supplied 40 percent of all
U.S. merchandise imports and contributed some $68 billion to the U.S. trade
deficit, 70 percent of the total. As for the promise, there is the emergence of a market of more than two billion potential consumers. In the last 25 years, as the Pacificregion began its time-bending leap into the twentieth century, millions of Asians
began an equally rapid transition from rural to urban, from agrarian to industrial,and from feudal to contemporary society. With more of the Pacific region’s rural
population traveling to cities to shop every day, the demand for goods and services—from the most basic household commodities to sophisticated technicaldevices—is soaring. Despite the recent currency problems, in the coming years, asrising incomes continue to bolster the spending power of Asia’s new consumer
population, the opportunities for shrewd marketers will be unparalleled.
Barriers to conducting business in the region are beginning to fall, too.
Increasingly, throughout the region English is the language of commerce, and an
allegiance to free market economics is widespread. And, as companies such as

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McDonald’s, General Foods, Unilever, and Coca-Cola have already discovered,from Penang to Taipei, this is a region where well-made and well-marketed products and services are witnessing increasing acceptance.
As modern influences exert greater pressure on traditional Asian cultures,
two trends with important implications for marketers are starting to take shape:• Although each Asian nation is culturally distinct, consumers throughout the
Pacific region are gradually sharing more of the same wants and needs. As Asianhomogenization progresses, sophisticated strategies and considerable economies
of scale in regional and global marketing and advertising will become increasingly relevant.
• Many Western marketers misinterpret the nature of current changes in the Pacificregion. Despite the Big Macs, the Levi’s, the Nikes, and all the other familiar trappings, Asia is not Westernizing—it’s modernizing. Asian consumers are buying
Western goods and services, not Western values and cultures.

Elsewhere in the East, India and China are two large markets that should provide unprecedented opportunities for U.S. corporations as we enter the next century, and as their economies become fully market oriented. A growing number ofU.S. consumer-goods companies have begun to make inroads in China. In
November 1987, Kentucky Fried Chicken Corp. opened the first Western fastfood restaurant in China. Coca-Cola and PepsiCo are aggressively expanding distribution. Kodak and other foreign film suppliers have attained a 70 percent shareof the color film market. Nescafé and Maxwell House are waging coffee combat
in a land of tea.6
A number of U.S. companies—PepsiCo, Timex, General Foods, Kellogg—
have entered India to serve its emerging middle class.7 Thus, the developing
countries provide new opportunities for U.S. corporations to expand businessoverseas: as their wealth grows, U.S. marketing possibilities expand.
It has been observed that early in the next century Latin American countries,
too, will emerge as modern, Northern-styled marketplaces with improved transportation systems, subsidized credit to native businesses, and marketing education programs. All of these changes should result in more efficient channels of
distribution, more local marketing support services, and fewer bottlenecks that
hamper exchanges. All of these indications point toward a variety of emerging
opportunities for U.S. corporations in Latin America.
For example, a few years ago, the Gillette Co., discovered that only eight percent of Mexican men who shave used shaving cream. Sensing an opportunity,
Gillette introduced plastic tubes of shaving cream in Guadalajara, Mexico, thatsold for half the price of its aerosol. In a year’s time, 13 percent of Guadalajaran
men began to use shaving cream. Gillette has been selling its new product,
Prestobarba (Spanish for “quick shave”), in the rest of Mexico, in Colombia, andin Brazil.8
These emerging markets in less-developed countries can help many U.S. corporations to counter the results of demographic changes in Western nations
examined above.9 As mentioned above, in most advanced nations of the world,

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birthrates are declining while population in the developing countries is growing.
This increasing population holds the future growth potential for U.S. business.
With the fall of the Berlin Wall and the lifting of the Iron Curtain, new opportunities await Western managers in Eastern Europe, previously a forbidden
region. In many ways, the opening of Eastern Europe could prove even more
important than the drive for a single market in Western Europe. Take, for example, Poland, Hungary, and Czechoslovakia. Their combined GNP is larger thanthat of China. These three countries also have relatively well-trained and reliable
workers who work for less than a quarter of what Western Europeans are paid.10
Giving them access to their developed neighbors’ markets and hefty injections ofWestern capital, they could become the tigers of Europe. As their economies grow,they should develop into viable markets for a variety of goods and services.
Developments in Eastern Europe will benefit American companies in two
ways. First, as Eastern Europe’s backward economies finally integrate into theglobal economy and take off, new market opportunities should emerge. Second,sales to Western Europe by U.S. firms, made even more dynamic by its expanding Eastern frontier, will increase. Just as markets in the 1980s were developed by
Reaganomics and Thatcherism, markets in the next century will be developed by
the shifting of the ideological plates that have separated the world’s geopoliticalland masses. Companies that aim for global market and remain competitive willbe the winners.
The Triad Market

From a global perspective, the United States, Canada, Japan, and Western Europe,
often referred to as triad countries, constitute the major market. Although elsewhere opportunities are emerging, in the foreseeable future these countries continue to be the leading markets. They account for approximately 14 percent of theworld’s population, but they represent over 70 percent of world gross product. As
such, these countries absorb a major proportion of capital and consumer products
and, thus, are the most advanced consuming societies in the world. Not only domost product innovations take place in these countries, but they also serve as theopinion leaders and mold the purchasing and consumption behavior of theremaining 86 percent of the world’s population.
For example, over 90 percent of the world’s computers are used by triad
countries. In the case of numerically controlled machine tools, almost 100 percent
are distributed in the triad market. The same pattern follows in consumer products. The triad accounts for 90 percent of the demand for electronic consumer
goods. What these statistics point to is that a company that ignores the market
potential of the triad does so at its own peril.
An interesting characteristic of the triad market is the universalization ofneeds. For example, not too long ago manufacturers of capital equipment produced machinery that reflected strong cultural distinctions. West Germanmachines reflected that nation’s penchant for craftsmanship; American equipment was often extravagant in its use of raw materials. But these distinctions havedisappeared. The best-selling factory machines have lost the “art” element thatonce distinguished them and have become both in appearance and in the level of

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skill that they require much more similar. The current revolution in productionengineering has brought about ever-increasing global standards of performance.
In an era when productivity improvements can quickly determine life or death ona global scale, companies cannot afford to indulge in a metallic piece of art thatwill last 30 years.
At the same time, consumer markets have become fairly homogeneous.
Ohmae notes that
Triad consumption patterns, which is both a cause and an effect of cultural patterns,
has its roots to a large extent in the educational system. As educational systems enable
more people to use technology, they tend to become more similar to each other. It
follows, therefore, that education leading to higher levels of technological achievement also tends to eradicate differences in lifestyles. Penetration of television, whichenables everyone possessing a television set to share sophisticated behavioral information instantaneously throughout the world, has also accelerated this trend. There
are, for example, 750 million consumers in all three parts of the Triad (Japan, theUnited States and Canada, the nations of Western Europe) with strikingly similarneeds and preferences. . . . A new generation worships the universal “now” gods—
ABBA, Levi’s and Arpege. . . . Youngsters in Denmark, West Germany, Japan, andCalifornia are all growing up with ketchup, jeans, and guitars. Their lifestyles, aspirations, and desires are so similar that you might call them “OECDites” or Triadians,
rather than by names denoting their national identity.11

There are many reasons for the similarities and commonalities in the triad’s
consumer demand and lifestyle patterns. First, the purchasing power of triad residents, as expressed in discretionary income per individual, is more than 10 times
greater than that of residents of developing countries. For example, television
penetration in triad countries is greater than 94 percent, whereas in newly industrialized countries it is 25 percent; for the developing countries, it is less than 10
percent. Second, their technological infrastructure is more advanced. For example, over 70 percent of triadian households have a telephone. This makes it feasible to use such products as facsimile, teletext, and digital data transmission/
processing equipment. Third, the educational level is much higher in triad
nations than in other parts of the world. Fourth, the number of physicians per
10,000 in triad countries, which creates demand for pharmaceuticals and medical
electronics, exceeds 30. Fifth, better infrastructure in the triad leads to opportunities not feasible in less-developed markets. For example, paved roads have maderapid penetration of radial tires and sports cars possible.

ENTRY STRATEGIESFour different modes of business offer a company entry into foreign markets: (a)exporting, (b) contractual agreement, (c) joint venture, and (d) manufacturing.
Exporting

A company may minimize the risk of dealing internationally by exporting domestically manufactured products either by minimal response to inquiries or by systematic development of demand in foreign markets. Exporting requires minimal

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capital and is easy to initiate. Exporting is also a good way to gain international
experience. A major part of overseas involvement among large U.S. firms isthrough export trade.
Contractual
Agreements

There are several types of contractual agreements:• Patent licensing agreements—These agreements are based on either a fixed-fee
or a royalty basis and include managerial training.
• Turnkey operations—These operations are based on a fixed-fee or cost-plus
arrangement and include plant construction, personnel training, and initial production runs.
• Coproduction agreements—These agreements are most common in socialist
countries, where plants are built and then paid for with part of the output.
• Management contracts—Currently widely used in the Middle East, these contracts require that a multinational corporation provide key personnel to operate a
foreign enterprise for a fee until local people acquire the ability to manage thebusiness independently. For example, Whittaker Corp. of Los Angeles operates
government-owned hospitals in several cities in Saudi Arabia.
• Licensing—Licensing works as a viable alternative in some contractual agreement
situations where risk of expropriation and resistance to foreign investments create
uncertainty. Licensing encompasses a variety of contractual agreements whereby amultinational marketer makes available intangible assets—such as patents, trade
secrets, know-how, trademarks, and company name—to foreign companies in
return for royalties or other forms of payment. Transfer of these assets usually isaccompanied by technical services to ensure proper use. Licensing, however, hassome advantages and disadvantages as summarized below.

Advantages of Licensing
1. Licensing requires little capital and serves as a quick and easy entry to foreign
markets.
2. In some countries, licensing is the only way to tap the market.
3. Licensing provides life extension for products in the maturity stage of theirlife cycles.
4. Licensing is a good alternative to foreign production and marketing in anenvironment where there is worldwide inflation, shortages of skilled labor,
increasing domestic and foreign governmental regulation and restriction, andtough international competition.
5. Licensing royalties are guaranteed and periodic, whereas shared income frominvestment fluctuates and is risky.
6. Domestically based firms can benefit from product development abroad without incurring research expense through technical feedback arrangements.
7. When exports no longer are profitable because of intense competition, licensing provides an alternative.
8. Licensing can overcome high transportation costs, which make some exports
noncompetitive in target markets.
9. Licensing is also immune to expropriation.
10. In some countries, manufacturers of military equipment or any productdeemed critical to the national interest (including communications equipment) may be compelled to enter licensing agreements.

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Disadvantages of Licensing
1. To attract licensees, a firm must possess distinctive technology, a trademark,and a company or brand name that is attractive to potential foreign users.
2. The licensor has no control over production and marketing by the licensee.
3. Licensing royalties are negligible compared with equity investment potential.
Royalty rates seldom exceed 5 percent of gross sales because of government
restrictions in the host country.
4. The licensee may lose interest in renewing the contract unless the licensor
holds interest through innovation and new technology.
5. There is a danger of creating competition in third, or even home, markets if
the licensee violates territorial agreements. Going to court in these situations
is expensive and time-consuming, and no international adjudicatory body
exists.

Joint Ventures

Joint venture represents a higher-risk alternative than exporting or contractual
agreements because it requires various levels of direct investment. A joint venture
between a U.S. firm and a native operation abroad involves sharing risks toaccomplish mutual enterprise. Once a firm moves beyond the exporting stage,
joint ventures, incidentally, are the next most common form of entry. One example of a joint venture is General Motors Corporation’s partnership with Egypt’s
state-owned Nasar Car Company, a joint venture for the assembly of trucks anddiesel engines. Another example of a joint venture is between Matsushita of Japanand IBM, a joint venture established to manufacture small computers. Joint ventures normally are designed to take advantage of the strong functions of the partners and to supplement their weak functions, be they management, research, ormarketing.
Joint ventures provide a mutually beneficial arrangement for domestic andforeign businesses to join forces. For both parties, the venture is a means to sharecapital and risk and make use of each other’s technical strength. Japanese companies, for example, prefer entering into joint ventures with U.S. firms becausesuch arrangements help ensure against possible American trade barriers.
American firms, on the other hand, like the opportunity to enter a previously forbidden market, to utilize established channels, to link American product innovation with low-cost Japanese manufacturing technology, and to curb a potentiallytough competitor.
As a case in point, General Foods Corporation tried for more than a decadeto succeed in Japan on its own but watched the market share of its instant coffee(Maxwell House) drop from 20 to 14 percent. Then the firm established a joint
venture with Ajinomoto, a food manufacturer, to use the full power of
Ajinomoto’s product distribution system and personnel and managerial capabilities. Within two years, Maxwell House’s share of the Japanese instant coffee market recovered.12
Joint ventures, however, are not an unmixed blessing. The major problem inmanaging joint ventures stems from one cause: there is more than one partner andone of the partners must play a key dominant role to steer the business to success.

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Joint ventures should be designed to supplement each partner’s shortcomings, not to exploit each other’s strengths and weaknesses. It takes as much effort
to make a joint venture a success as to start a grass roots operation and eventually bring it up to a successful level. In both cases, each partner must be fully prepared to expend the effort necessary to understand customers, competitors, anditself. A joint venture is a means of resource appropriation and of easing a foreignbusiness’s entry into a new terrain. It should not be viewed as a handy vehicle toreap money without effort, interest, and/or additional resources.
Joint ventures are a wave of the future. There is hardly a Fortune 500 company active overseas that does not have at least one joint venture. Widespreadinterest in joint ventures is related to the following:
1. Seeing market opportunities—Companies in mature industries in the UnitedStates find joint venture a desirable entry mode to enter attractive new markets
overseas.
2. Dealing with rising economic nationalism—Host governments are often more
receptive to or require joint ventures.
3. Preempting raw materials—Countries with raw materials, such as petroleum or
extractable material, usually do not allow foreign firms to be active there otherthan through joint venture.
4. Sharing risk—Rather than taking the entire risk, a joint venture allows the risk to
be shared with a partner, which can be especially important in politically sensitive areas.
5. Developing an export base—In areas where economic blocs play a significant role,
joint venture with a local firm smooths the entry into the entire region, such as
entry into the European Union through a joint venture with an English company.
6. Selling technology—Selling technology to developing countries becomes easierthrough a joint venture.

Even a joint venture with a well-qualified majority foreign partner may provide significant advantages:
1. Participation in income and growth—The minority partner shares in the earnings and growth of the venture even if its own technology becomes obsolete.
2. Low cash requirements—Know-how and patents or both can be considered as
partial capital contribution.
3. Preferred treatment—Because it is locally controlled, the venture is treated withpreference by government.
4. Easier access to a market and to market information—A locally controlled firm
can seek market access and information much more easily than can a firm controlled by foreigners.
5. Less drain on managerial resources—The local partner takes care of most managerial responsibilities.
6. U.S. income tax deferral—Income to the U.S. minority partner is not subject to
U.S. taxation until distribution.13

Manufacturing

A multinational corporation may also establish itself in an overseas market bydirect investment in a manufacturing and/or assembly subsidiary. Because of thevolatility of worldwide economic, social, and political conditions, this form of

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involvement is most risky. An example of a direct investment situation is
Chesebrough-Pond’s operation of overseas manufacturing plants in Japan,
England, and Monte Carlo.
Manufacturing around the world is riskier, as illustrated by Union Carbide’s
disaster in Bhopal, India: in the worst industrial accident that has ever occurred, a poisonous gas leak killed over 2,000 people and permanently disabledthousands. It is suggested that multinational corporations should not manufacture overseas where the risk of a mishap may jeopardize the survival of the whole
company. As a matter of fact, in the wake of the Bhopal accident, many host countries tightened safety and environmental regulations. For example, Brazil, theworld’s fourth-largest user of agricultural chemicals, restricted the use of thedeadly methyl isocyanate.14
Conclusion

A firm interested in entering the international market must evaluate the risk andcommitment involved with each entry and choose the entry mode that best fits
the company’s objectives and resources. Entry risk and commitment can be examined by considering five factors:
1. Characteristics of the product.
2. The market’s external macroenvironment, particularly economic and political factors, and the demand and buying patterns of potential customers.
3. The firm’s competitive position, especially the product’s life-cycle stage, as wellas various corporate strengths and weaknesses.
4. Dynamic capital budgeting considerations, including resource costs and availabilities.
5. Internal corporate perceptions that affect corporate selection of information andthe psychic distance between a firm’s decision makers and its target customers aswell as control and risk-taking preferences.

These five factors combined indicate that risk should be reviewed vis-à-vis a
company’s resources before determining a mode of entry.
Computerized simulation models can be employed to determine the desired
entry route by simultaneously evaluating such factors as environmental opportunity, risk index, competitive risk index, corporate strength index, product channel
direction index, comparative cost index, and corporate policy and perception
index.

GLOBAL MARKET ENVIRONMENT
Not only are the risk factors underlying the mode of entry largely contingent on
the nature of the foreign environment, but these environmental forces also
influence the development of marketing strategies. Decision making for expansion into global markets is strategically similar to the decision-making process
guiding domestic marketing endeavors. More specifically, four marketing strategy variables—product, price, distribution, and promotion—need to be as systematically addressed in the context of international marketing as they are inGlobal Market Strategies

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formulating domestic marketing strategies. What is different about international marketing, however, is the environment in which marketing decisions
must be made and the influence that environment has in shaping marketingstrategies. The principal components of the international marketing environment include cultural, political, legal, commercial, and economic forces. Each ofthese forces represents informational inputs that must enter into the strategy
formulation process.
CultureCulture refers to learned behavior over time, passed on from generation to generation. This behavior manifests itself in the form of social structure, habits, faith,customs, rituals, and religion, each of which tends to affect individual lifestyles,
which in turn shape consumption patterns in the marketplace. Thus, what peopleof a particular country buy, why they buy, when they buy, where they buy, andhow they buy are largely culturally determined. There are five elements of culture:material culture, social institutions, man and universe, aesthetics, and language.
Each of these elements varies from country to country. The importance to marketers of understanding these often subtle variations has been illustrated by
Dichter:
In puritanical cultures it is customary to think of cleanliness as being next to godliness.
The body and its functions are covered up as much as possible.
But in Catholic and Latin countries, to fool too much with one’s body, tooverindulge in bathing or toiletries, has opposite meaning. Accordingly, an advertising approach based on puritanical principles, threatening Frenchmen that if they didn’t brush their teeth regularly, they would develop cavities or would not find a lover,failed to impress. To fit the accepted concept of morality, the French advertising
agency changed this approach to a permissive one.15

Similarly, language differences from one country to another could lead toproblems because literal translations of words often connote different meanings.
Two classic examples of marketing blunders include “Body by Fisher,” which
when literally translated into Flemish meant “Corpse by Fisher,” and “Let Hertz
Put You in the Driver’s Seat,” which when literally translated into Spanish meant“Let Hertz Make You a Chauffeur.”16 Even the choice of color for packaging andadvertising may influence marketing decisions. For example, in the United States,
white is equated with purity. In most Asian countries, however, white is associated with death in the same way that black is a symbol of mourning in American
culture. In short, culture could have and has had far-reaching effects on the success of overseas marketing strategies.
Politics

The laissez-faire era when governments had little if anything to do with the conduct of business is past history. Today, even in democratic societies, governments
exercise a pervasive influence on business decisions. In fact, it is not uncommon
to find that the governments of many overseas countries actually own and operate certain businesses. One example of a government-owned and governmentoperated business is Air France, the French airline company.

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Although the degree of intervention varies across countries, developments indeveloping countries perhaps represent situations where government policies aremost extreme. Therefore, to be successful overseas, a global marketer should
determine the most favorable political climates and exploit those opportunities
first. Robinson suggests that the degree of political vulnerability in a given overseas market can be ascertained by researching certain key issues. Positive answers
to the following questions signal political troubles for a foreign marketer:
1. Is the supply of the product ever subject to important political debates? (sugar,salt, gasoline, public utilities, medicines, foodstuffs)
2. Do other industries depend upon the production of the product? (cement,
power, machine tools, construction machinery, steel)
3. Is the product considered socially or economically essential? (key drugs, laboratory equipment, medicines)
4. Is the product essential to agricultural industries? (farm tools and machinery,crops, fertilizers, seed)
5. Does the product affect national defense capabilities? (transportation industry,
communications)
6. Does the product require important components that would be available fromlocal sources and that otherwise would not be used as effectively? (labor, skill,materials)
7. Is there competition or is it likely from local manufacturers in the near future?
(small, low-investment manufacturing)
8. Does the product relate to channels of mass communication media? (newsprint,
radio equipment)
9. Is the product primarily a service?
10. Does the use of the product, or its design, rest upon some legal requirements?
11. Is the product potentially dangerous to the user? (explosives, drugs)
12. Does the product induce a net drain on scarce foreign exchange?17

Legal Aspects

Despite the best intentions, differences may reasonably arise between parties doing
business. What recourse exists for the resolution of differences and whose laws will
apply are of vital concern to global marketers. Although there is no simple solution
to such a complex problem, it is important that marketers anticipate areas where
disputes are likely to arise and establish beforehand agreements on the means to
use and which country will have jurisdiction in the resolution of differences. Legaldifficulties in marketing are most prevalent regarding the following issues:
1. Rules of competition abouta. collusion
b. discrimination against certain buyers
c. promotional methods
d. variable pricing
e. exclusive territory agreement.
2. Retail price maintenance laws.
3. Cancellation of distributor or wholesaler agreements.
4. Product quality laws and controls.
5. Packaging laws.

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6. Warranty and after-sales exposure.
7. Price controls and limitations on markups or markdowns.
8. Patents, trademarks, and copyright laws and practices.

Needless to say, the marketer in conjunction with legal counsel should probethese areas and establish with the buyer various contingencies prior to the making of commitments.
Commercial
Practices

An international marketer must be thoroughly familiar with the business customs
and practices in effect in overseas markets. Although some evidence suggests thatbusiness traditions in a country may undergo a change as a result of dealing withforeign corporations, such transformations are long-term processes. Thus, local
customs and practices must be researched and adhered to in order to gain theconfidence and support of local buyers, channel intermediaries, and other business operatives. The specific customs and practices of a country may be studied
with reference to the following factors:
Business Structure
Size
Ownership
Various business publics
Sources and level of authority
Top management decision making
Decentralized decision making
Committee decision making
Management Attitudes and Behavior
Personal background
Business status
Objectives and aspirations
Security and mobility
Personal life
Social acceptance
Advancement
Power
Patterns of Competition
Mode of Doing Business
Level of contact
Communications emphasis
Formality and tempo
Business ethics
Negotiation emphasis

Economic Climate

Only a small percentage of people in the world approach the standard of living
experienced in the United States and in other advanced industrialized countries.
The level of economic development in various countries can be explained and

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described through a number of measures. One common measure used to rank
nations economically is per capita GNP.
According to Rostow, the countries of the world can be grouped into the following stages of economic development: (a) the traditional, (b) the precondition
for takeoff, (c) the takeoff, (d) the drive to maturity, and (e) mass consumption.18
Most African, Asian, and Latin American countries would be categorized asunderdeveloped, having lower living standards and limited discretionary
income. The amount of work required to earn enough to purchase a productvaries greatly among different countries. For example, to buy one kilogram ofsugar, a person in the United States needs to work a little over five minutes; in
Greece it takes 53 minutes of labor to earn an equivalent amount. In many Africanand Asian countries, the effort needed to buy a kilogram of sugar and, for thatmatter, other similar products is even higher.

STRATEGY FOR GLOBAL MARKETING PROGRAMS
Two opposite viewpoints for developing global marketing strategy are commonly
expounded. According to one school of thought, marketing is an inherently local
problem. Due to cultural and other differences among countries, marketing programs should be tailor-made for each country. The opposing view treats marketing
as know-how that can be transferred from country to country. It has been argued
that the worldwide marketplace has become so homogenized that multinational
corporations can market standardized products and services all over the world
with identical strategies, thus lowering their costs and earning higher margins.
Localized Strategy

The proponents of localized marketing strategies support their viewpoint basedon four differences across countries:19 (a) buyer behavior characteristics, (b)socioeconomic condition, (c) marketing infrastructure, and (d) competitive environment. A review of the marketing literature shows how companies often experience difficulties in foreign markets because they did not fully understanddifferences in buyer behavior. For example, Campbell’s canned soups—mostly
vegetable and beef combinations packed in extra-large cans—did not catch on insoup-loving Brazil. A postmortem study showed that most Brazilian housewives
felt they were not fulfilling their roles if they served soup that they could not calltheir own. Brazilian housewives had no problems using dehydrated competitive
products, such as Knorr and Maggi, which they could use as soup starters andstill add their own ingredients and flair.20 Also, Johnson & Johnson’s baby powder did not sell well in Japan until its original package was changed to a flat box
with a powder puff. Japanese mothers feared that powder would fly around theirsmall homes and enter their spotlessly clean kitchens when sprinkled from a plastic bottle. Powder puffs allowed them to apply powder sparingly.21 Similarly,
advertisers have encountered difficulty when using colors in certain foreigncountries. For example, purple is a death color in Brazil, white is for funerals in
Hong Kong, and yellow signifies jealousy in Thailand. In Egypt the use of green,
which is the national color, is frowned upon for packaging.22

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Socioeconomic differences (i.e., per capita income, level of education, level of
unemployment) among countries also call for a localized approach toward international marketing. For example, limited economic means may prevent masses indeveloping countries from buying the variety of products that U.S. consumers
consider essential. To bring such products as automobiles and appliances within
the reach of the middle class in developing countries, for example, the products
must be appropriately modified to cut costs without reducing functional quality.
Differences in the character of local marketing infrastructure across countries
may suggest pursuing country-specific marketing strategies. The marketing
infrastructure consists of the institutions and functions necessary to create,develop, and service demand, including retailers, wholesalers, sales agents, warehousing, transportation, credit, media, and more. Consider the case of media.
Commercial television is not available in many countries. Sweden, for example,
lacks this element of the marketing infrastructure. In many countries, for example, Switzerland, commercials on television are allowed on a limited scale.
Suntory (a Japanese liquor company) considers the ban on advertising liquor on
U.S. television as a main deterrent for not entering the U.S. market in a big way.23
Similarly, the physical conditions of a country (i.e., climate, topography, andresources) may require localized strategies. In hot climates, as in the Middle East,
such products as cars and air conditioners must have additional features. Differences in telephone systems, road networks, postal practices, and the like may
require modifications in marketing practices. For example, mail-order retailing is
popular in the United States but is virtually nonexistent in Italy because of differences in its mail system.24
Finally, differences in the competitive environment among countries may
require following localized marketing strategies. Nestlé, for example, achieved
more than a 60 percent market share in the instant coffee market in Japan but lessthan 30 percent in the United States. Nestlé had to contend with two strong
domestic competitors in the United States, namely General Foods, which markets
Maxwell House and other brands, and more recently Procter & Gamble, whichmarkets Folgers and High Point. Nestlé faced relatively weak domestic competitors in Japan. IBM, which is the leading computer company in the world, slippedto third place in the Japanese market behind Fujitsu Ltd. and NEC Corporation interms of total revenue. Nestlé and IBM must reflect differences in their competitive environments in such marketing choices as pricing, sales force behavior, andadvertising.
Standardized
Strategy

In contrast to the view that marketing strategies must be localized, many scholars
and practitioners argue that significant benefits can be achieved through standardization of marketing strategies on a global basis. As a matter of fact, somepeople recommend an extreme strategy: offering identical products at identicalprices through identical distribution channels and supporting these identicalproducts by identical sales and promotional programs throughout the world.
Levitt asserts that “commercially, nothing confirms this as much as the success of
McDonald’s from the Champs Elysees to the Ginza, of Coca-Cola in Bahrain and

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Pepsi-Cola in Moscow, and of rock music, Greek salad, Hollywood movies,
Revlon cosmetics, Sony televisions, and Levi’s jeans everywhere.”25 Althoughacross-the-board standardization, as proposed by Levitt, may be difficult, it iscommonly accepted that the marketplace is becoming increasingly global, andindeed standardized strategies have been successfully pursued in many cases.
Among consumer durable goods, Mercedes-Benz sells its cars by following a universal marketing program. Among nondurable goods, Coca-Cola is ubiquitous.
Among industrial goods, Boeing jets are sold worldwide based on common marketing perspectives.
Past research shows that, other things being equal, companies usually opt forstandardization. A recent study on the subject lends support to the high propensity to standardize all or parts of marketing strategy in foreign markets. For example, an extremely high degree of standardization appears to exist in brand names,
physical characteristics of products, and packaging. More than half of the products that multinational corporations sell in less-developed countries originate in
the parent companies’ home markets. Of the 2,200 products sold by the 61 subsidiaries in the sample, 1,200 had originated in the United States or the United
Kingdom.26
The arguments in favor of standardization are realization of cost savings,
development of worldwide products, and achievement of better marketing performance. Standardization of products across national borders eliminates duplication of such costs as research and development, product design, and packaging.
Further, standardization permits realization of economies of scale. Also, standardization makes it feasible to achieve consistency in dealing with customers
and in product design. Consistency in product style—features, design, brand
name, packaging—should establish a common image of the product worldwide
and help increase overall sales. For example, a person accustomed to a particularbrand is likely to buy the same brand overseas if it is available. The global exposure that brands receive these days as a result of extensive world travel and mass
media requires the consistency that is feasible through standardization. Finally,
standardization may be urged on the grounds that a product that has proved tobe successful in one country should do equally well in other countries that present more or less similar markets and similar competitive conditions.27
Conclusion

Although standardization offers benefits, too much attachment to standardization can be counterproductive. Marketing environments vary from country tocountry, and thus a standard product originally conceived and developed in the
United States may not really match the conditions in each and every market. In
other words, standardization can lead to substantial opportunity loss.
Pond’s cold cream, Coca-Cola, and Colgate toothpaste have been cited as
evidence that a universal product and marketing strategy for consumer goods canwin worldwide success. However, the applicability of a universal approach forconsumer goods appears to be limited to products that have certain characteristics, among them universal brand name recognition (generally earned by hugefinancial outlays), minimal product knowledge requirements for consumer use,Global Market Strategies

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and product advertisements that demand low information content. Clearly, CocaCola, Colgate toothpaste, McDonald’s, Levi’s jeans, and Pond’s cold cream display these traits. Thus, whereas a universal strategy can be effective for someconsumer products, it is clearly an exception rather than the general rule. Those
who argue that consumer products no longer require market tailoring due to theglobalization of markets brought about by today’s advanced technology are notalways correct.
A multinational corporation that intends to launch a new product into a foreign market should consider the nature of its products, its organizational capabilities, and the level of adaptation required to accommodate cultural differences
between the home and the host country. A multinational corporation should also
analyze such factors as market structures, competitors’ strategic orientations, andhost government demands.
The international marketplace is far more competitive today than in the 1980s
and most likely will remain so as we enter the next century. Thus, to enhance competitive advantage some sort of adaptation might provide a better match between
a product and local marketing conditions. Ohmae’s charges against Americancompanies for not adapting their products to Japanese needs are revealing:
Yet, American merchandisers push such products as oversize cars with left-wheel
drive, devices measuring in inches, appliances not adapted to lower voltage and frequencies, office equipment without kanji capabilities and clothes not cut to smaller
dimensions. Most Japanese like sweet oranges and sour cherries, not visa versa. Thatis because they compare imported oranges with domestic mikans (very sweet tangerines) and cherries with plums (somewhat tangy and sour).28

There are several patterns and various degrees of differentiation that firms
can adopt to do business on an international scale. The most common of these are
obligatory and discretionary product adaptation. An obligatory, or minimal,
product adaptation implies that a manufacturer is forced to introduce minorchanges or modifications in product design for either of two reasons. First, adaptation is mandatory in order to seek entry into particular foreign markets. Second,
adaptation is imposed on a firm by external environmental factors, including thespecial needs of a foreign market. In brief, obligatory adaptation is related tosafety regulations, trademark registration, quality standards, and media standards. An obligatory adaptation requires mostly physical changes in a product.
Discretionary, or voluntary, product adaptation reflects a sort of self-imposed
discipline and a deliberate move on the part of an exporter to build stable foreign
markets through a better alignment of product with market needs and/or cultural preferences.
Swiss-based pharmaceutical maker Ciba-Geigy’s efforts in adapting its products to local conditions are noteworthy. Basic to the company’s adaptation program are quality circles. These circles include local executives with line
responsibilities for packaging, labeling, advertising, and manufacturing. They are
responsible for determining (a) if Ciba-Geigy’s products are appropriate for thecultures in which they are sold and meet users’ needs, (b) if products are promoted

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in such a way that they can be used correctly for purposes intended, and (c) if,
when used properly, products present no unresponsible hazards to human healthand safety.29

MARKETING IN GLOBAL BUSINESS STRATEGYInternational marketing strategy is significant in formulating global businessstrategy in three different ways.30 First, what should be the global configuration ofmarketing activities? That is, where should such activities as new product development, advertising, sales promotion, channel selection, marketing research, etc.,
be performed? Second, how should global marketing activities performed in different countries be coordinated? Third, how should marketing activities be linked
with other activities of the firm? Each of these aspects is examined below.
Configuration ofMarketing
Activities

Marketing activities, unlike those in other functional areas of a business, must be
dispersed in each host country to make an adequate response to local environments. Although this configuration is valuable in being customer oriented, not all
marketing activities need to be performed on a dispersed basis. In many cases,
competitive advantage is gained in the form of lower cost or enhanced differentiation if selected activities are performed centrally as a result of technologicalchanges, buyer shifts, and evolution of marketing media. These activities comprise production of promotional materials, sales force, service support organization, training, and advertising.
The centralized production of advertisements, sales promotion materials, anduser manuals can lead to a variety of benefits. Economies of scale can be reapedin both development and production. For example, experienced art directors andproducers can be hired to create better ads at a greater speed or lower cost. The
use of centralized printing permits the latest technology to be adopted. On theother hand, excessive transportation costs and cultural differences among nations
may make the production of some materials (e.g., user manuals) impractical.
Sales force, at least for some businesses, can be centralized in one location.
Alternatively, highly skilled sales specialists can be stationed at the headquarters
or in a regional office to provide sales support in different countries.
Centralization of the sales force is most effective when the complexity of the selling task is very high and the products being sold are high-ticket items purchased
infrequently.
Like sales force, high-skilled service specialists can be located at world orregional headquarters. They can visit different subsidiaries to provide nonroutine
service. Along the same lines, service facilities (service center, repair shop) can beregionalized at a few locations, especially for complex jobs. Such centralization
should permit the use of state-of-the-art facilities and qualified service people,
resulting in better service at lower cost.
Training of marketing personnel can be effectively centralized and lead toeconomies of scale in production and delivery of training programs, faster accumulated learning (brought by people with varied experiences assembled in one

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place), and increased uniformity around the world in implementing marketing
programs. Training centralization, however, must be weighed against travel timeand cost.
Although cultural differences between nations require advertising to be tailored to each country, in many ways global advertising is gaining acceptance.
First, a company may select one ad agency to handle its global campaign, economizing in campaign development, seeking better coordination between the parent and subsidiaries, and facilitating a consistent advertising approachworldwide. For example, British Airways uses one agency worldwide. Second,
many companies advertise in the global media, for example, in The Economist, incertain trade magazines, or at international sports events seen by viewers aroundthe world, such as at U.S. Open tennis matches. Finally, many media (e.g., airport
billboards, and airline and hotel magazines) have a decidedly international reach.
For these reasons, centralization of advertising makes sense. Yet government
rules and regulations relative to advertising, distinct national habits, language
differences, and lack of media outlets may require dispersion of advertising todifferent countries.
International
Marketing
Coordination

International marketing activities dispersed in different countries should be properly coordinated to gain competitive advantage. Such coordination can beachieved in the following ways:
1. Performing marketing activities using similar methods across countries—This
form of coordination implies standardizing activities across nations. Some strategies, including brand name, product positioning, service standards, warranties,
and advertising theme, are easier to coordinate than are other marketing strategies. On the other hand, distribution, personal selling, sales training, pricing, andmedia selection are difficult to coordinate across nations.
2. Transferring marketing know-how and skills from country to country—For
example, a market entry strategy successfully tried in one country can be transferred and applied in another country. Likewise, customer and market information can be transferred for use by other subsidiaries. Such information may relate
to shifts in buyer purchasing patterns, recent trends in technology, lifestylechanges, successful new product or feature introductions, new promotion ideas,
and early market signals by competitors.
3. Sequencing of marketing programs across countries—For example, new products or new marketing practices may be introduced in various countries in aplanned sequence. In this way, programs developed by one subsidiary can beshared by others to their mutual advantage and, thus, should result in substantial
cost savings. To reap the benefits of sequencing, a company must create organizational mechanisms to manage the product line from a worldwide perspective andto overcome manager resistance to change in all participating countries.
4. Integrating the efforts of various marketing groups in different countries—
Perhaps the most common form of such integration is managing relationships
with important multinational customers, often called international account management. International account management systems are commonly used in service
firms. For example, Citibank handles some accounts on a worldwide basis. It has

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account officers responsible for coordinating services to its large corporate customers anywhere in the world.

Competitive advantage can result from international account management
systems in a variety of ways. They can lead to economies in the utilization of thesales force if duplication of selling effort is avoided. They can allow a company todifferentiate itself from its competitors by offering a single contact for international buyers. They can also leverage the skills of top salespersons by giving themmore influence over the entire relationship with major customers. Some of thepotential impediments to using international account management include
increased travel time, language barriers, and cultural differences in how businessis conducted. Dealing with a major customer through a single coordinator may
also heighten the customer’s awareness of its bargaining power.
Integration of effort across countries can lead to competitive advantage inother areas as well; for example, after-sale service. Some international companies
have come to realize that the availability of after-sale service is often as important as the product itself, especially when a multinational customer has operations in remote areas of the world or when the customer moves from country tocountry.
Marketing’s Linkage
to Nonmarketing
Activities

A global view of international marketing permits linking marketing functions to
upstream and support activities of the firm, which can lead to advantage in various ways. For example, marketing can unlock economies of scale and learningin production and/or research and development by (a) supporting the development of universal products by providing the information necessary todevelop a physical product design that can be sold worldwide; (b) creating
demand for more universal products even if historical demand has been for
more varied products in different countries; (c) identifying and penetrating segments in many countries to allow the sale of universal products; and (d) providing services and/or local accessories that effectively tailor the standard
physical product.

DEVELOPING GLOBAL MARKET STRATEGY: AN EXAMPLE
Decisions related to foreign market entry, expansion, and conversion as well as tophasing out of foreign markets call for systematic effort. Illustrated here is one
method of developing a global market strategy. The method consists of threephases:1. Appropriate national markets are selected by quickly screening the full range ofoptions without regard to any preconceived notions.
2. Specific strategic approaches are devised for each country or group of countries
based on the company’s specific product technologies.
3. Marketing plans for each country or group of countries are developed, reviewed,
revised, and incorporated into the overall corporate concept without regard toconventional wisdom or stereotypes.

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Phase 1: Selecting
National Markets

There are over 132 countries in the world; of these, the majority may appear topresent entry opportunities. Many countries go out of their way to attract foreign
investment by offering lures ranging from tax exemptions to low-paid, amply
skilled labor. These inducements, valid as they may be in individual cases, haverepeatedly led to hasty foreign market entry.
A good basis for selecting national markets is arrived at through a comparative analysis of different countries, with long-term economic environment having
the greatest weight. First, certain countries, because of their political situations(e.g., Libya under Qaddafi), should be considered unsuitable for market entry. It
might help to consult a political index that rates different countries for businessattractiveness. The final choice should be based on the company’s own assessment and risk preference. Further, markets that are either too small in terms of
population and per capita income or that are economically too weak should be
eliminated. For example, a number of countries with populations of less than
20 million and with annual per capita incomes below $2,000 are of little interest
to many companies because of limited demand potential.
The markets surviving this screening should then be assessed for strategic
attractiveness. A battery of criteria should be developed to fit the specific requirements of the corporation. Basically, the criteria should focus on the following fivefactors (industry/product characteristics may require slight modification):
1. Future demand and economic potential.
2. Distribution of purchasing power by population groups or market segments.
3. Country-specific technical product standards.
4. Spillover from the national market (e.g., the Andes Pact provides for low-duty
exports from Colombia to Peru).
5. Access to vital resources (qualified labor force, raw materials sources, suppliers).

There is no reason to expand the list because additional criteria are rarely significant enough to result in useful new insights. Rather, management should concentrate on developing truly meaningful and practical parameters for each of thefive criteria listed above so that the selection process does not become unnecessarily costly and the results are fully relevant to the company concerned. For
example, a German flooring manufacturer, selling principally to the building
industry, selected the following yardsticks:
1. Economic potential—New housing needs and GNP growth.
2. Wealth—Per capita income, per capita market size for institutional building or
private dwellings (the higher the per capita income, market volume, and share of
institutional buildings, the more attractive the market).
3. Technical product standards—Price level of similar products, for example, priceper square meter for floor coverings (the higher the price level, the more attractive the market tends to be for a technically advanced producer).
4. Spillover—Area in which the same building standards (especially fire safety
standards) apply (e.g., the U.S. National Electrical Manufacturers’ Association
standards are widely applicable in Latin America; British standards apply in most
Commonwealth countries).

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5. Resource availability—Annual production volume of PVC (an important raw
material for the company).

Through these criteria, the analysis of economic potential was based on two
factors: housing needs and economic base (see Exhibit 18-4). In specifying thesecriteria, the company deliberately confined itself to measures that (a) could readily be developed from existing sources of macroeconomic data, (b) would show
trends as well as current positions, and (c) matched the company’s particularcharacteristics as closely as possible.
Since German producers of floor covering employ a highly sophisticatedtechnology, it would have been senseless to give a high ranking to a country with
only rudimentary production technology in this particular facet. Companies inother industries, of course, would consider other factors—auto registrations per
1,000 population, percentage of households with telephones, density of household appliance installations, and the like.
The resulting values are rated for each criterion on a scale of one to five sothat, by weighting the criteria on a percentage basis, each country can be assigned
an index number indicating its overall attractiveness. In this particular case, theresult was that, out of the 49 countries surviving the initial screening, 16 were ultimately judged attractive enough on the basis of market potential, per capita market size, level of technical sophistication, prevailing regulations, and resource
availability to warrant serious attention.
Interestingly, the traditionally German-favored markets of Austria andBelgium emerged with low rankings from this strategically based assessment
because the level of potential demand was judged to be insufficient. Some newmarkets, Egypt and Pakistan, for example, were also downgraded because of
inadequate economic base. Likewise, even such high-potential markets as Italy
and Indonesia were eliminated for objective reasons (in the latter case, the low
technical standard of most products).
Phase 2:
Determining
Marketing Strategy

After a short list of attractive foreign markets has been compiled, the next step is
to group these countries according to their respective stages of economic development. Here the criterion of classification is not per capita income but the degreeof market penetration by the generic product in question. For example, the floor
covering manufacturer grouped countries into three categories—developing,takeoff, and mature—as defined by these factors (see Exhibit 18-5):
1. Accessibility of markets—Crucial for the choice between export and import production.
2. Local competitive situation—Crucial for the choice between independent construction, joint venture, and acquisition.
3. Customer structure—Crucial for sales and distribution strategy.
4. Re-import potential—Crucial for international product/market strategy.

The established development phases and their defining criteria must be very
closely geared to the company situation because it is these factors, not the apparent

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EXHIBIT 18-4
Assessing Country Economic Potential: The Case of a Building Industry Flooring Supplier

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EXHIBIT 18-5
Grouping Countries by Phase of Development

ExamplesPersons
per dwellingCountry
features

Nigeria, Zaire, Egypt

Pakistan, Indonesia, Mexico

Spain, UK

More than 6.5

4.0 to 6.5

Less than 4.0• Markets open to imports(local production has
inadequate capacities)• Few big customers; intermediaries have much influence• Good opportunities for reimport to industrializedcountries• Markets are tending to close toprotect local production• Small local suppliers cooperatewith international firms• Local export efforts supported

USA
Germany• Markets open or are opening forworld trade (own large-scale production facilities often dependent onexports)• Markets in most cases adequately
covered• Many customers in each segment

attractiveness of markets, that will make or break the company’s strategic thrust
into a given country.
This being the case, for each country or group of countries on the short list,
management should formulate a generic marketing strategy with respect toinvestment, risk, product, and pricing policies; that is, a unified strategic framework applicable to all the countries in each stage of development should be prepared. This step should yield a clear understanding of what the respective stagesof economic development of each country entail for the company’s marketingstrategies (see Exhibit 18-6).
Companies are too often inclined to regard “overseas” as a single market orat least to differentiate very little among individual overseas markets. Anothercommon error is the assumption that product or service concepts suited to aGlobal Market Strategies

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EXHIBIT 18-6
Developing Standard Strategies
Phase

Developing

Takeoff

MatureBasic Strategy

Test Market

Build Base

Expand/Round Off Operations

Pursue profitable individual projects and/or export
activities

Allocate substantial resourcesto establish leading positionin market

Allocate resources selectively
to develop market niches

Investment

Minimize (distribution andservices)

Invest to expand capacity(relatively long payback)Expand selectively in R&D,
production, and distribution(relatively short payback)

Risk

Avoid

AcceptLimit

Know-howtransfer (R&D)

Document know-how onreference projects

Use local know-how in• Product technology• Production engineering

Transfer know-how in special
product lines; acquire local
know-how to round off own
baseMarket shareobjective

Concentrate on key
projects; possibly build
position in profitable businesses with local support

Extend base with
• New products• New outlets• New applications

Expand/defend

Cost leadershipobjective

Minimum acceptable(especially reduction ofguarantee risks)

Economies of scale; reductionof fixed costs

Rationalize; optimize
resources

Product

Standard technology;
simple products

Aim for wide range;“innovator” role

Full product line in selectedareas; products of hightechnical quality

Price

Price high

Aim for price leadership (atboth ends)

Back stable market price level

Distribution

Use select local distributors (exclusive
distribution)

Use a large number of small
distributors (intensive
distribution)

Use company sales force(selective distribution)

Promotion

Selective advertising• With typical highprestige products• Aiming at decision
makersActive utilization of selective
marketing resources

Selected product advertising

Elements of Strategy

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543

highly developed consumer economy work as well in any foreign market. This israrely true: different markets demand different approaches.
Across-the-board strategic approaches typically result in ill-advised and inappropriate allocation of resources. In less-developed markets that could be perfectly
well served by a few distributors, companies have in some cases established production facilities that are doomed to permanent unprofitability. In markets alreadyat the takeoff point, companies have failed to build the necessary local plants andinstead have complained about declining exports only to finally abandon the field
to competitors. In markets already approaching saturation, companies have oftensought to impose domestic technical standards where adequate standards andknowledge already exist or have tried to operate like mini replicas of parent corporations, marketing too many product lines with too few salespeople. Again andagain, product line offerings are weighted toward either cheaper- or higher-quality products than the local market will accept. Clearly, the best insurance against
such errors is to select strategies appropriate to the country.
Phase 3:Developing
Marketing Plans

In developing detailed marketing plans, it is first necessary to determine which
product lines fit which local markets as well as the appropriate allocation of
resources. A rough analysis of potential international business, global sales, andprofit targets based on the estimates worked out in Phase 1 help in assigning product lines. A framework for resource allocation can then be mapped according torough comparative figures for investment quotas, management needs, and skilledlabor requirements. This framework should be supplemented by company-specific examples of standard marketing strategies for each group of countries.
Exhibit 18-7 illustrates the resource allocation process. Different product lines
are assigned to different country groups, and for each country category, different
strategic approaches—for example, support on large-scale products, establishment of local production facilities, cooperation with local manufacturers—are
specified.
The level of detail in this resource allocation decision framework depends ona number of factors: company history and philosophy, business policy objectives,
scope and variety of product lines, and the number of countries to be served.
Working within this decision framework, each product division should analyze
its own market in terms of size, growth, and competitive situations; assess its
profitability prospects, opportunities, and risks; and identify its own current
strategic position on the basis of market share, profit situation, and vulnerability
to local risks. Each product division is then in a position to develop country-specific marketing alternatives for servicing each national market. Top management’s role throughout is to coordinate marketing strategy development efforts
of various divisions and continually to monitor the strategic decision framework.
The three-phase approach illustrated above exhibits a number of advantages:• It allows management to set up, with a minimum of planning effort, a strategic
framework that gives clear priority to market selection decisions, thus making itmuch easier for divisions to work out effective product line strategies unhampered by the usual chicken-or-egg problem.

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PART 6 Marketing Strategies

EXHIBIT 18-7
A Specimen Framework for Resource Allocation• Division managers can foresee at a fairly early stage what reallocations of management, labor, and capital resources are needed and what adjustments may need
to be imposed from the top due to inadequate resources.
• The company’s future risk profile can be worked out in terms of resource commitment by country group and type of investment.
• The usual plethora of “exceptional” (and mostly opportunistic) product/market
situations is sharply reduced. Only the really unique opportunities pass throughthe filter; exceptions are no longer the rule.
• The dazzling-in-theory but unrealistic-in-practice concept of establishing production bases in low-wage countries, buying from the world’s lowest-cost sources,
and selling products wherever best prices can be had is replaced by a realistic
country-by-country market evaluation.

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545• Issues of organization, personnel assignment, and integration of overseas operations into corporate planning and control systems reach management’s attention
only after the fundamental strategic aspects of the company’s overseas involvement have been thoroughly prepared.

In brief, the three-phase approach enables management to profitably concentrate resources and attention on a handful of really attractive countries instead of
dissipating its efforts in vain attempts to serve the entire world.

SUMMARY

Internationalization of business has become a fact of life. Company after company
finds that decisions made elsewhere in the world have a deep impact on its business. Although many firms have long been engaged in foreign business ventures,the real impetus to overseas expansion came after World War II. The globalizationof business is accounted for by such forces as (a) growing similarity of countries(e.g., commonality of infrastructure and channels of distribution); (b) falling tariff barriers; and (c) technological developments that, for example, permit thedevelopment of compact, easy-to-ship products.
Traditionally, major U.S. business activities overseas have been concentrated
in developed countries. In recent years, developing countries have provided
additional opportunities for U.S. corporations, especially in more politically stable countries. Yet although an individual developing country may not provide
adequate potential for U.S. companies, developing countries as a group constitutea major market. The emerging markets in developing countries can help many
U.S. corporations counter the results of matured markets in Western nations.
A firm aspiring to enter the international market may choose among various
entry modes—exporting, contractual agreement, joint venture, or manufacturing.
Each entry mode provides different opportunities and risks. The differentiation of
global and domestic marketing largely revolves around the nature of environmental forces impinging on the formulation of strategy. International marketersmust be sensitive to the environmental influences operating in overseas markets.
The principal components of the international marketing environment include
cultural, political, legal, commercial, and economic forces. Each of these forces
represents informational inputs that must be factored into the decision-making
process.
An important question that global marketers need to answer is whether thesame product, price, distribution, and promotion approach is adequate in foreign
markets. In other words, a decision must be made about which is the more appropriate of two marketing strategies: localization or standardization. On the one
hand, environmental differences between nations suggest using localization. On
the other hand, there are potential gains to consider in standardizing market strategy. International marketers must examine all criteria in order to decide the extent
to which marketing perspectives should vary from country to country.
International marketing plays three important roles in global business strategy. These are configuration of marketing activities (i.e., where different marketing
activities should be performed), coordination (i.e., how international marketingGlobal Market Strategies

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PART 6 Marketing Strategies

activities dispersed in different countries should be coordinated), and the linkage
of international marketing with other functions of the business.
The chapter ended with a framework for designing global market strategy.
The framework consists of three steps: (a) selecting national markets, (b) determining marketing strategy, and (c) developing marketing plans.

DISCUSSIONQUESTIONS

NOTES

1. What forces are responsible for the globalization of markets?
2. How does culture affect international marketing decisions? Explain with
examples.
3. Given their low per capita income, why should companies be interested indeveloping countries?
4. What are the different modes of entry into the international market? What are
the relative advantages and disadvantages of each mode?
5. What are the advantages of international marketing strategy standardization?
6. Under what circumstances should marketing be adapted to local conditions?
7. What role does marketing play in global business strategy?

1 George S. Yip, “Global Strategy in a World of Nations?” Sloan Management Review (Fall1991): 29–39. Also see Thomas A. Stewart, “Welcome to the Revolution,” Fortune (13December 1993): 66.
2 Crossborder Monitor (27 August 1997): 12.
3 Jane Fraser and Jeremy Oppenheim, “What’s New About Globalization?” The McKinsey
Quarterly 2 (1997): 168-179.
4 “Leap Forward or Sink Back,” Development Forum (March 1982): 3.
5 The Global Century: A Source Book on U.S. Business and the Third World (Washington,
D.C.: National Cooperative Business Association, 1997).
6 “Laying Foundation for the Great Mall of China,” Business Week (25 January 1988): 68.
7 Subhash C. Jain, Market Evolution in Developing Countries: Unfolding of the Indian Market(Binghamton N.Y.: The Haworth Press, Inc., 1993).
8 David Wessel, “Gillette Keys Sales to Third World Tastes,” The Wall Street Journal (23January 1986): 35.
9 See Anthony J. O’Reilly, “Establishing Successful Joint Ventures in Developing Nations:
A CEO’s Perspective,” Columbia Journal of World Business (Spring 1988): 3–9.
10 Richard I. Kirkland, Jr., “Who Gains from the New Europe,” Fortune (18 December
1989): 83.
11 Kenichi Ohmae, Triad Power (New York: The Free Press, 1985): Chapter 4.
12 Ohmae, Triad Power, 116.
13 F. Kingston Berlew, “The Joint Venture: A Way into Foreign Markets,” Harvard Business
Review (July–August 1984): 48. Also see Farok Contractor, “A Generalized Theorem of
Joint-Venture and Licensing Negotiations,” Journal of International Business Studies(Summer 1985): 23–49.
14 “For Multinationals It Will Never Be the Same,” Business Week (24 December 1984): 57.
15 Ernest Dichter, “The World Customer,” Harvard Business Review (July–August 1962):
116.
16 David A. Ricks, Big Business Blunders (Homewood, IL: Dow Jones-Irwin, 1983): 83–85.

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17 Richard D. Robinson, “Background Concepts and Philosophy of International Businessfrom World War II to the Present,” Journal of International Business Studies(Spring–Summer 1981): 13–21.
18 Walt W. Rostow, The Stages of Economic Growth (London: Cambridge University Press,
1960): 10.
19 Subhash C. Jain, “Standardization of International Marketing Strategy,” Journal ofMarketing (January 1989): 70–79.
20 “Brazil: Campbell Soup Fails to Make It to the Table,” Business Week (21 October 1981):
66.
21 Louis Kraar, “Inside Japan’s ‘Open’ Market,” Fortune (5 October 1981): 122.
22 C. L. Lapp, “Marketing Goofs in International Trade,” The Diary of Alpha Kappa Psi(February 1983): 4.
23 Hirotaka Takeuchi and Michael E. Porter, “Three Roles of International Marketing in
Global Strategy,” in Competition in Global Industries, ed. Michael Porter (Boston:
Harvard Business School Press, 1986): 113.
24 Takeuchi and Porter, “Three Roles of International Marketing,” 114.
25 Ted Levitt, “The Globalization of Markets,” Harvard Business Review (May–June 1983):
92–102.
26 John S. Hill and Richard R. Still, “Adapting Products to LDC Tastes,” Harvard Business
Review (March–April 1984): 93–94.
27 William W. Lewis and Marvin Harris, “Why Globalization Must Prevail,” The
McKinsey Quarterly 2 (1992): 114–131.
28 Ohmae, Triad Power, 101–102. See also C.K. Prahalad and Kenneth Lieberthal, “The End
of Corporate Imperialism,” Harvard Business Review (July-August 1996): 68–79.
29 W. Chan Kim and R. A. Manborgue, “Cross-cultural Strategies,” Journal of Business
Strategy (Spring 1987): 30–31.
30 See Takeuchi and Porter, “Three Roles of International Marketing,” 111–146.

The Gillette Company (A)In the spring of 1986, Joseph A. Marino, vice president of marketing in Gillette’s shaving division,
was concerned about the future prospects of his
business. With sales of $2.4 billion, Gillette was theworld’s largest blade and razor manufacturer andclaimed a remarkable 62 percent share of the $700million U.S. shaving market.
Growth in razors and blades had been slowing
down, however, and competitors were putting a
few nicks in Gillette’s performance. Revenues had
increased just 3 percent over the previous three
years (i.e., 1982–85), and during 1985, profits hadrisen only 1 percent to $160 million. Gillette had to
produce a steady stream of new shaving products
just to hold its ground in the United States.
More disturbing was that cheap disposable
razors—unknown 12 years ago—now accounted
for more than half of U.S. sales. That figure has
been growing, and even though Gillette dominatedthe disposable market, cheaper razors meant lower
profits. For a company that received one-third of its
sales and two-thirds of its earnings from blades
and razors, that was bad news. Foreign business,
which accounted for about 57 percent of corporate
sales and 61 percent of profits, was a sore spot, too.
Although a weaker dollar was expected to boost
Gillette’s overseas earnings, a weaker dollar would
help Gillette only in the short term. Foreign razor
and blade markets were also mature.
RAZOR TECHNOLOGYEver since an ambitious inventor named King C.
Gillette introduced the first safety razor in 1903,
men have been accustomed to continual, extensively advertised advances from Gillette in the stateof the art of shaving. The company spends morethan $20 million a year on shaving research anddevelopment. With the aid of the latest scientific

19
CASE 11
instruments, a staff of 200 explores the fringes ofmetallurgical technology and biochemical research.
They subject the processes of beard growth andshaving to the most rigorous scrutiny.
Every day, some 10,000 men carefully record theresults of their shaves for Gillette on data processing cards, including the precise number of theirnicks and cuts. Five hundred of those men shave in
32 special in-plant cubicles under carefully controlled and monitored conditions, including observation by two-way mirrors and videotape cameras.
In certain cases, sheared whiskers are collected,
weighed, and measured. The results of the tests are
fed into a computer and processed by sophisticatedstatistical programs.
Gillette scientists know, for instance, that a
man’s beard grows an average of 15/1000 of aninch a day, or 51/2 inches a year; that it covers abouta third of a square foot of his face and contains
15,500 hairs; that shaving removes about 65 milligrams of whiskers daily, which amounts to apound of hair every 16 years; that during an average lifetime a man will spend 3,350 hours scraping
27½ feet of whiskers from his face.
Occasionally, other companies have obtained atechnological jump on Gillette. In the early 1960s, a
new longer-life stainless steel blade from Wilkinson
Sword of Great Britain temporarily stole a big shareof the market from Gillette’s carbon steel Super
Blue Blade. But Gillette, as it always does, soon
introduced its own longer-life version and recaptured much of the lost market.
To fully comprehend Gillette’s research anddevelopment inroads, one must visit its researchfacilities in South Boston. Displayed there are pictures taken through a field emission scanning electron microscope that can magnify objects 50,000
times. The photographs showed tiny sections—
1/10,000 of an inch—of the edges of razor bladesThis case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

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The Gillette Company (A)552

CASE 1 The Gillette Company (A)made by Gillette and some of its competitors. The
edges of the competitors’ blades looked rough andjagged. Although not exactly Iowa farmland, theedges of the Gillette blade resembled softly rolling
hills, like the Berkshires in Connecticut. The reason
for Gillette’s less formidable topography was the
new “microsmooth’’ process invented by Gillette,
whereby blades are given extra smooth edges byparticles of aluminum oxide energized by ultrasonic waves.

COMPETITION
Probably no company in this country has so thoroughly dominated one consumer market as long as
Gillette. A huge concern with $2.4 billion in annual
sales (1985 figure), it controls over 62 percent of theshaving market. Electric razors in their initial years
appeared to pose a big challenge to Gillette’s wetshaving products. But today, they are used by only
a quarter of all shavers, and most owners shavewith them only occasionally. As a matter of fact, due
to continual advances in wet shaving and the inability of electrics to deliver a comparably close shave,their use is slowly declining. Gillette’s few competitors, such as Schick (22 percent of the market),
American Safety Razor, and Wilkinson, have been
reduced mainly to manufacturing knockoff versionsof and refill blades for Gillette razors.
Just when its competitors adjusted to one shaving system, Gillette unleashed yet another advance.
In 1971 it was Trac II, a razor system that featured
two parallel blades mounted in a cartridge 60/1000
of an inch apart. Gillette said the idea arose from aphenomenon called hysteresis discovered by its
research and development people through slow
motion microphotography. When a razor blade
cuts through a whisker, the whisker is pulled
slightly out of the follicle. A second blade, arranged
in tandem, can thus take a second, closer slice off
the whisker before it retracts and can thus provide
a cleaner shave. In 1977, after research and development expenditures of over $8 million, Gillettemade another “quantum leap forward,’’ as thecompany termed it, with Atra, a razor featuring a
twin-blade cartridge that swivels during shaving
and thus follows the face’s contours. Gillette said
its tests showed that, whereas the twin Trac II
blades are in contact with the face an average of
only 77 percent of the time, the Atra can raise thefigure to 89 percent.
The $7.95 Atra razor is the apotheosis of Gillette
technology, engineering, and design. Weighing ahefty 11/2 ounces, it is a luxurious, elaborately
crafted machine with a thick, beautifully tooled
aluminum handle. Refill blades retail for 56 centseach. The Atra is available in expensive gift versions: one ($19.95) is goldplated with a rosewood
handle; another ($49.95) features a sterling silver
handle designed by Reed and Barton that resembles an antique table knife.
Recently, the company rolled out a new versionof Atra called Atra Plus, a razor with a lubricating
strip above the blade for smoother shaves.
A relatively recent entrant into the shaving business is the Bic Pen Corporation, maker of the familiar ballpoint pen. The company, which has $200
million in annual sales, is located in modest quarters in Milford, Connecticut. It does not haveanyone regularly assigned to explore the fringes ofshaving technology. It does not have a field emission scanning electron microscope. It does not do
any ultrasonic honing. It maintains only a small
shave-testing panel of about a hundred people who
do not fill out data processing cards. It does notknow and does not care how many hairs are in the
average man’s beard or how fast they grow.
The apotheosis of Bic technology, engineering,and design is the Bic Shaver. Weighing only a quarter of an ounce, it is a diminutive, characterless
object made of white plastic that looks like something used in hospitals. In fact, a version of it isused in hospitals. It has only one blade mounted ona short, hollow handle and sells for about 99 centsfor four or 25 cents each. When the blade wears out,
you throw the whole thing away. The Bic Shaver is
not available in gold or silver plate or aluminum oranything else but plastic. It does not come in gift
versions.

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The Gillette Company (A)CASE 1 The Gillette Company (A)Bic Pen Corporation, though, is selling 200 million shavers a year in the United States, nearly
twice as many as the number of Atra blades that
Gillette is selling. The Bic Shaver, in fact, is the mostserious challenge Gillette has faced since the earlydays of King Gillette.
Though Bic and Gillette came to purvey disposability from different perspectives, it was inevitablethat sooner or later they would clash. The first clash
between Gillette and Bic was in pens. Beginning in
the 1950s, the pen market rapidly became commoditized as inexpensive but high-quality ballpoints gained at the expense of high-priced,
high-status pens. When Bic’s throwaway “stick’’
pen began selling for 19 cents in the U.S. market in
1958, its major competitor was a 98-cent refillable
pen made by Paper Mate, which Gillette had
acquired in 1955. Paper Mate fought back with its
low-priced Write Brothers line of stick pens. But
Gillette’s mass market advertising and promotion
skills were no match for those of Baron Bich. Bic
now has 60 percent of the ballpoint market versus
Paper Mate’s 20 percent.
The next clash involved butane cigarette
lighters. Gillette initially went the cachet route withthe 1971 purchase of S.T. Dupont, a prestigious
French concern that produces luxury lighters selling for several hundred dollars. According to an ad,
500 separate steps and six months are required to
manufacture Dupont lighters. Bic and Gillette,though, recognized that the lighter market was ripe
for commoditization. By 1974, both were selling
disposable lighters for $1.49, which were later
reduced to 89 cents. These disposable lighters
quickly stole market share from status brands.
“Dupont lighters are in a class by themselves,and people are willing to pay a premium for them.’’
It was said that the click of a Dupont was so distinctive that, if you lit up in a restaurant, people
knew you were using a Dupont. Now you can buy
a disposable—a light at the end of a piece of plastic—for 89 cents. Why do people want a disposable
lighter? They’re utilitarian. They work. You canlose them and not care because you have no investment in them, no loyalty toward them.

553

Gillette has done only slightly better with disposable lighters than with disposable pens. Bic’s
lighter now has a 52 percent share of the market;
Gillette’s disposable Cricket has 30 percent. Bic’s
feel for the mass market, it should be noted, is notunerring. Its felt-tip Bic Banana pen, though lower
priced, has solidly been bested by Gillette’s Flair.
“In all honesty, the Banana just wasn’t a very good
product,’’ concedes a Bic marketing manager.
The shaving market is the most recent and most
crucial clash. Bic introduced its disposable shaverto Europe in 1975 and moved into Canada the following year. Aware that the United States would be
next, Gillette came out with its own blue plastic disposable called Good News!, which has a Trac II
twin-blade head, in 1976. Gillette, which knows a
lot more about selling shavers than lighters andpens, has been no pushover for Bic. Each company
now has about half of the disposable market.
Good News!, though, is really bad news for
Gillette. One must appreciate that the razor blade
business is a fixed-sum game: sales in this country
are relatively static at about two billion blades ayear. Since Gillette is the dominant manufacturer,
every new razor and blade it introduces in effectcannibalizes its older products. Atra takes businessaway from Trac II, which took business away fromdouble-edge blades. But Gillette has never bothered much about this because its new products areinvariably higher priced than its old products.
The problem is that Good News! sells for a lot
less than any of Gillette’s older products. Price isthe key to commodity competition, and to staycompetitive with the 25-cent Bic Shaver and withdisposables from a few other producers, Gillette
has had to sell Good News! for much less than theretail price of an Atra or Trac II cartridge. As many
Trac II and Atra users have figured out, although
you have to pay as much as 56 cents for a twinblade refill cartridge from Gillette, you can get precisely the same cartridge mounted on a plastic
handle for as little as 25 cents. Good News! not only
produces fewer revenues per blade sale for Gillettebut creates higher costs because Gillette must
supply a handle as well as a cartridge. Every time

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The Gillette Company (A)554

CASE 1 The Gillette Company (A)Good News! gains a couple of points of market
share, Gillette loses millions of dollars in sales andprofits.
CORPORATE CULTURE
To fully grasp the intensity of Bic Pen Corporation’schallenge, it is necessary to flash back briefly to theearly days of Bic and Gillette. The founders of the twocompanies were strong-willed men who single-mindedly pursued powerful and remarkably similar
visions. King Gillette’s vision came one morning in
1895 when he started shaving with his old straightedged razor. It was not only dull, he realized, but
beyond the help of his leather strop. To reestablish
its edge, it would have to be honed by the local
barber or cutler. At the time, Gillette was working
for a company that made a great deal of money
manufacturing bottle caps. The inventor of thebottle cap had often regaled Gillette with the bountiful proceeds derived from putting out an inexpensive item that people repeatedly use and throw
away. In a flash, as he looked at his spent straightedged razor, Gillette conceived of the idea of asafety razor with a disposable blade.
Less is known of the early vision of Marcel L.
Bich, the reclusive Italian-born businessman andyachtsman who founded Société Bic in Paris, which
controls the U.S.-based Bic Pen Corporation. But it
is said that, in the late 1940s, “Baron” Bich, as hecalls himself, hit upon the idea of a low-priced, reliable, disposable ballpoint pen. Existing ballpoints,
which not only were expensive and required refills,
frequently malfunctioned.
Gillette and Bich went on to make fortunes from
disposability. But over a period of time, the philosophies of their companies diverged. Particularly
after the death of King Gillette in 1932, his company sought to give its blades, and especially its
handsome razor handles, an aura of not only superior performance but class and cachet. Each newtechnological leap could thus be more easily
accompanied by a liberal leap in price and profit
margin. Gillette’s chief marketing strategy became
the promotion of new captive “systems,” or blade-handle combinations. Just as Kodak makes most ofits money not on its cameras but on its film, profits
in shaving are not in razor handles but in blades.
Yet if a man could become convinced to trade up toa new, more expensive handle, such as Atra, hewould then have to buy new, more expensive
blades designed to fit only that handle.
Gillette was never concerned about what its
people call “the low end of the market,” that is,cheap private label blades. If you put out a classproduct, Gillette believed, the major portion of thealways-status-seeking masses would buy it. Shaving
being serious business and the way one’s face
appears to other people all day being a matter ofsome importance, most men, Gillette knew, didn’t
want to skimp and settle for an ordinary shave
when, for a little more money, they could feel securethat they were getting the “best” shave from Gillette.
In recent years, as the vision of its founder
faded, Gillette conglomerated into nondisposability. It acquired other companies and began marketing such class durables as cameras and hi-fi
equipment. Durables, though, have never been as
profitable for Gillette as razors and blades. In 1985,
although the company’s shaving division produced only 33 percent of its sales, it yielded 67 percent of the year’s profits.
Baron Bich, whose first business venture wasmaking parts for pen makers in Paris, eschewed
class and pursued mass with a vengeance. He wastaken with the potential of what Bic people call“commoditization,” the devolution in recent yearsof certain expensive, high-status durables, including watches and cigarette lighters, into inexpensive, nonstatus, more or less disposable items.
Commoditization has several basic causes. One is a
shift in taste: different eras accord cachet to different products. More important is the technology ofmass production. An item often has status because
it is difficult and time-consuming to make andmust sell at a high price. But if production techniques are developed that allow the item to be
spewed out by automated assembly lines at a costof pennies with little if any loss in functional quality, its status and allure will abate. People will not

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The Gillette Company (A)CASE 1 The Gillette Company (A)feel embarrassed to buy and to be seen using thenew, cheap version of the item.
A final cause of commoditization is consumers’
growing resistance to what is called market “segmentation,” the proliferation of new brands, flavors, and other diverse variants of common
consumer goods. Although 35 years ago, according
to a Los Angeles Times article, a retailer could satisfy
88 percent of his or her customers by stocking only
five brands of cigarettes, now, to supply the same
percentage of smokers, 58 different cigarette brands
with a bewildering variety of lengths, filters, packages, flavors, and tar and nicotine contents must be
carried. Large conglomerate consumer goods firms
compete, not on the basis of who can sell for thelowest price, but on the basis of who can churn out
and most aggressively market the largest numberof new products.
Though all of this adds heavily to cost, consumers have generally been willing to pay premium prices for cosmetic differentiation. This
allows companies to recoup their extra costs and toearn extra profits. But now, according to a recent
Harvard Business Review study, consumers havebecome more price- and value-conscious and are
beginning to rebel. In growing numbers, they arerefusing to pay extra for individualized frills. They
are bypassing national brands in favor of heavily
discounted brandless products.
Baron Bich put a brand on his products. But tosell them as cheaply as possible and make themappeal to as many people as possible, he stripped
them of all traces of cachet, glamour, and nonfunctional frills. He reduced them to pure generic utility and simplicity. He made them commodities. His
marketing strategy was just as simple: high value ata low price. It was a strategy that would have won
the admiration of King C. Gillette.
PSYCHOLOGY OF SHAVING
The battle between Bic and Gillette is more than aconventional contest over which kind of razor
people want to use. It is a battle over one of themost enduring male rituals of daily American life.

555

Those of us who are old enough remember how
the ritual used to be conducted because many of us
watched it every morning. Like a chemist withmortar and pestle, our fathers would whip up arich lather by stirring their shaving brushes aroundin their large ceramic mugs. Like an orchestra conductor during a brisk allegro, they would strop
their gleaming straight-edge razors on long stripsof leather. Writer Richard Armour once recalled thescene: “I loved to watch him grimace and pull theskin taut with his fingers preparatory to a daring
swipe from cheekbone to chin. I held my breath
while he shaved his upper lip, coming perilously
close to his nose, and when he started his hazardous course along his jawbone, risking an ear
lobe. When he scraped around his Adam’s apple,
with a good chance of cutting his throat, I had toturn away until I thought the danger was past.”
Armour lamented that safety razors andaerosol lathers had taken the “skill, fun, anddanger” out of shaving. Though the audience, if
there is an audience, may be less apt, the morning
ritual continues to occupy a very special place inmost men’s lives. Face shaving is one of the few
remaining exclusively male prerogatives. It is adaily affirmation of masculinity. One study indicated that beard growth is actually stimulated by
the prospect of sexual relations. A survey by New
York psychologists reported that, although men
complain about the bother of shaving, 97 percentof the sample would not want to use a cream,
were one to be developed, that would permanently rid them of all facial hair. Gillette once
introduced a new razor that came in versions forheavy, regular, and light beards. Almost nobody
bought the light version because nobody wanted
to acknowledge lackluster beard production.
(Later Gillette brought out an adjustable razor thatenabled men with sparse whiskers to cope with
their insufficiency in private.)
The first shave remains a rite of passage into
manhood that is often celebrated with the gift of ahandsome new razor (or the handing down of avenerable old razor) and a demonstration of its use
from the father. Though shaving may now require

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The Gillette Company (A)556

CASE 1 The Gillette Company (A)less skill and involve less danger than it once did,most men still want the razor they use to reflect
their belief that shaving remains serious business.
They regard their razor as an important personaltool, a kind of extension of self, like an expensive
pen, cigarette lighter, attaché case, or golf club set.
Gillette has labored hard, with success, to maintainthe razor’s masculine look, heft, and feel as well as
its status as an item of personal identification
worthy of, for instance, a Christmas gift.
For over 80 years, Gillette’s perception of theshaving market and the psychology of shaving has
been unerring. Though its products formally have
only a 62 percent share, its technology and marketing philosophy have held sway over the entire
market.
Now, however, millions of men—about 12 million, to be more precise—are scraping their faces
with small, asexual, nondescript pieces of plastic
costing 25 cents, an act that would seem to be theultimate deromanticization, even negation, of theshaving ritual, thus relegating shaving to a pedestrian, trivial daily task.
NEW SEGMENTS
Good News! is a defensive product for Gillette.
Though distributing it widely, the company isspending negligible money advertising it. Gillette
knows, though, that it must do more than counterthe Bic threat. It must keep the whole disposable
market contained. That means, most immediately,
luring from disposables two chief categories ofusers: teenagers and women.
According to Marino, shaving is just not a highinterest category to a lot of kids in high school.
“They don’t have to have a Gillette razor or theirfather’s razor to prove they’re old enough to shave.
They don’t need life-style reflection in a razor. They
want a good shave, but they don’t want to pay a lotof money.” One might venture several explanationsfor kids’ indifference to the traditional aura of shaving. According to some people, there has been a
progressive emasculation of the American male.
Given this hypothesis, the unisex plastic disposable

is a predictable response. Another view is that boys
today are more secure in their sexual identities thanthe previous generation and thus don’t need theold symbols of masculinity.
Whatever the case, as far as Gillette is concerned,
use of disposables is an ephemeral adolescent affection. As kids grow up, Gillette expects that promotion, advertising, and sampling will convince themthat captive systems, such as Atra and Trac II, are abetter and more mature way to shave.
Women are a more complex problem. Despite
the fact that as many adult women shave as men,though much less often, Gillette and the other U.S.
razor manufacturers are so male oriented that until
quite recently they never sold a razor designed for
women. Women had no choice but to pay for such
masculine features as hefty metal handles. One
Gillette marketing man contends with a leer that“women seem to like a longer handle for some
unknown reason.” Yet already nearly 40 percent of
women who shave have switched to disposables.
Bic is now selling the Bic Lady Shaver, a slightly
modified version of its regular disposables.
Gillette, Schick, and other producers are trying tofind ways to entice women away from disposables
with feminine versions of their male products.
So far, Gillette’s contain-and-switch strategy has
not been very successful. In 1976, Gillette said disposables would never get more than 7 percent of
the market. Marino said at the time, “You know, we
considered it for trips and locker rooms, for the guy
who forgets his razor.” The disposable market,
though, soon soared past 7 percent, forcing Gillette
into continual upward revisions of its estimates. In
terms of units sold, disposables have now reached
50 percent of the market.
Bic is predicting that disposables will ultimately capture 60 percent of the market. Indeed,
Bic has been investing so much money advertising
its shaver—$15 million in 1985—that it lost $5 million on the product. Baron Bich is known for his
willingness to run a deficit promoting a product aslong as it keeps gaining market share. As evidence
that gains will continue, Bic people point to thehuge disposable market share in many European

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The Gillette Company (A)CASE 1 The Gillette Company (A)countries: 75 percent in Greece, 50 percent inAustria, 45 percent in Switzerland, 40 percent inFrance. According to Bic, mass products tend tofollow the population curve. If 40 percent of one
segment of the population uses disposables, eventually everybody will.
PRODUCT IMPROVEMENTS
When it got into a war in the old days, Gillette
could always win by unleashing its ultimate
weapon: superior technological strength. Shaving
technology, though, has come a long way since1903. Further innovations are not easy. It is awfully
hard to make the next dramatic improvement.
One potential leap would be a blade so toughthat you would not have to wash your face tosoften your beard. But few experts see such a blade
as technically feasible. Dry beard hair is extremely
abrasive and about as strong as copper wire of thesame thickness. Even though today’s blades are
made of very durable steel, their precision-honed
edges are quickly destroyed by dry whiskers.
Another potential improvement is a much
longer-lasting blade. Yet such an advance may not
be worth the effort. The only technology that matters now is that of assembly lines, which can reduce
manufacturing costs.
Whatever the likelihood of future quantum
leaps, the fact remains: despite the topographicaldifferences discernable by high-powered microscopes, today all brands of razor blades deliver an
extremely good shave. Gillette studies show thatover 93 percent of shavers rate the shaves they arereceiving as very good or excellent. Asked about
the quality of Schick’s blades, a Gillette executive
conceded that it is much the same as that of his
company’s blades. “They have the same steel, thesame coatings. Schick has copied us very well anddone a hell of a good job. I think our quality is moreconsistent, but as far as giving you a good shave,their blades are damn good.”
Gillette’s chief selling point against Bic is thealleged superiority of twin blades against a single
blade. But to what degree this advantage can be557

capitalized on is debatable. As a Bic executive putit, “We don’t really know what happens when two
blades shave the skin, but our tests show that alarge percentage of customers can’t tell the difference. I give Gillette a lot of credit for coming up
with the two-blade concept. It’s a magnificent marketing idea. Two blades are better than one. It has asurface sense of logic to it. But on a perceptual
level, which is the level most of us deal on, there
isn’t any difference.”
OPPORTUNITIES IN
THIRD WORLD MARKETS
Gillette discovered a while back that only 8 percent
of Mexican men who shave use shaving cream. The
rest soften their beards with soapy water or—
ouch!—plain water, neither of which Gillette sells.
Sensing an opportunity, Gillette introduced
plastic tubes of shaving cream that sold for half
the price of its aerosol in Guadalajara (Mexico) in
1985. After a year, 13 percent of Guadalajaran men
used shaving cream. Gillette is now planning tosell its new product, Prestobarba (Spanish for“quick shave”), in the rest of Mexico, Colombia,
and Brazil.
Tailoring its marketing to Third World budgets
and tastes—from packaging blades so they can besold one at a time to educating the unshaven about
the joys of a smooth face—has become an important part of Gillette’s growth strategy. The company
sells its pens, toiletries, toothbrushes, and otherproducts in developing countries. But despite
Gillette’s efforts to diversify, razor blades still produce one-third of the company’s revenue and twothirds of its pre-tax profit.
The market for blades in developed countries isstagnant. On the other hand, in the Third World avery high proportion of the population is under 15
years old. All those young men are going to be in
the shaving population in a very short time.
Few U.S. consumer-products companies thatcompete in the Third World have devoted as muchenergy or made as many inroads as Gillette, whichdraws more than half its sales from abroad. Since

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The Gillette Company (A)558

CASE 1 The Gillette Company (A)the company targeted the developing world in
1969, the proportion of its sales that come from
Latin America, Asia, Africa, and the Middle East
has doubled to 20 percent; dollar volume has risen
sevenfold.
Gillette has had a strong business in Latin
America since it began building plants there in the
1940s. Fidel Castro once told television interviewer
Barbara Walters that he grew a beard because hecouldn’t get Gillette blades while fighting in themountains.
The company’s push into Asia, Africa, and the
Middle East dates to 1969 when Gillette dropped apolicy of investing only where it could have 100
percent-owned subsidiaries. That year, it formed ajoint venture in Malaysia, which was threatening to
bar imports of Gillette products. The company has
added one foreign plant nearly every year in suchcountries as China, Egypt, Thailand, and India andis now looking at Pakistan, Nigeria, and Turkey.
The company always starts with a factory thatmakes double-edged blades—still popular in the
Third World—and, if all goes well, expands later
into production of pens, deodorants, shampoo, or
toothbrushes. Only a few ventures have gone sour:
a Yugoslav project never got off the ground andGillette had to sell its interest in Iran to its local
partners.
In a few markets, Gillette has developed products exclusively for the Third World. Low-cost
shaving cream is one. Another is Black Silk, a hairrelaxer developed for sale to blacks in South Africa
that is now being introduced in Kenya.
Gillette often sells familiar products in different
packages or smaller sizes. Because many Latin
American consumers cannot afford a seven-ouncebottle of Silkience shampoo, for instance, Gillettesells it in half-ounce plastic bubbles. In Brazil,
Gillette sells Right Guard deodorant in plastic
squeeze bottles instead of metal cans.
But the toughest task for Gillette is convincing
Third World men to shave. The company recently
began dispatching portable theaters to remote villages—Gillette calls them “mobile propaganda
units”—to show movies and commercials thatteach daily shaving. In South African andIndonesian versions, a bewildered bearded man
enters a locker room where clean-shaven friends
show him how to shave. In the Mexican one, ahandsome sheriff, tracking bandits who have kidnapped a woman, pauses on the trail to shave
every morning. The camera lingers as he snaps adouble-edged blade into his razor, lathers his face,and strokes it carefully. In the end, of course, thesmooth-faced sheriff gets the woman.
In other commercials, Gillette agents with anoversized shaving brush and a mug of shaving
cream lather up and shave a villager while others
watch. Plastic razors are then distributed free andblades, which of course must be bought, are left
with the local storekeeper.
Such campaigns may not win immediate converts, but in the long run, they should establish thecompany’s name in the market.
GILLETTE’S OTHER PRODUCTS
The outlook is even dimmer in toiletries, Gillette’s
second most important market. The company has
lost market share in each of its major product categories since 1981. Consider Right Guard, Gillette’s
leading brand. In 1970 it claimed 30 percent of the$1.2 billion deodorant business; now it gets a mere
7 percent. Right Guard’s positioning as a “family
deodorant” was undercut when rivals successfully
split the market into men’s and women’s products.
Gillette’s current $30 million advertising campaign,reasserting the brand as a man’s deodorant, hasn’t
stopped the slide.
Because of the limited prospects in blades andtoiletries, Gillette is searching for other opportunities in personal health care products. Given
Gillette’s track record and cautious nature, that
won’t be easy. Sales of writing and office products,
such as Paper Mate and Flair pens, peaked at $304
million in 1981. In 1985, profits fell 12 percent, to$10 million. The writing and office products division now accounts for 11 percent of company revenues but just 2 percent of earnings. In anotherrecent attempt to diversify, Gillette bought small

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The Gillette Company (A)CASE 1 The Gillette Company (A)stakes in a half-dozen tiny companies in suchdiverse fields as hearing aids, biotechnology, andpersonal computer software. But these “greenhouse projects” have yet to bloom.
Why hasn’t the company done better? Critics say
Gillette has become risk-averse, partly because of acivil service mentality among employees. Middle
management is considered weak because the company has a history of promoting people who’vebeen there the longest. That tendency has kept
Gillette from moving aggressively.
Gillette’s plan for creating a new line of branded
low-price personal care products is an example. For
18 months it has been testing a line of unisex toiletries under its Good News! label, which now
appears only on disposable razors. Gillette plans tosell 12 products, from shaving cream to shampoo,
all for the same price in nearly identical packages.
It hopes these “branded generics” will rack up $100
million in sales when available nationally.
Unfortunately, that date keeps being postponed.
Test marketing took six months longer thanplanned, and a national rollout was still more thana year off. Part of the delay resulted from a change
in advertising. Initial ads, which had a patriotic
theme, failed to emphasize quality and low price.
Gillette has also cut the wholesale price on thegenerics from $1.25 to $1.09.
A second new venture also had problems.
Gillette’s German subsidiary, Braun, introduced anelectric shaver in the United States. Backed by a relatively small $7 million budget, it started runningnational advertising in the fall of 1985. But successis not easy. Braun has been entering a declining U.S.
electric shaver market where rigid consumer loyalties have generated a phenomenal 90 percent
repurchase rate for market leaders Norelco andRemington.

GILLETTE’S STRATEGY
In the final analysis, Gillette’s strategy is to keep asmuch pressure as possible on Bic’s profits with thehope that its rival will be forced out of the razor

559

market. To increase that pressure, Gillette has been
putting the squeeze on Bic’s other businesses.
The competition between the Boston-based giant
and the French-owned upstart has begun to take on
the characteristics of a vicious street fight in which
price slashing is the main weapon and market
share the main prize. In terms of size, the match isuneven. Gillette weighs in at about $24 billion insales; Bic tips the scales at around $750 million,some $225 million of which comes from its
American offshoot, Bic Pen Corporation. Even so,
the smaller company has managed to cut up its
competitor, first with disposable ballpoint pens,then disposable lighters, and most recently withdisposable razors.
Take the seesaw battle over lighters. Gillette was
the first of the two companies to go after the U.S.
market. In 1972 it brought out its Cricket brand. By
the time Bic introduced its own lighter the following year, Gillette had cornered 40 percent of themarket. Demand was growing so rapidly, however,that at first Bic had no trouble gaining on Gillette.
But when supply began to catch up with demand,
Bic recognized it had a problem. Despite what it
claimed was a better product and despite its flashy“Flick My Bic” ad campaign, sales of the twolighters ran neck and neck.
At the time Bic had to decide what it wanted toachieve. As a company executive recalls: “We had
to decide whether we wanted to just sit back andenjoy substantial short-term profits or go aftermarket share.” Bic opted for market share and in
mid-1977 slashed the wholesale price of its lighterby 32 percent.
Gillette did not follow suit immediately, largely
because its per unit manufacturing costs werehigher than Bic’s and its management was reluctant
to accept such a low return. When Gillette finally
did retaliate with a price cut, Bic reduced its pricestill further and a ferocious price war ensued. By
the end of 1978, it was apparent that Bic’s “bigplay” was successful. Bic had taken over nearly 50
percent of the market; Gillette’s share had slumped
to 30 percent. Moreover, in 1978 Bic reported $9.2
million on pre-tax profits for its lighter division,

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The Gillette Company (A)560

CASE 1 The Gillette Company (A)while Gillette suffered an estimated loss of almost
the same amount.
In 1981, despite continuing losses, Gilletteturned the tables and started selling its Cricket
lighters at a 10 percent discount off the Bic price.
The counterattack hasn’t substantially hurt Bic’s
market share, but it has effectively limited profits
and thus the amount of money Bic can keep pouring into razors.

The big question is whether such pressure on
profits will force Bic to abandon the razor market
before Gillette’s own business is radically altered oreven irreparably harmed. According to one
observer, the competition between the rivals is nolonger just a matter of one pen or one lighter or one
razor against another. It is a war on all fronts.

20
CASE 2The Gillette Company (B)In April 1998, Gillette unveiled a revolutionary
advance in shaving: the Mach3. Gillette had
spent 15 years and $750 million in developing thisproduct. The Mach3 was the company’s biggest
and most important new product since Sensor, andthe company hoped it would have a similar effect.
Eight years ago, Gillette was losing its grip on the
razor market to cheap throwaways and facing thefourth in a succession of hostile takeover bids.
Sensor saved the company on both counts. Today,
Gillette is vastly stronger. Its market capitalization
jumped from $3 billion in 1986 to $66.1 billion in
1998, putting it among America’s 30 biggest companies. The company, however, was concerned
about the higher price tag of the Mach3 and theimpact it might have in its foreign markets.
Gillette’s future might not exactly be on a razor’s
edge—it had 71 percent of the North American andEuropean market for razors and blades. The company, whose consumer brands included Duracellbatteries, Oral-B toothbrushes and Parker andWaterman pens, was beloved by management consultants. However, investors had begun to fretabout slowing growth, lackluster sales and an
imminent change in top management. Growth had
slowed in the hugely profitable razors division,
partly because Schick, its smaller rival, hadrecently launched a new razor of its own. In
August 1997, the mildest of profit warnings wasenough to send the shares tumbling nearly 20 percent, although they had since recovered.
Gillette had an unusual approach to innovationin the consumer-products business. Most suchcompanies tweaked their offerings in response tocompetition or demand. Gillette launched a new
product only when it had made a genuine technical advance. To make the Mach3, Gillette hadfound a way to bond diamond-hard carbon to slivers of steel. Michael Hawley, the company’s chief

operating officer, boasted that it “will blow thedoors off other technology.”
Razors, however, were not the only products
where the company’s researchers beavered away atinnovation. Duracell Ultra, due to be launched in
May 1998, was an alkaline battery designed to last
50 percent longer than its rivals in devices thatneeded a lot of power, such as palmtop computersand personal CD-players. The company also
promised in late 1998 a “universally new, remarkable” toothbrush, which abandoned the usual practice of stapling the filaments through the brushhead.
At heart, Gillette liked to think of itself as a giant
research laboratory. It spent 2.2 percent of sales on
R&D, twice as much as the average consumerproducts company. “We manage ourselves like apharmaceutical company,” remarked Mr. Zeien,the chairman of the company. “The people working
on our toothbrushes are PhDs in polymer chemicals.” Like a drug company, Gillette had a productpipeline: the successor to the Mach3 was alreadybeing developed. It does better than the pharmaceutical industry on another measure: almost halfof its $ 10 billion sales in 1997 came from products
introduced in the past five years, more thanSmithKline Beecham or Johnson & Johnson could
boast. Mr. Zeien expected to maintain that, helpedby more than 20 big products launched in 1998
alone.
MARKETING STRATEGY
Gillette’s marketing strategy was equally unique.
The slower growth that scared Wall Street in 1997
was caused partly by Gillette’s decision to run
down stocks of its Sensor and Atra shavers ahead of
the week’s launch. While most rivals would consider this suicidal, Gillette used the strategy to ramp

This case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

561

563

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The Gillette Company (B)562

CASE 2 The Gillette Company (B)up prices of new products. Mach3 would sell foraround 35 percent more than SensorExcel, whichitself was 60 percent more expensive than Atra, itspredecessor. Duracell Ultra cost 20 percent morethan a conventional battery. Mr. Zeien insisted thatpremium prices did not matter: “People neverremember what they used to pay, but they do want
to feel they are getting value for money.” Perhaps,
but shavers might nick themselves at the thought ofpaying a hefty $1.60 a blade for the Mach3.
Gillette’s emphasis on refining the manufacturing process was much admired by managementgurus. Few companies were as good at combining
new products with new ways of making them. It
gave the company a huge advantage over the competition. Three-quarters of the $1 billion spent on
the Mach3 paid for 200 new pieces of dedicatedmachinery, designed in-house, which would chumout 600 blade cartridges a minute, tripling the current speed of production. This meant, according toGillette calculations, the investment would pay foritself within two years. The fact that the company
spent more on new production equipment than on
new products was one reason why Gillette regularly hit its target of reducing manufacturing costsby 4 percent a year.
Another difference between Gillette and mostother consumer-product companies was that it did
not tailor its products to local tastes. That gave it
vast economies of scale in manufacturing. Those
were mirrored on the distribution side, where it
usually broke into new markets with razors andthen pumped its batteries, pens, and toiletries
through the established sales channels. The impact

EXHIBIT A
Skinned Alive with Mach3 Gillette Company
Most men spend a few precious morning minutes reluctantly dragging a razor across their skin. Cuts and razor
bum are all part of the raw deal as they scrape their faces
up to 700 times per shave, chopping away 27 feet (8.2
meters) of hair over a lifetime. Scientists at Gillette’s“world shaving headquarters” in Boston had spent 15
years and $750m developing their latest response.
Unveiled in New York on April 8, 1998, in a presentation
worthy of a NASA space launch, complete with imagesof jet engines shattering sound barriers, the new razor
had a name to match: Mach3.
Such high-tech allusions were appropriate. The
Mach3 was covered by 35 patents, astonishing for something as commonplace as a razor. Its three springmounted blades were some 10 percent thinner at the tip
than the two blades of its predecessor, Sensor-Excel. They
were toughened with diamond-like carbon from thesemiconductor industry and this was bonded on to thesteel with niobium, a rare tin alloy normally used insuperconducting magnets. John Bush, vice-president ofGillette’s research and development, likened the reduced
drag to cutting down a tree with an ax rather than awedge. Since irritated skin was the shaver’s main complaint and most men blamed their razors rather thanthemselves for cuts and rashes, this looked like a genuine
improvement.
There was, boasted Gillette folk, another bonus: productivity. Each stroke with the new razor took off around40 percent more stubble than before. Imagine 40 million
working American males saving one minute a day thisway. That could add up to 7 million working days ayear—assuming they did not dawdle over breakfast
instead.
Of course, all this innovation came with a catch.
Gillette expected customers to pay almost $7 for a Mach3
with two spare blade cartridges—a 35 percent premium
to SensorExcel, currently the priciest razor on the market.
The company had a successful history of persuading
shoppers to trade up. However, it risked arousing thesame complaints as Microsoft, whose customers grumbled about the relentless cycle of software upgrades they
had to make. Shavers could slice through stubble just as
easily if they only soaked their chins in hot water for two
minutes first. That changes whiskers from inflexible
copper wire to the pliability of aluminum. The Mach3
offered a state-of-the-art shave, but for the cost-conscious
a hot shower and a plastic disposable might be just thething.

565

The Gillette Company (B)CASE 2 The Gillette Company (B)on margins was dramatic: the company’s operating
margin, currently a fat 23 percent was rising by apercentage point a year.
Gillette’s products obviously had global
appeal. In 1997, 70 percent of the company’s sales
were outside America. More than 1.2 billion
people now used at least one of its products every
day, compared with 800 million in 1990. The company had sliced into developing markets: it had 91
percent of the market for blades in Latin America
and 69 percent in India, measured by value. It
would love to shave China, too, but the trouble
there was the Chinese beard, or lack of it. “If they
shake their heads, they don’t need to shave,” commented a Gillette executive. Gillette might, therefore, rely on the Chinese passion for gadgets suchas pagers, and lead its push into that market with
Duracell.
FUTURE PERSPECTIVES
The biggest question concerning Gillette’s future
was not technical but human. Much of the company’s recent success must be put down to Mr.

563

Zeien. When he took over, Gillette’s name was on
everything from sunglasses to watches to calculators. He forced a focus on a few world-leading
products. However, he was now past normal retirement age, and had been persuaded to stay on theboard for another year with the lure of new stock
options. Investors worried about his heir-apparent,
Mr. Hawley, who was 60 and had a very different
management style. Compared with the clear-thinking, strategic Mr. Zeien, whose ability to communicate had been a hit on both Wall Street and in thecompany, Mr. Hawley came across rather as astrong operational manager.
Mr. Hawley acknowledged their different styles.
“Al is an architect first, then a builder; he has a newconcept, and then worries about how to make itwork. I would flip it for me. My experience has
been building and expanding. I see myself as a catalyst, helping to make something new from what
we have.”
But Gillette’s global sensibilities were ingrainedin the culture. This was not a cult of personality, but
the new shaving system, with so much invested init, had to prove a success.

C A S E 3 Dell Computer CorporationM

ichael Dell, founder, CEO, and chairman ofDell Computer, reflected with satisfaction on
the company’s first decade of achievement. By
1994, the company had topped $3.3 billion in sales
and its desktop computers had a significant shareof installations in large U.S. corporations. With
nearly 30 percent of its sales in 1994 derived fromoverseas business, Dell had broadened its international reach. However, with a close call in calendar
year 1993 when it had only $20 million in cash to
support its operations, Michael Dell concluded:“The only constant thing about our business is thateverything is changing. We have to take advantage
of change and not let it take advantage of us. We
have to be ahead of the game.” Dell had recently
added many luminaries to its board, the CEO of
Westinghouse and CFO of AMR Corporation.
Almost its entire top management team was new;and at the very top Michael Dell had hired, as vicechairman, Morton Topfer—the seasoned and experienced general manager of Motorola’s Two-Way
Radio sector and Paging Group.
Topfer was convinced that the computer industry
had too many players with too little direction. “Thequestion is not whether the industry will grow. It
certainly will. But there will only be a handful ofplayers with a coherent strategy and consistentbottom line, and we have to be one of them,” added
Topfer, whose systematic, by-the-numbers management style stood in stark contrast to the creative andrestless approach taken by Michael Dell. The 30year-old CEO of Dell knew that he would need all
the experience of his gray-haired vice chairman togrow the company to $10 billion or more by the year
2000. Most important, the strategy had to be fundamentally sound and profitable.

21

THE EVOLUTION OF THE PERSONALCOMPUTER MARKET
Until 1976, the microcomputer industry was highly
fragmented and characterized by low entry barriers
and the absence of any industry leader or standards. Ironically, the early spark was provided by
the rivalry between two electronics magazines. In
July 1974, Radio-Electronics promoted the Mark 8
machine, which was a printed circuit board with abook of simulations at a price of about $1,000. Over
one thousand units of Mark 8 were sold and thisprompted Popular Electronics to promote the Altair
computer. The MITS Altair, as it was called, wassold for $395 in kit form and $621 preassembled. All
this changed in 1977 with rapid technologicalimprovements in four areas.
First, Intel, Zilog, and Commodore launched 8bit microprocessors that offered significant
improvements over the previous generation ofIntel 8080 microprocessors. Second, with the development of a standard operating system, CP/M-80,
a wider variety of application software became
usable on the microcomputer. Third, Shugart
developed a 51/4” disk drive for data storage,
enabling microcomputers to move away fromcumbersome external cassette tape drives. Finally,
with rapid improvements in the cost per bit ofrandom access memory (RAM)1 and read-only
1 Memory for which the time of access is independent of thedata item required. All primary storage such as core or semiconductor memory are random access so that memory can beread from, or written to, in a random fashion.
2 A form of storage that can only be read from and not written to. Once information has been entered into this memory, it
can be read as often as required, but cannot be changed. CDROMs are a currently available example.

Professors Das Narayandas and V. Kasturi Rangan prepared this case as the basis for class discussion rather than to illustrateeither effective or ineffective handling of an administrative situation. Reprinted by permission of the Harvard Business School.
Harvard Business School Case 9-596-058, Rev. 9/25/96. Copyright © 1995 by the President and Fellows of Harvard College.

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Dell Computer Corporation

CASE 3 Dell Computer Corporation

memory (ROM),2 microcomputers could offer
computing power at an affordable cost. This was
critical for microcomputers to be able to run application software that was designed to support theneeds of the business users. Bv late 1977, vendors
were able to offer machines based on an 8-bit
microprocessor with 16k RAM, an 80-character
cathode ray terminal (CRT) with a keyboard, andBASIC software for $3000. The market had grown
to nearly 100,000 units.
While mail-order had been the dominant modeof distribution in the early stages, the rapidchanges in the market led to changes in distribution channels. By 1977, distribution was mainly
through electronic stores such as Radio Shack,computer retail stores such as ComputerLand, andsmaller independent specialty electronic stores.
The smaller specialty retailers had average sales of$500,000 and gross margins of 30 percent and net
margins of 10 percent before taxes. Users weremainly hobbyists and computer “hackers” whowere willing to travel to out-of-the-way locations
to buy from these specialty retailers. Electronicmagazines were the primary vehicle for advertisements, while exhibitions, trade shows, and clubs
served as forums for exchanging information on
developments in the industry.
Apple: The Early Leader
Starting in 1977, there were several waves ofentries by firms into the microcomputer market.
The first wave was between 1977 and 1978, withthe entry of Apple (a new venture), Tandy Radio
Shack, and Commodore—all entrepreneurial
firms. The second wave brought in giants like
Texas Instruments and Zenith. By 1980, there was asignificant growth in the business and professional
segments of the microcomputer market. Of theearly entrants, Apple was the clear technology
leader. It offered a unique operating system withan intuitive and easy Graphical User Interface(GUI) that enabled applications to be driven by asimple point-and-click menu system rather thantyping in commands. This ease of use attracted

565

many first-time users in the consumer market andmade Apple particularly strong in the educationaland hobbyist market.
IBM Enters
While in the past, firms such as IBM, HewlettPackard, and DEC had viewed the microcomputer
market as not being important to the business segment, the proliferation of software programs andthe increasing capabilities of microcomputers madeit a serious threat to these mainframe and minicomputer manufacturers. Even though the U.S.
personal computer market was only about $1 billion at that time (compared to mainframes at $7.6
billion and minicomputers at $2 billion), it was
growing rapidly at 30 percent annually comparedto the 3 percent and 13 percent for mainframes andminicomputers, respectively.
IBM entered the market in 1981. At that time, it
had revenues of $26 billion and an R&D budget of$1.5 billion. Other firms to enter around this time
were Xerox, Hewlett-Packard, DEC, Wang, andEuropean manufacturers such as ICL, Philips, andOlivetti, together with Japanese firms NEC,
Toshiba, and Fujitsu. In most cases, the main focus
was on the business segment of the market. All new
entrants were attempting to protect their existing
markets/installed base of computer users in thelower end of the business market segment.
In the first year of its launch, IBM PC had a 5 percent market share which increased to 22 percent
in 1982 and 42 percent in 1983. IBM’s strategy forthe personal computer market was a complete
departure from its traditional practice. It chose tooutsource supply of hardware and software components. Further, by adopting an “open architecture,”3
IBM encouraged third-party software houses tocarry the costs of associated software development.

3 Open architecture refers to a computer system in which all
the system specifications are made public so that other companies can be encouraged to develop add-on products such as
peripherals and other extensions for the system.

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CASE 3 Dell Computer Corporation

Also, by adopting a 16-bit architecture using theIntel 8086 chip, IBM offered software developers theopportunity for higher performance software to be
developed. In addition, by collaborating with
Microsoft, IBM introduced a new operating systemstandard, PC-DOS, that was available to all PC manufacturers. Apple, on the other hand, chose to keep
its operating system proprietary and thus was born
the world of two standards: IBM compatible andApple. Apple, which dominated the industry in thelate 1970s and early 1980s, found its market sharesteadily slipping to about 20 percent by 1983.
IBM sold to the large corporate customers and thesmall business users somewhat differently. For large
corporations, the company made use of bulk discounting in an effort to switch the purchasing fromindividuals spread all over the organization to centralized purchasing by corporate buyers, i.e., the MIS
managers. In doing so, IBM legitimized the personal
computer in the minds of data processing managers
in large corporations. For IBM, it made sense toemphasize this segment because it accounted forover 60 percent of the mainframe shipments in 1982.
By networking these PCs and linking up to theirmainframes, IBM could leverage its existing direct
sales and service organization (of nearly 2,500
people) to sell and support these systems. Further,
IBM was able to create a barrier to entry for competitors by creating a corporate customer mind-set
that was wary of non-IBM equipment.
For the small to medium business segments,
IBM was keen on maintaining its standards of service and support and hence the image of the firm.
However, its direct salesforce was too expensive toserve this segment. IBM, therefore, recruited retaildealers to stock, sell, and service the product. It
also launched a massive advertising program thatinvolved expenditures that were greater than the
promotion budgets of all other personal computer
manufacturers put together. Product availability
and variety brought new dealerships to themarket. An average computer store cracked the $1
million mark in sales. Gross profits of about 25
percent and net profits before taxes of about 8 percent were quite common.

The Coming of the IBM Compatibles
IBM’s concentrated efforts to make the PC a legitimate option in the minds of the corporate customers led to an explosion in the demand for IBM
PCs which the company could not satisfy. This
unmet demand led to the entry of new IBM PC
compatibles (or IBM clone manufacturers). One
such successful manufacturer was Compaq.
Compaq was founded in 1982. Unlike IBM, it
had never been in the computer business andtherefore had no salesforce of its own. To get tomarket, the company recruited retail dealers bypromising them full rein of the market, including
the large-volume corporate accounts.
For the next five years, Compaq witnessed substantial growth and profitability selling PCs
through independent, full-service computer specialty dealers all over the world. By 1987, Compaq
was recognized as an important player in the PC
business and its first attempt to establish a leadership position came in the same year. IBM
announced a new internal computer architecture(called MCA-Micro Channel Architecture) thatchanged the size and electrical configuration of theslots in a PC used for add-on boards. As a result,computers using MCA did not permit the use ofthird-party add-on boards such as modems or
expanded memory. In response to IBM’s movetoward a proprietary hardware configuration,eight PC manufacturers, under the leadership ofCompaq, announced the Extended Industry
Standard Architecture (EISA) that was compatible
with existing industry standards. This allowed
Compaq and the other manufacturers to deliver
systems that were fully compatible with the worldwide installed base of over 30 million PCs at thattime.
On the software front, with the availability of avariety of PCs, mostly IBM compatibles, software
writers found it even more lucrative to port theirapplications for MS-DOS, the operating system
written by Microsoft Corporation for the IBM
standard. This led to an explosion in application
software available in the IBM-PC/MS-DOS

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environment. This was also a period of strong
growth for retail chains like BusinessLand andComputerLand that topped over $100 million inrevenues. Compared to the early 1980s, retailgross margins had dropped to around 20 percent,but better managed retailers still continued toreturn a net of 5 percent after taxes. There wereclose to 5000 computer stores at that time, with
about half of them being significant players intheir market area. IBM, Apple, and Compaq were
the three most popular brands on their shelves.
While a variety of hardware and software
became available, end-users started to focus on
solutions for specific problems. Customers in vertical markets like banking, manufacturing, andretailing started to seek customized solutions
which were beyond the scope of retail dealers.
Value-added resellers (VARS) emerged to plug thisgap. Some were independent software writers
called ISVs; others actually integrated customized
software with hardware platforms and provided
training and support as well. Most of the larger
VARs (less than 1000 in number) were on-going
businesses that had traditionally provided support
for minicomputer applications and had moved into
the PC arena. At this stage, sensing the explosion inPCs, many others entered the business, resulting innearly 4000 VARs of all sizes available for verticalmarket distribution.
The Market Comes of Age
In 1980, the majority of computers sold were mainframe computers (about 75 percent of industry
volume), the rest were minicomputers. Within adecade this picture had changed. By 1990, theindustry was dominated by personal computers,
which accounted for about 40 percent of thevolume.
Over the course of a decade, personal computers
had zoomed from birth to a $40 billion industry in
the United States. This growth was fueled by dramatic breakthroughs in processing and storage
technologies. The cost of processing a million

567

instructions per second (MIPS) fell from $75,000 in1980 to $10,000 by 1985 and further down to $2,000
by 1991. Similarly, the costs of storing a megabyteof information slumped from about $250 in 1980 to$75 by 1991. With this breakneck growth came atremendous churning of the personal computerindustry. Literally, hundreds of manufacturers anddistributors entered this industry with high hopes
for success only to leave as paupers a couple ofyears later. Even those who successfully weathered
the storm found their margins severely curtailed by
1991:
Just four years ago, the industry’s annual growth rate
was tearing ahead at a 37% annual clip. . . . Now,
worldwide sales will grow just 15% in 1991. In the
U.S., growth will be more like 8%. Other analysts are
predicting no growth at all.
—Business Week, August 12, 1991
Computers have become commodities. . . . Once anicon of technological wizardry, personal computers
have become a commodity. . . . The price of a complete
computer system is being dragged down to the sum of
its parts. . . . And customers are less willing to pay forservice and hand-holding.
—The Economist, November 2, 1991
Now that PCs are considered more a commodity thana novelty, consumers and corporations are shopping
for them much the same way they shop for a TV or
VCR. . . . Instead of seeking assistance and expert
advice from a traditional computer dealer, home andbusiness computer purchasers are looking for bargains
from mass merchandisers and computer superstores:“People are buying computers the same way they buy
blenders and toasters. One product has more or lessessentially the same features as another. Price has
become more important.”—Advertising Age, November 11, 1991

New types of distributors and hardware vendors
emerged in the new environment. All shared one
feature in common—”cost efficiency.”
Outbound marketers like NEECO and
Compucom and superstores like MicroCenter andSoft Warehouse (which later became CompUSA)

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CASE 3 Dell Computer Corporation

emerged. These new generation dealers survived
on 10 percent to 15 percent gross margins and 3
percent to 5 percent net margins after tax.
Channels of distribution underwent a major shakeout, with traditional dealers like ComputerLand
and BusinessLand being restructured andacquired. According to Seymour Merrin, a computer industry distribution expert, “The bankruptcy gap forced the stuck-in-the-middle out ofbusiness. A high-price/high-service value- added
niche operation was just as viable as a low
price/low service high volume channel, as long as
each focused on its respective market. Everybody
else was sucked up by the bankruptcy gap.”
Meanwhile, Microsoft launched Windows in
1990. Through the 1980s, the operating systemused by IBM-PC compatibles, MS-DOS, did notoffer a friendly interface to the user and thisrestricted the use of PCs in the home and education
markets where Apple reigned supreme. Windows
had a much friendlier interface than MS-DOS andoffered IBM-PC compatible users a Mac-like environment for the first time. This, along with performance jumps in microprocessor speed andperipherals such as hard disks, led to a spurt inapplication software available for IBM-PC compatibles. It also marked the beginning of a shift inmarket power from hardware vendors like IBM to
software vendors like Microsoft. See Exhibits 1, 2,
3, and 4 for a historical overview of target market
segments, market share, and channel share.

THE STORY OF DELL
In 1983, an 18-year-old freshman at the Universityof Texas at Austin, Michael Dell spent his evenings
and weekends preformatting “hard disks” forupgrading the capabilities of IBM-compatible PCs.
“That was quick and easy business, and decent
pocket money for a college student,” said Dell.
However, what started out as a pastime could not
be shut off as more and more businesses in theAustin area found Dell’s upgrades to be of added
value. “One day I realized that we could actually
buy surplus PCs from retail at a discount, upgrade
them, and sell them to businesses at a nice margin.
Soon we started advertising in trade magazinesand orders kept coming,” added Dell.
In May of 1984, Michael Dell had dropped out ofcollege to attend to business full time. The key
transformation came quite suddenly according to
Dell. “Within a very short period of time, we got
calls from Exxon, Mobil, and some government
agencies who all wanted our PCs, 50 to 100 systems at a time. They wanted to come see us. I was
taken aback. Imagine, we had to clean up ourworkshop, buy some suits and ties, and get readyfor meeting America’s largest corporations face toface.”
Dell was an ideal choice for these educated customers who wanted good performance machines
at a reasonable price. Within the first couple ofyears, in response to its customers, Dell was able to

EXHIBIT 1
Breakdown of Unit Sales by Market Segment (%)

Home/Hobby
Education
Small/Medium business
Large business/Corporation
Government
Total
Source: Computer Industry Forecasts

1983

1987

1990

1993

17
18
24
29
12

7
10
28
48
7

8
11
28
45
8

22
8
35
26
9

100

100

100

100

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CASE 3 Dell Computer Corporation

EXHIBIT 2
Market Share of Vendors—Personal Computer Market

IBM
CompaqApple
Dell
ADT/Tandya
Gateway
Packard BellHP
DEC
Others

1980

1982

1983

1985

1987

1989

1990

1991

1992

1993

1994

0.0
—
29.3
—
37.6
—
—
5.3
—
27.8

22.2
—
28.4
—
10.1
—
—
4.7
1.1
35.5

42.0
—
20.0
—
5.0
—
—
—
—
33.0

37.0
4.0
18.0
—
3.0
—
—
—
—
35.0

28.0
7.5
14.0
—
2.0
—
—
—
—
40.0

16.9
4.4
10.7
0.9
1.7
0.2
3.3
na
na
61.9

16.1
4.5
10.9
1.0
1.8
1.0
3.9
na
na
60.6

14.1
4.1
13.8
1.6
2.7
2.5
4.7
na
na
56.5

11.7
5.7
13.2
3.7
2.7
3.6
5.3
na
na
54.1

14.0
9.6
13.9
5.4
3.6
4.4
6.7
na
na
42.4

10.2
12.8
12.2
4.2
4.0
5.1
10.8
2.4
2.4
35.9

a1980 to 1983 sales are Tandy sales. ADT acquired Tandy in 1992.
Source: Computer Industry Forecasts and New Games: Strategic Competition in the PC Revolution by John Steffens (New York,
Pergamon Press, 1994).

provide support services such as a 24-hour hotline
for complaints, 24- to 48-hour guaranteed shipmentof replacement parts, and a supply of replacement
systems in case the field service could not resolve
problems. In addition, Dell was able to incorporate
the latest improvements in microprocessor andperipheral technologies into their systems at amuch lower cost than market leaders like IBM.
Dell grew from nothing to $6 million in 1985 bysimply upgrading IBM compatibles. In 1985, Dellshifted to assembling and marketing its own brandof PCs and the business grew dramatically, ending
1985 at $70 million in sales. “We even won a coupleof trade magazine performance shoot-outs in thoseearly years,” added Dell. Simultaneously, Dell also
set up in-house teams for product marketing,advertising, market research, and sales support. By
1990, Dell had a broad product line of desktop andportable computers based on the most recent Intelmicroprocessors—386, 386SX, and 486—and had

EXHIBIT 3
Breakdown of Sales Volumes by Channel (% of units shipped)

1984
1987
1988
1990
1992
1994

DirectSales

DirectResponse

SI/VARs

Dealers

ComputerSuperstores

Mass
Merchants

ConsumerElectronics

15.0
10.4
9.5
8.3
5.1
3.9

10.0
13.1
14.2
14.6
16.1
14.2

10.0
12.3
13.4
14.9
15.5
16.2

60.0
56.8
55.1
51.2
44.7
42.0

0
0
0
1.5
4.9
8.5

2.0
3.4
3.6
5.0
8.6
9.6

3.0
4.1
4.1
4.5
5.1
5.6

Note: Direct Response includes mail-order; System Integrators includes VARS; Mass Merchants includes other superstores such as
Office Superstores.
Source: Computer Industry Forecasts and New Games: Strategic Competition in the PC Revolution by John Steffens (New York,
Pergamon Press, 1994).

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EXHIBIT 4
Buying Patterns
Percentage of Fortune 1000
Companies Using Desktop
Brands in 1994

Channels for Purchasing
by Fortune 1000 Firms
SI/VARs
Dealers and resellers
Manufacturers
Others

30%
40
19
11

IBM
Compaq
Dell
Apple
AST
Gateway
H-P

Share Retail PCs in 1994
77%
71
35
24
22
21
13

Packard BellApple
CompaqIBM
AST
Others

25%
25
19
11
9
11

Source: Computer Industry Forecasts

earned a strong reputation for its products andservices.
Nearly all of Dell’s sales were to corporate
accounts, split almost evenly between the large
corporate accounts and medium and small businesses. A large portion of medium and small business sales were to individuals. Even thoughrevenue from individual consumers was only avery small (less than 5 percent) proportion of its
sales, Dell did not turn down individual orders.
Dell’s reputation was built on its unique and distinctive “Direct Model.”The Dell Direct ModelIn the beginning, Dell’s focus was on selling somewhat more customized products via mail order tobusiness customers. The manufacturing cycle was“made-to-order” giving important economies.
However, in the last five years, Dell had considerably embellished its Dell Direct Model—a highvelocity, low-cost distribution system characterized by direct customer relationships, buildto-order manufacturing, and products and services
targeted at distinct customer segments. Dell segmented its customers into “Relationship” and“Transaction” customers. The demarcation was
based on the volume potential of customers’ PCpurchases.

Dell’s large Relationship customers were
Fortune 2000 companies, government, and educational accounts that had multiple unit “repeat purchase” requirements and were usually serviced bya team of outside and inside sales reps. Dell’s maincompetitors in the relationship segment wereresellers of Compaq, IBM, HP, and other leading
brands. Relationship customers evaluated vendors
based on product reliability, compatibility withinstalled base, and stability in technology. In 1994,
Dell had about 150 field-based sales reps and asimilar number of inside telephone reps dedicatedto Relationship accounts. The outside rep, known
as a field Account Executive, was dedicated to thecustomers in a region and was responsible forunderstanding their information technology environment and service needs. He would then sellthem customized product and service solutions. In
some cases, where the customer insisted on being
serviced through a value-added reseller, Dell
would invariably honor the request and route
products accordingly.
Inside sales reps were paired with field repsand dedicated to the same Relationship accounts.
They were responsible for order processing andhandling inbound sales calls. When a customer
called in, the telephone sales rep was able toquickly call up their sales history on-line andguide the customer accordingly. For example, the

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customer might have been eligible for a standard
corporate discount. In other cases, the customer
headquarters buying group may have required acertain product configuration for all its individual
departments, of which the caller might not havebeen aware. The inside reps were also responsible
for “upsell” at the time of purchase-selling the customer a higher-end system with a richer mix ofsoftware and peripherals.
Transaction customers comprised medium andsmall businesses, and home office customers. These
customers were primarily interested in value-toperformance. Dell’s main competitors in this segment were Gateway 2000, other mail-order firms,
and the retail channel. Transaction customers called
into a unique phone number (1-800-BUY-DELL),
distinct from the number offered to Relationshipcustomers, and were served by a team of several
hundred inside sales reps. For medium and small
businesses, Dell reps could call up historical sales
records to assist customers in choosing a systemthat fit their prior purchase patterns.
Transaction customers were given the option of
paying for their purchase using a credit card or
being charged on delivery. In the case ofRelationship buyers, payment was usually completed through corporate purchase orders or credit
cards, resulting in a significantly longer payment
cycle. Overall, the larger volume per account andgreater value addition resulted in higher gross margins for Dell in the Relationship segment.
Once the order was received, the configuration
details were sent to manufacturing. Dell offeredcustomers a variety of options on peripherals. The
customers could choose from a menu of disk
drives, monitors, memory sizes, network cards, andother hardware options. These were configured toensure they were compatible with the rest of thesystem. Only after extensive pre-testing were certain combinations of components allowed as
options for the customer. Dell had established close
relationships with component suppliers to ensure
early access to new technology and to guarantee
compatibility with other sub-systems and components of the PC.

571

Upon receiving an order, the information was
passed on to the assembly line where the productwas custom made. Dell had one factory in Austin,
Texas, to serve its American customers. Its assembly line was similar to that of other mass-produced
goods such as automobiles. At the beginning, achassis would be put on the assembly line with a“spec” sheet that identified the configuration
ordered. As the chassis went through the assembly
line, the motherboard was installed in the systemwith the ordered microprocessor and required
amount of RAM. As the chassis progressed throughthe assembly line, other sub-systems such as thehard disk, video card, and CD-ROM drive were
installed and wired to the motherboard. Dell maintained around 30 days of component inventory, but
its component suppliers usually carried sufficientbuffer stock (45 to 60 days) to be able to quickly
replenish Dell’s requirements. At several points inthe line, the sub-systems installed were, qualitychecked to ensure that only defect-free systems
were passed down the line. After all the hardware
options had been installed as per the spec sheet, thesystem was sent to the software loading zone,
where the software ordered, including operating
systems software, application software, and diagnostic software4 was loaded onto the hard disk ofthe system.
After all the software was loaded, the system wassent to a “burn-in” area where it was powered andtested for four to eight hours before being packed ina box and sent to the packing area. Here, the completed system was boxed with peripherals such as a
keyboard, mouse, mouse pad, and the manuals andfloppy disks for all the installed software. At thispoint, the system assembly line was synchronizedwith another assembly line for monitors so that thesystem box arrived at the shipping dock at the sametime as the monitor; the two boxes were then tagged
and transferred to the shipper’s truck. Dell had contracts with multiple shippers to deliver the systems

4 The diagnostic software is used to identify and localize
problems that might come up in the field.

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to customers anywhere in the United States. The
time taken to ship the product after receiving theorder was typically between three to five days. If
the order size was for more than 100 computers at
a time, there could be a delay of a week or so toaccommodate factory scheduling.
The manufacturing process was particularlycomplicated in Den’s European factory in Limerick,Ireland, where products for all European countries
were assembled. In addition to building a productto a customer’s specifications, Dell also had tocomply with different regulatory requirements, different power conventions, and versions of software
customized for different European languages.
After shipment, if a customer called in with aproblem, the first level of support was provided
over the phone. Dell had over 300 technical support representatives who could be accessed byphone at any time. Given the nature of the product, this was very effective in taking care of service problems that required hand-holding
customers and walking them through standard
trouble-shooting procedures. Using a very comprehensive electronic maintenance system, theservice rep was able to diagnose the problem andlead the customer through its resolution, solving
the problem in 91 percent of the cases.5 If the
problem was one of defective parts, Dell had
third-party maintenance agreements with service
companies (office automation vendors like Xerox)
who sent technicians to solve the problem. Most
problems were resolved in 24 to 48 hours. Michael
Dell explained:
We introduced the concept of build-to-order in the PC
industry. We were also the first to introduce on-site
service. We knew that our corporate customers andexperienced individual customers had needs that
weren’t being filled by the traditional retail channel.

Morton Topfer added, “Consumers at retail
don’t know what they are looking for other thanprice. Every time they call with a problem, it is a

5 Business Week, July 1, 1991.

$100 to $200 expense. We, on the other hand, like tosell to the educated consumer.’Dell’s Competition in the Early 1990s
By 1990, Dell’s success spawned many imitators in
the form of upstart, low-overhead mail-order vendors. Notable amongst these were CompuAdd
with $516 million in revenues and Gateway 2000
with $275 million in revenues in 1990. In the words
of a computer industry expert, “Everyone is piggybacking Michael Dell’s distribution concept. He
forged the trail and everyone is just following.”6
Michael Dell saw the entry of these smaller companies as a potential threat to the profitability of
the firm in the short run, as they could undercut
Dell’s prices by 15 percent to 30 percent.
As Dell focused on the direct distribution business, Compaq responded to the growing needs ofthe corporate market by introducing, in 1990, desktops that were designed to work optimally in a networked environment. Compaq also signed
strategic integration agreements with operating
system software vendors to jointly develop andsupport the integration of systems into networks.
A year later, Compaq reorganized itself into the
Personal Computer Division and the Systems
Division.7 The PC division was structured to bringto market high performance desktops and laptops
suited to the large corporate environment and tomeet the needs of entry level products for the small
business and home market that had started to
grow very quickly. The Systems division was
designed to offer advanced integrated solutions fora network that involved not only hardware, butalso software, service, and support.
In 1992, Compaq expanded its commitment toserve the needs of the small business and individual
buyer by announcing major price cuts that brought

6 Financial World, March 17, 1992.
7 An interesting point to note is that, in 1991, Compaq sued
Dell to stop it from running ads in trade magazines that compared Dell's product prices to those of Compaqs.

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its price down by over 30 percent. In the words of
one industry expert, “Compaq was out to out-Dell
Dell.” The umbrella of high prices charged by the
major players that allowed upstart, low-overhead
vendors to flourish vanished overnight.8 Over aspan of the next 18 months, Compaq announced
relationships with computer superstores, consumer
electronic outlets, and office product superstores andexpanded its base of VARs by setting up two distributors in the United States that serviced these smaller
VARS. Compaq also announced that, by mid-1993, it
was going to enter the mail-order channel in
response to growing needs of customers that wanted
to purchase direct. Several other market leaders,
including IBM, announced similar plans to enter theretail and direct mail business.
Dell’s Growing Pains, 1991–1993
By late 1990, Michael Dell saw that the changes
taking place in the PC industry could take their tollon the firm unless Dell was able to expand its horizons, “I didn’t think for a second that our competitors (like Compaq and IBM) were going to sit
around and keep doing what they were doing
because it clearly was not working. I was actuallysurprised that it took them so long to react.”9According to Dell, “The way to sustain growth andprofitability was to have a broad range of businessactivities that were all performing well.”
In 1991, in an effort to reach out to a growing segment of small business and individual customers
that preferred to shop in a showroom setting withphysical access to the products, Dell entered into
distribution agreements with CompUSA, Staples,and Sam’s Clubs in the United States; Price Club in
the United States, Canada, and Mexico; Business
Depot in Canada; and PC World in the United
Kingdom. The agreements allowed retailers to sell
the product, with Dell providing the post-sales service and support. To service the new segments, Dell

8 Business Week, July 6, 1992.
9 Business Week, July 1, 1991.

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launched two new brands; namely, the Dimension
and Precision lines. Both lines were essentially similar, with Dimension marketed through CompUSAand Staples, and the Precision line sold throughPrice Club and Sam’s Club. The systems soldthrough the indirect channels were a limited set ofpredetermined configurations, unlike the customization option available to customers that purchased directly from Dell.
These entries into new markets with new products led to a major spurt in sales for Dell and sales
jumped from $890 million in 1991 to over $2 billion
in 1992. (Refer to Table A.)
In 1993, in response to increasing sophisticationof the large accounts, Dell introduced four new
families of systems that included NetPlex for corporate networks, OptiPlex for advanced standalone applications, OmniPlex for mission criticalbusiness operations, and Dimension XPS for thetechnologically sophisticated individual user. All
these moves led to another significant increase insales in 1993. However, this rapid growth led toseveral problems.
The Laptop Setback
Portable computers (first assembled by Osborne in1981) were around in the 1980s, but hardly successful. They weighed over 20 lbs. and were referred tojokingly as “luggables.” In 1982, Grid announced
one of the first successful 10 lb., battery-powered
laptops. Hewlett-Packard, Zenith, IBM, Toshiba,
Compaq, and Apple all followed suit. By the late1980s, industry experts predicted that the laptop
market would take off.
Several technological innovations made this possible. First, display technology was revolutionized by
Japanese firms with flat screen LCD displays that took
less space and lower power than the existing CRT(Cathode Ray Tube) technology. This reduced the size
and weight of the system dramatically. Next, harddisk drives that were small and compact and consumed low levels of power were developed. Finally,
there were breakthroughs in battery technologythat allowed these systems to run for over an hourDell Computer Corporation

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TABLE A
Dell Sales—1991 to 1993
1991

1992

1993

Net sales (SM)$890M

$2,014M$2,873M

Products

Desktops—90%
Laptops—10%

Desktops—88%
Laptops—12%

Desktops—94%
Laptops—2%
Servers—4%

Microprocessor

486—35%
386—65%486—71%
386—29%Pentium—<1%
486—94%
386—5%

BrandsDell

Dimension
Precision

Dimension
Precision
NetplexOptiplex
Omniplex

Sales to market segments

Relationship—59%
Transaction—41%

Relationship—61%
Transaction—39%

Relationship—64%
Transaction—36%

Channels

DirectRetail
VARs

DirectRetail
VARs

DirectRetailVARs

Markets

U.S.—72.8%
Europe—27.2%

U.S.—72.5%
Europe—27.5%

U.S.—70.9%
Europe—27.2%
Asia—1.9%

Note: Richly configured PCs sold as servers accounted for less than 1 percent of desktops in 1991, and around 12 percent in 1992
and 1993.

before they needed to be recharged. This rapid
advance in technology, coupled with a pent-up
demand for more features from buyers who werewilling to pay for them, led to reduced price competition and higher margins in the portable market ascompared to the desktop market.10
Thus, in the late 1980s, the portable market
attracted desktop manufacturers who saw it as alogical extension of their desktop business. Dell,
10 According to industry sources, laptops typically offered
20–30 percent lower performance in processor speed, disk
capacity, memory and other peripherals when compared tosimilarly priced desktops. This trend was expected to continue
over the next few years.

with several desktop manufacturers, jumped into
the laptop market around this time. Many of them,including Dell, approached the product with a“shrunken desktop” mentality, leading to severe
quality problems.
In 1993, there was a major recall of Dell’s existing laptop product and the company ended up
taking a large loss because of the resulting inventory write-off. At that time, Dell was selling about
30,000 laptop units a quarter. According to Dell,“When we pulled out in 1993, we were committed
to reentering the laptop market only after we knewthat we had a world-class product that matched or
exceeded the level of quality offered in our desktop
business.”

577

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CASE 3 Dell Computer Corporation

Dell Exits the Retail Channel
By early 1994, Michael Dell realized that the company’s foray into retail channels was not successful.
The operating model that was successful in the
direct channel was not designed to profitably
manage the retail channels. (Refer to Table B.)
Further, the retail channel did not permit Dell touse one of its major attributes, mass-customizationof its products.
Michael Dell summarized:
We got tempted by the 20,000-odd retail storefronts
that competitors like Compaq could access. But thatwould have meant at least 60 days of channel inventory and a similar amount of finished goods at ourend to service the channels. That is completely contrary to our direct model. Dell turns inventory 12
times, while our competitors who sell through retail
only turn their inventory 6 times. Even though customization increases our manufacturing cost by about
5 percent, we are able to get a 15 percent price premium because of the upgrades and added features.
But for the standard configurations we offeredthrough retail, we were not able to get any premiumin the market. In fact Compaq, not us, got a 10 percent
price advantage.

While Dell continued to grow rapidly, the costs ofsupporting the retail channel led to severe pressure
on margins and Dell formally pulled out of thischannel in mid-July 1994. In fact, Dell had begun towork with retailers to take back pipeline inventory
and handle the transition informally even as early aslate 1993. At the time of the withdrawal, Dell was

TABLE B
Margins in Direct versus Retail in 1994

575

selling at the rate of 25,000 units per quarter throughthe retail channel. According to a senior Dell executive, “Retailers were disappointed, but thought our
attitude toward the channel was ambivalent to startwith. They appreciated our honesty.”
Even as Dell was attempting to cope with the
new complexities of the market, Gateway 2000
(founded in 1985) grew from $275 million in sales in1990 to $2.7 billion in 1994 by following Dell’s
direct distribution model. In the process, Gateway
became the largest direct marketer of PCs in the
United States. Gateway’s strategy was to stay awayfrom R&D and sub-system manufacturing and only
assemble purchased components at its facilities inNorth Sioux City, South Dakota. Further, Gateway
focused primarily on the U.S. desktop market,
which accounted for over 94 percent of Gateway’s
total sales in 1993. Along with Dell, Gateway 2000
was one of the first PC vendors to introduce systems based on the Pentium microprocessors fromIntel in 1993.
Dell Bites the Bullet
Undeterred by his company’s recent setbacks,
Michael Dell kept plugging ahead.
I learned an important lesson. We were no longer thelonesome upstart carving out a niche in the market.
We were an important player. We had arrived, but wedidn’t really grasp the fundamentals of managing a
big business. In July 1994 with only $20 million to funda $2.5 billion business, we were as close to the jaws ofdefeat as we have ever been. That’s when we restructured the management team to reflect the experience
we needed and position the company for the future.

Morton Topfer, vice chairman, concurred.

Dell Direct

Dell Retail

Price

100.0

88.0

Cost of sales

81.0

81.0

Gross margins

19.0

7.0

Operating expense

14.0

10.0

Operating income

5.0%

–3.0%

We left an opening in the market for Gateway to takeadvantage of. We had a 15 percent to 20 percent premium and our prices were too high. We had lost
focus. Consumers were willing to pay up to a 5 percent premium for Dell products, not more. We corrected all of that. We were the innovators in bringing
Pentium [Intel’s most recent and advanced microprocessor] computers to market. Our prices were once
again competitive. Our humility was back and along

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CASE 3 Dell Computer Corporation

with that a spurt in sales. First-to-volume is the nameof the game.

In 1994, sales of the firm rose to $ 3.5 billion.
Sales to major accounts and VARs represented 67
percent of total sales; medium and small businesses
and individuals accounted for the remaining 33

percent. Pentium-based systems represented 29
percent of total sales in 1994, while 486-based systems accounted for 71 percent. Overall, international sales accounted for 30 percent of Dell’s sales
in 1994. (See Exhibits 5, 6, and 7 for relative financial performance of Dell, Compaq, and Gateway.)

EXHIBIT 5
Financial Performance of Dell Computer Company ($ in millions)
Year

1986

1987

1988

1989

1990

1991

1992

1993

1994

Net sales ($ in millions)

69.5

159.0

257.8

388.6

546.2

889.9

2,013.9

2,873.2

3,475.3

United States
EuropeOther International
Cost of Sales

69.5

153.1
6.0

218.2
39.6

300.3
88.3

358.9
187.4

648.1
241.9

53.6

109.3

177.3

279.0

364.2

607.8

1,459.6553.0
1.3
1,564.5

2,037.2781.9
54.0
2,440.4

2,400.0
952.9
122.4
2,737.3

Gross Profit

15.9

49.7

80.5

109.6

182.1

282.2

449.5

432.8

738.0

Operating Expenses:
SGA
R&D

10.3
1.5

27.4
5.1

51.0
6.6

79.7
17.0

115.0
22.4

182.2
33.1

268.0
42.4

422.9
48.9

423.4
65.4

Total Operating Expenses

11.7

32.5

57.7

96.7

137.5

215.3

310.3

471.8

488.8

Operating Income
Net Income

4.1
2.2

17.2
9.4

22.8
14.4

12.9
5.1

44.6
27.2

66.9
50.9

139.1
101.6

–39.0
–35.8

249.3
149.2

Net Sales

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

United States
International—Europe
International—Others
Cost of Sales

100.0
0.0
0.0
76.9

96.3
3.7
0.0
68.5

84.6
15.4
0.0
68.5

77.3
22.7
0.0
71.8

65.7
34.3
0.0
66.7

72.8
27.2
0.0
68.3

72.5
27.5
0.1
77.7

70.9
27.2
1.9
84.9

69.1
27.4
3.5
78.8

Gross Profit

23.1

31.5

31.5

28.2

33.3

31.7

22.3

15.1

21.2

Operating Expenses:
Marketing and Sales
R&D

14.8
2.3

17.2
3.5

19.8
2.8

20.5
4.4

20.9
4.1

20.5
3.7

13.3
2.1

14.7
1.7

12.2
1.9

Total Operating Expenses
Operating Income
Net Income

17.1
6.0
3.1

20.7
10.8
5.9

22.6
8.9
5.6

24.9
3.3
1.3

20.5
8.3
5.0

24.2
7.5
5.7

15.4
6.9
5.0

16.4
–1.3
–1.3

14.1
7.1
4.0

% of Net Sales

Source: Company annual reports.

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CASE 3 Dell Computer Corporation

577

EXHIBIT 6
Financial Performance of Compaq Computer Corporation
Year

1987

1988

1989

1990

1991

1992

1993

1994

Net Sales
Cost of Sales

1,224
717

2,066
1,233

2,876
1,715

3,599
2,058

3,271
2,053

4,100
2,905

7,191
5,493

10,866
8,139

Gross Profit

507

832

1,161

1,541

1,218

1,195

1,698

2,727

Operating Expenses:
SGA
R&D
Other

226
47
6

397
75
–7

539
132
5

706
186
8

722
197
145

699
173
28

837
169
76

1,235
226
94

Total Operating Expenses

279

765

676

900

1,064

900

1,082

1,555

Operating Income

228

367

485

641

154

295

616

1,172

Net Sales
Cost of Sales

100.0
58.6

100.0
59.7

100.0
59.6

100.0
57.2

100.0
62.8

100.0
70.9

100.0
76.4

100.0
74.9

Gross Profit

41.4

40.3

40.4

42.8

37.2

29.1

23.6

25.1

Operating Expenses:
SGA
R&D
Other

18.5
3.8
0.5

19.2
3.6
–0.3

18.8
4.6
0.2

19.6
5.2
0.2

22.1
6.0
4.4

17.0
4.2
0.7

11.6
2.3
1.1

11.4
2.1
0.8

Total Operating Expenses
Operating Income

22.8
18.6

22.5
17.8

23.6
16.8

25.0
17.8

32.5
4.7

21.9
7.2

15.0
8.6

14.3
10.8

$ in millions% of Net Sales

Source: Company annual reports.

Strategic Decisions
Dell and Topfer had three strategic issues toresolve. First of all, they had to decide the balanceof product emphasis between laptops, desktops,
and servers. (See Exhibit 8 for U.S. market growth
projections per product class.)
The immediate concern was Dell’s strategy forthe laptop market. The first move was made inearly 1993 with the hiring of John Medica, the leaddeveloper of Apple Computer’s much acclaimed
and extremely successful Powerbook line, as the VPof portable products.
John Medica’s team had gone back to the designboard to develop a new line of portables that was

expected to be available by the third quarter of 1994.
In the interim, Dell re-entered the portable marketplace in early 1994 by selling a line of laptops thatwere sourced from Taiwan and developed in partnership with AST Research. In August of 1994, Delllaunched its own line of notebook computers whichwere very well received by the market.
The laptop market was different from the desktop market in several ways. First, in 1994, laptop
gross margins for the major players were typicallythree to five percentage points greater than desktops. Second, the manufacturing process for laptops was different from desktops. Typically, thechassis with the display and motherboard would

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CASE 3 Dell Computer Corporation

EXHIBIT 7
Financial Performance of Gateway 2000
Year

1989

1990

1991

1992

1993

1994

Net Sales
Cost of Sales

70.6
56.6

275.5
220.9

626.8
510.9

1,107.1
914.4

1,731.7
1,460.8

2,701.2
2,344.6

Gross Profit

14.0

54.6

115.9

192.7

270.8

356.6

Operating Expenses:
SGA
R&D

7.6
0.0

29.4
0.0

56.6
0.0

89.4
0.0

121.7
0.0

216.1
0.0

Total Operating Expenses

7.6

29.4

56.6

89.4

121.7

216.1

Operating Income

6.4

25.2

59.3

103.2

149.1

140.5

Net Sales
Cost of Sales

100.0
80.2

100.0
80.2

100.0
81.5

100.0
82.6

100.0
84.4

100.0
86.8

Gross Profit

19.8

19.8

18.5

17.4

15.6

13.2

Operating Expenses:
SGA
R&D

10.7
0.0

10.7
0.0

9.0
0.0

8.1
0.0

7.0
0.0

8.0
0.0

Total Operating Expenses
Operating Income

10.7
9.1

10.7
9.1

9.0
9.5

8.1
9.3

7.0
8.6

8.0
5.2

$ in millions% of Net Sales

Source: Company annual reports.

come prepackaged from an outside vendor. Only
the processor, memory, and hard disk drive wereadded to the system in the assembly line, in addition to the software. This reduced the degree ofcustomization possible in laptops as compared to
desktops. Third, the sophistication of the design
and the quality of workmanship required inassembling a laptop had to be significantly higher
than in the case of desktops, given that laptops
faced a harsher set of working conditions. Fourth,there was a lot more feature differentiation acrossbrands in laptops than in desktops.
A significant portion of laptop sales to large corporate customers was for their sales and process
automation projects that were usually managed bysystem integrators and VARS. There was also afast-growing segment of small office and home
(SOHO) buyers that were acquiring the latest laptops as a replacement for their existing desktops.
This group preferred shopping through the retailchannel because it gave them a chance to “touchand feel” multiple brands prior to purchase.
TABLE C
Market Shares and Market Penetration of Major
Players in the Laptop Market in 1994

ToshibaCompaqIBM
Apple

U.S. Market Share%% of Fortune 1000
Firms Using Brand

17.8
14.7
11.3
9.3

51
64
50
13

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EXHIBIT 8
Total Volume of U.S. Market Between 1982 and 1998 (in billion $ and units)
Projected($ billion)

1982

1984

1986

1988

1990

1992

1994

1996

1998

Desktops
Portables
Servers

10.16
0.29
0.03

19.17
1.74
0.18

18.36
2.54
0.95

20.05
3.28
1.64

20.78
3.87
2.97

22.52
4.75
5.47

25.06
8.48
8.11

33.0
11.6
12.5

36.5
16.0
18.5

Total

10.48

21.09

21.85

24.97

27.62

32.74

41.65

51.7

71.0

Projected(units shipped in ‘000s)

1982

1984

1986

1988

1990

1992

1994

1996

1998

Desktops
Portables
Servers

3,387
130
3

7,100
600
19

7,200
850
110

8,100
1,130
195

8,750
1,540
338

9,835
2,150
457

11,8023,800
739

13,1005,400
1,250

14,500
7,500
1,950

Total

3,520

7,719

8,130

9,425

10,62812,442

16,341

19,75023,950Source: BIS Strategic Decisions, Inc.
Note: Typical configuration in late 1994.
Desktops: Pentium processor, 8 MB RAM, 700 MB hard disk, 15” color monitor, floppy disk drive.
Laptop:

486 processor, 4 MB RAM, 400 MB hard disk, dual scan color monitor, floppy disk drive.

Servers:

Single/multi Pentium processor, 32 to 64 MB RAM, multiple disk drives with over 10 GB capacity,
15” color monitor, multiple floppy disk drives, back-up/storage tape drives,
advanced bus architecture for high input/output operations.

Given the above differences and Dell’s pastexperiences in laptops, three key strategic questions
existed. Was it advisable for Dell to get into thelaptop business again? Should the laptops be aimed
at the corporate market using the direct channel?
Was the retail market a better option for laptops
given the higher margins available?
The second area of concern was Dell’s strategy in
the PC LAN server market. The PC LAN servermarket was emerging as one of the most dynamic,
fast-growing, and fiercely competitive markets in
the industry with players like Compaq and HP setting the stage for customer acquisition strategies.
Fortunately, however, the competition wasrestricted to technology and service, not price. Mostof Dell’s large customers were moving away fromcomputing environments based on mainframes andminicomputers to LAN-based client/server solutions.11 Exhibit 9 gives more details on the servermarket segments, and Table D gives a breakdown
of sales by segment.

11 In the old system of integrating computing requirements
in a large corporation, mainframes served as the hub of allactivity. All the application software and databases resided on
the mainframe. The mainframe also directly controlledcommon resources such as printers. This was a centralized
environment with the mainframe responsible for all functions
and the individual units functioned like dumb terminals thatallowed users to access the common pool of resources available
on the mainframe. This scenario started to change rapidly inthe early 1990s with the availability of powerful desktops andlaptops. Large firms now had to think in terms of connecting
the distributed computing power located on individuals' desks
into networks to share common corporate databases and hardware resources, and to allow for internal communications suchas fax, electronic mail, etc. Managing these networks was doneby powerful microprocessor-based systems called LAN serversthat were very similar to desktops and shared a lot of common
technology and components with desktops.

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CASE 3 Dell Computer Corporation

TABLE D
Details of Server Market Segments
Nondedicated PC Serverand PC Desktop Server

PC Server

Super Server

1994:
Share of total server market (%)
Average unit price (S)

62
6,000

36
18,0002
30,0001998 (projected):
Share of total server market (%)
Average unit price (S)

40
4,000

58
14,0002
28,000Assembling servers was similar to desktops. The
primary difference was that servers were significantly more complicated than desktops, and quality and reliability of the product were criticallyimportant to the customer. Therefore, servers were
subjected to more intensive “burn-in” tests that
increased the manufacturing cycle time by several
days. However, when it came to marketing servers,
there were some major issues.
Internally, the senior executives of Dell weresplit in their approach to this market. Some
believed that server sales to the corporate market
would dictate the choice of desktop vendors- vendors who supplied servers to manage LANs would
win the desktops sales too. Losing server sales, intheir opinion, would lock Dell out of its primarydesktop market very quickly. These executives
wanted Dell to pursue the server market on all
fronts. On the other hand, there were others whobelieved that it was unlikely that large customers
would take Dell seriously as a server vendor. They
cited the recent success of HP and DEC in this segment as a clear indicator of customer preferences
for a certain type of server vendor. In addition, theyfelt that Dell did not have the marketing, sales, andservice expertise to support servers. They felt that
Dell should continue to focus on its direct modeland stay away from servers, or risk losing the next
round to Gateway.

The final area of concern for top management at
Dell was the rapid growth in international operations of the firm. In the span of five years between
1989 and 1994, international sales had gone fromnothing to close to a billion dollars. (Table E givesa breakdown of the operating income for Dell byregion.)By 1994, Dell was present in all major international markets with a combination of subsidiaries
and distribution agreements. (Exhibit 10 gives asummary of Dell’s international structure.) Dell’spresence in each market had evolved differently. In
some cases (for example, the United Kingdom) thebusiness model was very similar to the direct modelthat had been successful in the United States. In
other countries (Japan, for example) Dell had significant sales through the indirect channel. The notion

TABLE E
Dell’s Operating Income (U.S. and International) in $millions
1992

1993

1994

United States
EuropeOthers

110.7
34.7
(6.3)

(35.5)
14.6(18.1)

110.7
132.2
6.3

Total

139.1

(39.0)

249.3

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CASE 3 Dell Computer Corporation

581

EXHIBIT 9
Description of the PC LAN Server Market Segments
The hardware platform of the server was usually usedas the basis to segment the LAN server market.
The non-dedicated PC server and PC desktop server markets were the low-end of the server market and included
servers implemented in small work groups of larger
companies or within small businesses. Customers inthese markets were very price sensitive but had relatively low performance requirements. The primary
application was basic connectivity or file/print sharing
with little or no sophisticated application requirements.
Customers were also interested in the ease-of-use of theserver given their low level of skills in supporting them.
Compaq, IBM, AST, Gateway, and Apple were the maincompetitors in these markets. The typical gross margins
in this server segment were below 30 percent. Most vendors currently offered richly configured desktops withsome network management software as a solution tothese segments. This segment represented the bulk ofDell server sales until 1994.
Products in the mid-range segment of the market
were called, simply, PC servers. Customers in this segment required superior performance and reliability, andwere willing to pay a premium for it. They looked forpre- and post- sales service, and expect a high level oftechnical sophistication on the part of the vendors. To
serve this segment, vendors such as Compaq, HP, and
AST had established relationships with VARs and otherspecialized (niche) service providers that offered singlesource support for vertical markets while keeping a lid
on costs. Typical gross margins for vendors in this segment were between 40 and 45 percent. In early 1994,
Compaq announced an aggressive approach to protecting its number one position by improving its productperformance and reliability, establishing strategic
alliances with database vendors, and joint development
partnerships with manufacturers of network communications products.
At the high end, the super server market supports
high-end niche applications using multi- processor
servers. This segment is relatively undeveloped due tothe immaturity of multi-processing software and theincreasing functionality of lower-end uni-processor systems. This segment had Compaq, ALR, Tricord, andNetframe as the established competitors. New entrants
into this business included IBM, Zenith, AST, Digital,and AT&T GIS. Products in this segment typically had
gross margins over 50 percent.

Source: Internal company records.

of buying direct from the manufacturer was a newconcept in many markets so Dell had an uphill battle
to fight in some countries. Given the lack of an infrastructure in markets outside the United States andsome parts of Europe to support the direct model, asignificant part of the growth in international sales
had come through retailers and distributors.
Managing the international expansion was further complicated by the fact that Dell had supported this growth by forming international
subsidiaries as stand-alone entities adapted to facilitate effective and rapid local market penetration.
Morton Topfer wondered if Dell needed a global
channel strategy. Should Dell convert all its inter-national businesses to a replica of the direct modelin the United States, and if so, how rapidly? Should
Dell continue to expand into new markets or focus
on growing share in the markets the company currently competes in?
In the tumultuous computer business, Dell had
achieved compound annual sales growth of 59 percent per year since 1990 and had implemented a
rapid turnaround after the company stumbled in
1993. Furthermore, $100 invested in Dell stock in
January of 1990 would have been worth $1,090 by
the end of 1994, a 61 percent annual return. Despite
these achievements, Dell’s management team continued to push the organization to new heights.

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EXHIBIT 10International Organization, 1994
Country
Americas1. United States
2. Canada
3. Mexico
4. Other Latin Americas
European Countries
1. United Kingdom/Ireland
2. Germany
3. Benelux
4. France
5. Sweden
6. Spain
7. Finland
8. Denmark
9. Czech Republic
10. Poland
11. The Netherlands
12. Norway
13. Switzerland
14. Austria
15. Other European countries
16. Middle East and Africa(considered part of European region)
Asia Pacific Countries
1. Japan
2. Singapore
3. Malaysia
4. Thailand
5. Hong Kong
6. Australia

Organization

Percentage ofTotal Sales—1994
69.1

Regional HQ (Americas)
Local office
Local office27.4
Regional HQ (Europe)
Local office
Local office
Local office
Local office
Local office
Local office
Local office
Local office
Local office
Local office
Local office
Local office
Local office3.5
Regional HQ (Japan)
Local office
Local office
Local office
Regional HQ (Asia Pacific)
Local office

Source: Internal company records.

“By the year 2000, we aspire to be one of the top
five players worldwide. We need a global visionand strategy,” said Topfer.

Michael Dell disagreed with a smile, “You mean
top three!”

585

22
CASE 4
1

Kodak vs.Fuji

In the fall of 1997, Mr. George Fisher, CEO of
Eastman Kodak Company, was meeting his top
marketing executives to formulate the strategy tocontain Fuji Photo Film Co. from making further
inroads in the U.S. film market.
For some years now, Fuji and Kodak have beenbattling it out in overseas film markets. But in the
United States the picture was quite different. Kodak
and Fuji treated that market like a cozy, mutually
profitable duopoly. Both enjoyed fat margins. Kodak
controlled over 80 percent of the American film
market, and distant No. 2 Fuji always priced its film
just a little bit lower.
Then, in the spring of 1997, Fuji began slashingprices by as much as 25 percent. Fuji’s explanation
was that Costco, one of its five largest distributors
in the United States, ditched Fuji for Kodak and thecompany got stuck with 2.5 million rolls of film.
Fuji unloaded the film at a steep discount to other
distributors. When consumers saw that the familiar
red, white, and green boxes were a dollar or twocheaper, they snapped them up. Over the past year
Fuji increased its share of the U.S. film market tonearly 16 percent from 10 percent, while Kodak’s
share took an unprecedented tumble from 80 percent
to just under 75 percent.
Fuji executives deny that they intended to starta price war. Yet Fuji’s prices were still kept low evenafter the excess inventory had been worked off.
Whatever the case, for the first time in its long history,
Kodak can no longer take its home market for granted.
EASTMAN KODAK COMPANY
The Eastman Kodak Company was established in1884 in Rochester, New York, and still overwhelmingly dominates the $2.7 billion U.S. amateur film
market. Until recently, the Kodak brand remainedsolid gold, and its quality was never in dispute. But

Fuji’s gains in the United States were ominous,
especially because the Japanese film company was
already poised to surpass Kodak on a global basis,
particularly in Asia, where film sales were growing
at 20 percent a year or more. (Worldwide, Fuji andKodak were neck-and-neck, with about a third of
the market each.) Alex Henderson, managing director of technology research at Prudential Securities
Inc. in New York, who had been watching the twocompanies for twelve years, believes that if current
trends hold, Fuji will overtake Kodak by 1999.
“When that happens,” says Henderson, “Kodak
will go from being Coke to being Pepsi. That’s avery damning thing.” Worse yet, he expected that in
the United States, Fuji would continue to creep up
on Kodak by a rate of about 2 percent a year.
FUJI PHOTO FILM COMPANY
The Fuji Photo Film Company was established inJapan in 1909. In 1997, financially, Fuji was a verystrong company, giving it more flexibility to cut
prices. Fuji’s sales in 1996 were a record $11 billion,
and profits were a near-record $757 million; at thesame time, Fuji had a net cash position of about $4.5
billion and access to incredibly cheap borrowing—around 2.5 percent interest—thanks to Japan’s recordlow interest rates. Kodak had more than $1 billion in
short and long-term debt and was in the midst of asales and profit slide, in addition to impending
restructuring write-offs likely to run $1 billion or
more. Also, Kodak could not borrow at much under a
7 percent rate of interest. Fuji could afford a showdown, but Kodak could not.
MARKETPLACE
Kodak and Fuji have been slugging it out for threeequally important parts of the consumer photo

This case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

583

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Kodak vs. Fuji

584

CASE 4 Kodak vs. Fuji

business. Those little yellow and green film boxes
are the most obvious to the man in the street, but
Fuji and Kodak also manufacture photographic
paper, mostly for sale to big photo-processing laboratories and small retail developers. To ensure amarket for their paper, both companies haveinvested heavily in the third line of business—developing—by buying up big film-processing
companies across the United States. Fuji’s deep
pockets had enabled it to make acquisitions like theestimated $400 million purchase of Wal-Mart’s six
wholesale photo labs in 1996, a move that in one
swoop gave it about 15 percent of the U.S. photoprocessing market.
Fuji’s long-term strategy was to transplant asmuch film and paper production as possible onto
U.S. soil. That kept costs down, reduced nettlesome
trade disputes, and made Fuji’s factories more
responsive to local market demands. In 1987, just
3.5 percent of Fuji’s production was outside Japan;
now the figure was 31 percent, and the move offshore was accelerating. In April 1997, Fuji openeda highly automated, $300 million photographic
paper plant in Greenwood, South Carolina, which
was already producing about 20 percent of thephoto paper consumed in North America. Laterthat year, Fuji is scheduled to open an equally hightech, $200 million film plant in Greenwood.
According to industry sources, it would not takemuch time or investment to double the plants’capacities should Fuji need it.
COMPETITION
Fuji was one of the leanest and meanest of Japan’s
big companies. Led for the past 17 years by nononsense Chairman and CEO Minoru Ohnishi,
Fuji was cutting white-collar overhead long before
it started to become fashionable in Japan. In thepast ten years the company’s sales nearly doubled
worldwide, but its staffing in Japan remained
almost flat. Ohnishi tried to maintain a sense ofcrisis by reminding staff that Kodak was still out
front. “He likes to constantly cut costs in order toanticipate a rainy day,” says a consultant, “so that

there will be less pain down the road.” Or, more
likely, greater market share.
Fuji’s aggressive tactics had sometimes earned it
charges of unfair trading practices. In the early
1990s, the U.S. Commerce Department investigatedcharges that the Japanese company dumped photographic paper in the U.S. market. Fuji managed to
dodge import duties by agreeing to raise prices tolevels just above the going rate. (Fuji subsequently
lost most of its 20 percent market share but
bounced back when it opened its paper plant inGreenwood and bought out Wal-Mart’s processing
labs.) Also, the World Trade Organization is
expected to rule soon on U.S. allegations that the
government of Japan worked with Fuji to exclude
competitors from the Japanese market, which Fuji
dominated with a 70 percent market share. A decision is expected in the spring of 1998, though it was
not likely to affect either company’s business.
Ironically, Fuji got its big break in the American
market thanks to Kodak. The company opened its
first office in the United States in 1958 in the
Empire State Building, but it only began selling
film there in 1970, when it was one of several relative minnow—among them GAF, Agfa, and 3M—
swimming in Kodak’s pond. Then, in 1984, theOlympics came to Los Angeles. Olympic czar Peter
Ueberroth believed that Kodak was the natural
choice to be the exclusive film sponsor, but Kodak
wouldn’t bite. Even after Ueberroth visited
Rochester to make his pitch, Kodak refused to pay$1 million, far below the $4 million floor for sponsorships that Ueberroth had established. So heapproached Fuji, which in those days was still
barely known in the U.S. market. Ohnishi agreed
on the spot and eventually committed around $7
million. No marketing investment ever brought
better returns. Within months of becoming a sponsor, Fuji landed 50,000 new distribution outlets.
“Salespeople said that accounts that didn’t used toreturn their calls were suddenly calling them,”says Tom Shay, head of corporate communications
for Fuji USA and a 26-year Fuji veteran. “TheOlympics completely changed the way people
looked at us.”

589

Kodak vs. Fuji

CASE 4 Kodak vs. Fuji

Since then, Fuji has built a reputation for price,
quality, and sharp marketing. It has won a strong
following among professional photographers,some of whom rave over the film’s luminous blues
and greens. Its acceptance in the professional world
has given Fuji a lot of cachet with amateur shutterbugs. Fuji also adopted a hipper, more technologically oriented marketing image to differentiate
itself from the sentimental Kodak style. In 1993,
Fuji ran a highly successful, award-winning TV
campaign obliquely directed at Kodak. The killer
line: “Pictures should be nostalgic; your film
shouldn’t.” Fuji’s current slogan also painted thecompany as forward looking: “You can see thefuture from here.”In technology too, Fuji has shown that it could
set the pace by consistently spending about 7 percent of sales on R&D. In 1986, Fuji was the first to
introduce the disposable camera, a product thathas been a huge boon for both Kodak and Fuji. Fuji
also worked with Kodak and other companies tointroduce a new 24mm “advanced photo system”
film, which uses a new generation camera, ahybrid of digital and traditional systems. In Japan,
the launch was a great success, thanks to Fuji’s
ensuring that the cameras and processing werereadily available. Advanced Photo System film
already accounts for about 10 percent of the colornegative film market in Japan. “Fuji’s greatest
strength is that they always make sure that consumers are ready to buy their new products, andthey actually get the products to the consumers,”

585

remarked Toby Williams, an analyst at SBC
Warbug in Tokyo. By contrast, Kodak flubbed the
U.S. introduction of its advanced photo system,
called Advantix.
If Kodak and Fuji have one thing in common, itis their vulnerability as photography moves into
the digital age. In 1997 alone, market watchers
expect to see 1.8 million digital cameras sold worldwide, and that number will grow sharply as quality
improved and prices drop. That poses three big
issues for film companies: One was the danger—
still much in dispute—that film sales will soften as
digital cameras made by companies like Sony,
Canon, and Casio take up a bigger share of themarket. Another was a challenge on the photographic paper and processing front from Canon,
Epson, and Hewlett-Packard. Their latest generation ink-jet printers produce high quality prints ofdigital images on plain and coated paper. (Fuji justlaunched a printer of its own.) Both Kodak and Fuji
are working on ways to add value to digital photography, such as a service that lets customers
order prints directly over the Internet, but thoseideas are untested.
Finally, Kodak and Fuji have jumped into thedigital camera business themselves. But they are ina mob of nearly two dozen camera, computer, andconsumer electronics companies trying to get into
the same space. One thing is sure: The companies
that win in digital photography will need marketing and product smarts, technology and, not least,
money. Fuji, it seems, has them all.

23

C A S E 5 Loblaws“It’s been a year since we introduced green
products at Loblaws and the decisions still
are not getting any easier.” In early July 1990, Scott
Lindsay was reflecting upon his decision as towhich, if any, of three possible products he would
recommend for the G·R·E·E·N line: an energyefficient light bulb, toilet tissue made from recycled paper, or a high-fiber cereal.
As Director of International Trade for Intersave
Buying & Merchandising Services (a buying division for Loblaws), it was Scott’s job to source andmanage about 400 corporate brands (No Name,
President’s Choice, G·R·E·E·N)1 for Loblaws in
Canada. In four days, Scott would have to make his
recommendations to the buyers’ meeting.
The “green line” for which Scott was sourcing
products was a new concept for Loblaws and its
customers. Launched in 1989 as part of the corporate President’s Choice brands, green products had
characteristics that were less hazardous to the environment and/or contributed to a more healthy lifestyle. At issue for Scott was deciding what was“green” and balancing the financial requirementsof the company with the socially responsible initiative of the green line.
As well, his most pressing concern was his ability to convince the president, Dave Nichol, of themerits of his recommendations. Mr. Nichol was thedriving force behind the corporate brands, and hemaintained involvement and final authority onthese important product decisions.
In preparation for the buyers’ meeting, Scott had
to have his written recommendations on Dave
Nichol’s desk that day. Dave Nichol required thatrecommendations include retail price and costdata, projected annual sales in units and dollars, aswell as total gross margin expected. In addition to
the expected results, best and worst case scenarios
were also required. As well, primary reasons forand against the proposal needed to be given. Typically, the recommendations were made based on
the Ontario market as it was the proving groundfor new products.
The first product Scott was considering was a
new energy-efficient light bulb, which had beensuccessfully marketed in Germany. The bulb lasted
at least ten times longer than a regular light bulb but
was substantially more expensive. There was noquestion in Scott’s mind that the energy-efficientbulb had strong “green” characteristics and would
enhance Loblaws’ green image. However, a potential consumer price of $20 and low retail margins
were a troubling combination. He knew that store
managers, who were measured on sales volume
and profits, would not be enthusiastic about a product that would not deliver sales or profits. These
store managers controlled the individual products
and brands that were carried in their stores.
The second new product was, in fact, not a new
product at all. Loblaws had been selling a toilet
tissue manufactured with 100% recycled material
under its No Name corporate label. The existing product could be repackaged under the
G·R·E·E·N label and sold beside the No Name lineof products. The green packaging might alert consumers sensitive to the recycled feature, thereby
generating greater volumes for the product. Further, Scott realized there was an opportunity to
price the “green” toilet tissue at a higher price thanthe No Name, providing a higher profit margin.

1 No Name, President’s Choice, and G·R·E·E·N are all trademarks, owned by Loblaws Companies Limited.

This case was written by Professor Gordon H. G. McDougall and Professor Douglas Snetsinger of Wilfrid Laurier University asa basis of classroom discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
Reprinted by permission of the authors.
Copyright © 1991. Some data are disguised.

586

591

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Loblaws

CASE 5

The final product under consideration was a
new corn flake product for the very “crowded”
breakfast cereal category. The new cereal had an
unusually high fiber content. The “body friendly”
nature of the cereal was the basis for considering it
for the green line. Its additional feature was that it
could be sourced at a cost much lower than thenational brands.
LOBLAWS COMPANIES LIMITED
Loblaw Companies Limited is part of George
Weston Ltd., a conglomerate of companies that
operate in three basic areas: food processing, food
distribution, and natural resources. George Weston
is the sixth largest company in Canada with salesof $10.5 billion and net income of $988 million in
1989. The Loblaw Companies, an integrated groupof food wholesaling and retailing companies, had
total sales and net earnings in 1989 of $7,934 million and $70 million respectively.
THE GREEN IDEAThe G·R·E·E·N line launch had its origins in one ofDave Nichol’s buying trips to Germany in 1988,
where he was struck by the number of grocery
products that were promoted as “environmentallyfriendly.” He discovered that The Green Consumer
Guide, a “how-to” book for consumers to become
environmentally responsible, had become a bestseller in England. In late 1988, Loblaws began collecting information on Canadian attitudes about
the environment. The results suggested that anincreasing number of Canadians were concerned
about environmental issues, and some expressed awillingness to pay extra to purchase environmentally safe products. Further, many said they werewilling to change supermarkets to acquire theseproducts. (See Exhibit 1.)
THE G·R·E·E·N LAUNCH
Armed with this supportive data, in late January
1989, Loblaws management decided to launch, byLoblaws

587

July 1989, a line of 100 products that were either
environmentally friendly or healthy for the body.
These products would be added to the family of thecorporate line and called G·R·E·E·N. Although thetask was considered ambitious, the corporation
believed it had the requisite size, strength, influence, network, imagination, and courage to be successful. Loblaws contacted a number of prominentenvironmental groups to assist in the choice of
products. These groups were requested to make a“wish list” of environmentally safe products. Using
this as a guide, Loblaws began to source the products for the G·R·E·E·N launch.
A few products, such as baking soda, simply
required repackaging to advertise the already existing environmentally friendly qualities of the product. Intersave Buying and Merchandising Services
were able to source some products through foreign
suppliers, such as the Ecover line of householdcleaning products, to be marketed under the
G·R·E·E·N umbrella. All G·R·E·E·N products were
rigorously tested as well as screened by environmental groups such as Pollution Probe and Friendsof the Earth. This collaboration was developed tosuch an extent that a few of the products were endorsed by Pollution Probe.
The G·R·E·E·N product line, consisting of about
60 products, was launched on June 3, 1989. Initial
G·R·E·E·N products included phosphate-free laundry detergent, low-acid coffee, pet foods, andbiodegradable garbage bags. (See Exhibit 2.) A
holistic approach was taken in selecting these initial
products; for example, the pet food products were
included because they provided a more healthfulblend of ingredients for cats and dogs. The
G·R·E·E·N products were offered in a distinctively
designed package with vivid green coloring. Whenthe package design decisions were being made, it
was learned that 20 percent of the Canadian population is functionally illiterate. Management felt thatthe distinct design would give these consumers achance to readily identify these brands.
The G·R·E·E·N launch was supported with a $3
million television and print campaign. Consumers
were informed of the new product line using theLoblaws

588

CASE 5

Loblaws

EXHIBIT 1
Consumer Attitudes on Environment
1. National survey on issues.
What is the most important issue facing Canada today?
Issues

1985

1986

1987

1988

1989

Environment
Goods and services tax
Inflation/Economy
Deficit/Government
National unity
Free trade
Abortion
Employment

*
*
16
6
*
2
*
45

*
*
12
10
*
5
*
39

2
*
12
10
*
26
*
20

10
*
5
6
*
42
*
10

18
15
10
10
7
7
6
6

Source: Maclean’s/Decima Research*Not cited by a significant number of poll respondents.
Note: Survey conducted in early January of each year.

2. Loblaws customers surveys.
How concerned are you about the environment? (%)
Extremely (32), Quite (37), Somewhat (24), Not Very (5), Don’t Care (2)How likely is it that you would purchase environmentally friendly products?
Very (49), Somewhat (43), Not too (2), Not at all (4)How likely is it that you would switch supermarkets to purchase environmentally friendly products?
Very (2), Somewhat (45), Not too (24), Not at all (10)Note: Survey conducted in early 1989.

June 1989 issue of the Insider’s Report. In an open letter to consumers, Mr. Nichol addressed Loblaws
motivation for the G·R·E·E·N launch. (See Exhibit
3.) Part of the motivation was also to offer consumers a choice that could, in the longer term, provide educational benefits for consumers on specificgreen issues. As well, by offering the choice, consumers could “vote at the cash register” and, in asense, tell Loblaws what they were willing to buy
and what green products they would accept. The
G·R·E·E·N line was to be typically priced below
national brand products.
The G·R·E·E·N introduction was not without its
problems. Shortly after the launch, members of the
Pollution Probe rejected their previous endorsementof the G·R·E·E·N disposable diaper. These members
felt that the group should not support a less thanperfect product. The G·R·E·E·N diaper was moreenvironmentally friendly than any other disposablebrand. However, it was not, in Pollution Probe’s
opinion, environmentally pure. Further, it was feltthat endorsing such products compromised theintegrity and independence of the organization.
This prompted the resignation of Colin Issac, thedirector of Pollution Probe. The group subsequently
discontinued its endorsement of the diaper, but continued its support of six other G·R·E·E·N products.
Controversy also arose around the introductionof the G·R·E·E·N fertilizer. Greenpeace, a prominentenvironmental group, rejected Loblaws’ claims thatthe fertilizer had no toxic elements and therefore
was environmentally pure. The group did not knowthat Loblaws had spent substantial funds to determine that the product was free of toxic chemicals.

593

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Loblaws

CASE 5

Loblaws

589

EXHIBIT 2
The Initial G·R·E·E·N Products
Food
Just Peanuts Peanut Butter
Smart Snack Popcorn“The Virtuous” Soda Cracker
Cox’s Orange Pippin Apple JuiceWhite Hull-less Popcorn
Reduced Acid Coffee
Boneless and Skinless Sardines“Green” Natural Oat Bran
Naturally Flavoured Raisins: Lemon, Cherry,
Strawberry“Green” Turkey Frankfurters
100% Natural Rose Food
Norwegian Crackers
Turkey Whole Frozen
Gourmet Frozen Foods (low-fat)“If the World Were PERFECT” Water
Cleaning/Detergent Products
All-Purpose Liquid Cleaner with Bitrex“Green” Automatic Dishwasher Detergent
Ecover 100% Biodegradable Laundry Powder*
Ecover Dishwasher Detergent
Laundry Soil and Stain Remover with Bitrex
Drain Opener with Bitrex
Ecover Fabric Softener
Ecover 100% Biodegradable Toilet Cleaner
Ecover 100% Biodegradable Wool Wash
Ecover Floor Soap
“Green” 100% Phosphate-Free Laundry Detergent

Pet Food
Low Ash Cat Food
Slim & Trim Cat Food
All Natural Dog Biscuits
Cooking Products“The Virtuous” Canola Oil“The Virtuous” Cooking Spray
Baking Soda
Paper-Based Products
Bathroom Tissue“Green” Ultra Diapers“Green” Foam Plates
Swedish 100% Chlorine-Free Coffee Filters“Green” Baby Wipes“Green” Maxi Pads
Oil-Based Products
Biodegradable Garbage Bags
Hi-Performance Motor Oil
Natural Fertilizer
Lawn and Garden Soil
Other Products
Green T-Shirt/Sweatshirt
Green Panda Stuffed Toy
Green Polar Bear Stuffed Toy
Cedar Balls*The Ecover brands are a line of cleaning products made by Ecover of Belgium. These products are vegetable oil based and are
rapidly biodegradable. Loblaws marketed these products under the G·R·E·E·N umbrella.

Both incidents, although unfortunate, focused
the attention of Canadians on the G·R·E·E·N product line. The media highlighted Loblaws as the
only North American retailer to offer a line ofenvironmentally friendly products. The publicity
also prompted letters of encouragement from thepublic who supported Loblaws’ initiative. Surveys conducted four weeks after the line introduction revealed an 82 percent awareness of the
G·R·E·E·N line with 27 percent of the consumers
actually purchasing at least one of the G·R·E·E·N
products. In Ontario alone, the G·R·E·E·N line

doubled its projected sales and sold $5 million inJune 1989.
THE FIRST YEAR OF G·R·E·E·N
The launch of G·R·E·E·N was soon followed by a virtual avalanche of “environmentally friendly” products. Major consumer goods companies such as
Procter & Gamble, Lever Brothers, and ColgatePalmolive introduced Enviro-Paks, phosphate-freedetergents, and biodegradable cleaning products.
Competing supermarket chains had varied responses

Loblaws

590

CASE 5

Loblaws

EXHIBIT 3
The Insider’s Report—Open Letter

595

596

Loblaws

CASE 5from launching their own “green” line (Miracle Mart
introduced three “Green Circle” products, Oshawa
Foods introduced about 10 “Green-care” products)
to highlighting environmentally sensitive productsin their stores (Safeway) to improving its internal
practices through recycling and other activities(Provigo).
During the year, Loblaws continued to develop
and promote the G·R·E·E·N product line. In the firstyear of G·R·E·E·N, Loblaws sold approximately $60
million worth of G·R·E·E·N products and “brokeeven” on the line.
THE DECISIONSAs Scott began to make his decisions on the three
products, he reflected on the past year. He thoughtthat $60 million in sales for the G·R·E·E·N line wasreasonable, but he had hoped the line would do
better. He remembered some of the products thatjust didn’t fit in the line, such as “green” sardines.
“I don’t think we sold 20 cans of that stuff.” Scottand the other buyers at Intersave were very concerned when a product didn’t sell. Individual store
managers, who were held accountable for the sales
and profits of their stores, did not have to list (thatis, stock in the store that he or she managed) any
product, including any in the G·R·E·E·N line. If a
store manager thought the product was unsuitable
for the store, it wasn’t listed. As well, if a buyer got
a product listed and it didn’t sell, his or her reputation with the store managers would suffer.
Light Bulb
The proposal by Osram, a well-known German
manufacturer, was a true green product. The Osram
light bulb was a compact fluorescent bulb that
could replace the traditional incandescent light bulb
in specific applications. The unique aspect of thisproduct was that while fluorescent light technology
was commonplace (these long-tube lights werecommon in office buildings), only recently had the
product been modified for use as a replacement fortraditional light bulbs. The major benefits of fluo-

Loblaws591

rescent light bulbs were that they used considerably
less energy than incandescent light bulbs (for example, a nine watt fluorescent bulb could replace a 40
watt incandescent bulb and still provide the samelighting level, while using only 22.5 percent of theenergy) and it lasted at least 10 times longer (an estimated 2,000 hours versus 200 hours for the incandescent bulb). To date, the major application forcompact fluorescents had been in apartment buildings in stairwells where lights remained on 24 hours
a day. Apartment building owners purchased thembecause the bulbs lowered both energy costs andmaintenance costs (less frequent replacement).
The compact fluorescent had limited applications in the home. Because of its unique shape, it
could not be used with a typical lampshade. The
main application was likely to be in hallways
where it was difficult to replace a burned-out bulb.
Even in these situations, a new fixture (that is, anenclosure) might be required so that the compact
fluorescent would fit.
The bulb’s energy efficiency and long-lasting
features were well tested and had been sold for specialized industrial use for several years. The bulb
was making satisfactory inroads in Germany eventhough it was priced at the equivalent of $40
Canadian.
Loblaws sold a variety of 60 and 100 watt No
Name and Phillips light bulbs in packages of four.
In total, the light bulb category generated over $1
million in gross margin for Loblaws in 1989. (SeeExhibit 4.)
The initial Osram proposal was to sell the product to Loblaws at $19.00 per bulb. Even if the markup was set at 5 percent, Loblaw’s retail price would
be $19.99. Scott talked this over with a number ofpeople at Loblaws and concluded that the price
was too high to be accepted by Canadian consumers. At this time, Ontario Hydro entered thepicture. Ontario Hydro was extremely concerned
about its ability to meet the power demands of its
customers in the next decade and was engaged inaggressive energy conservation programs. Ontario
Hydro was prepared to offer a $5 rebate for every
light bulb that was sold in Ontario in the threeLoblaws

592

CASE 5

Loblaws

EXHIBIT 4
Light Bulbs (1989)
Average
RetailPrice*($)

Average
Cost($)

AnnualSales($000)

Total
Gross
Margin($000)

MarketShare(%)

60 Watt

2.25

1.25

470

209

18

60 Watt Soft

2.75

1.50

426

193

16

100 Watt

2.25

1.25

294

130

11

100 Watt Soft

2.75

1.50

279

127

11

1,468

659

56

Loblaws

Total Loblaws
Phillips
60 Watt

2.40

1.50

367

138

14

60 Watt Soft

3.20

1.65

341

165

13

100 Watt

2.40

1.50

236

88

9

100 Watt Soft

3.20

1.65

102

102

8

Total Phillips

1,153

493

44

Total

2,621

1,152

100

*Based on four-packs (that is, four light bulbs in a package). Total unit sales were 1,019,000 (four-packs).

months following the launch. Although it meantcustomers would need to request the rebate by
mail, it reduced the effective price of the bulb to theconsumer to $14.99.
Scott felt that the combination of the rebate, aretail price at only half that paid by German consumers, and a strong environmental message hadstrong merchandising appeal that could be
exploited in the launch of the bulb. Nevertheless,the sales potential was still unclear. Loblaws’
annual sales in Ontario were nearly four million
bulbs, or $2.7 million. Because this product was
unique and new, Scott had difficulty estimating
its sales potential. His best guess was that Loblaws might sell anywhere from 10,000 to 50,000
Osram bulbs in one year. Scott thought that half
the sales would come from regular customers andthe other half from customers coming to Loblaws
specifically to buy the bulb. Scott also felt thatafter three months, the price should be raised to$24.99 retail to generate a reasonable margin for
Loblaws.
Scott thought that if half the volume were generated at the higher price, it would certainly be easier
to maintain the support of the store managers. At
the $24.99 price, the margin would be $5.99 perbulb. Even considering the cannibalization issue,
the margin on the higher priced Osram would be
about four times higher than the margin for a fourpack of regular bulbs. However, it would be necessary to calculate the contribution for the year to see
what the net effect would be for the line. The shelf
space required for these bulbs would be minimal
and could be handled by some minor changes tothe layout of the existing bulbs.
Bathroom Tissue
The bathroom tissue category was a highly competitive, price-sensitive market. The category was

597

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Loblaws

CASE 5one of the largest in the Loblaws lineup, generatingover $31 million in retail sales in Ontario and $7
million in contribution. (See Exhibit 5.) Bathroom
tissue was more important to Loblaws than just a
volume generator. It was one of the few productcategories that would draw price-conscious buyers
into the store. Loblaws listed 40 different sizes andcolors from various manufacturers. There were six
Loblaws brands in the category. Loblaws wasaggressive at delisting any competitive or corporate brand that did not meet turnover or profitability goals. Manufacturers were just as aggressive at
providing allowance and merchandising incentives
to ensure satisfactory margins for Loblaws and to
facilitate retail price reductions that in turn would
enhance turnover and maintain volume goals. Twonational brands—Royale and Cottonelle—heldshares of 46 percent and 30 percent respectively.
For 1989, Loblaws’ brands held 16 percent of themarket with No Name White providing a total
gross margin of over $1 million. Loblaws’ No NameWhite was sourced for an average cost of $1.15 for a
4-roll package. These lower costs were largely
based on the fact that the tissue was manufactured
with totally recycled material. This product feature
made it a candidate for G·R·E·E·N line consideration. The existing product could simply be repackaged with the distinctive G·R·E·E·N labeling and anemphasis placed on the recycled character of the
product. No development or testing costs would be
required, and art work and new labeling costs
would be minimal.
Several decisions needed to be considered withrespect to the repackaging of the No Name product. Should the new product replace the old or simply be added to an already crowded category?
Should the price of the new product be set higher
than that set for the old? Should the product belaunched at all?
Ready-to-Eat Cereal
Loblaws sold more than $14 million worth of family cereals (that is, cereals targeted at the “family”
market) in Ontario in 1989. (See Exhibit 6.) Loblaws

Loblaws

593

corporate brand share of the family cereal segment, at
14 percent, was lower than corporate objectives forthis category. One of Scott Lindsay’s goals was toincrease Loblaws’ share for this category. The brandleaders, such as Kellogg’s Corn Flakes, Nabisco
Shreddies, and General Mills’ Cheerios, were as
familiar to shoppers as any other product or brandin a store. With decades of advertising and promotional support, these brands had become thoroughly
entrenched in the minds and pantries of generationsof Canadians.
The brand names of these market leaders provided
the manufacturers with strong protection against
competitors. However, the manufacturing process
did not. The manufacturing processes were wellknown in the industry, and many firms could produce identical products at favorable costs. Loblaws
had found several products from domestic sourcesthat appeared to be as good if not better than thenational brands. One such product was a corn flake
product that had a very high fiber content. The new
product would appeal to those customers who had
been primed by the health claims of high fiber diets.
In sensory tests, it had proven to have an excellent
taste and texture profile and was equal to or preferred in blind taste tests to some of the market leaders. Moreover, the product could be obtained for$1.40 per 500g package.
The President’s Choice brands were beginning to
make inroads in this market, and this new productcould increase the share. However, it was not clear
how to position the high-fiber corn flake product.
Should it go in the regular President’s Choice line asa line extension of the current corn flake product, or
should it be packaged as a G·R·E·E·N product? As aregular President’s Choice product, it would be positioned directly against Kellogg’s as an all-aroundcereal with extra value. As a G·R·E·E·N product, it
would be positioned less against Kellogg’s andmuch more towards a health/”good-for-you claim.”
G·R·E·E·N positioning might also minimize any cannibalization of the President’s Choice corn flakes.
The lower sourcing costs provided some flexibility
on pricing. It could be priced as low as $1.75, like thecurrent President’s Choice corn flakes, and still

Loblaws

594

CASE 5

Loblaws

EXHIBIT 5
Bathroom Tissue (1989)
Average
RetailPrice 1($)

Average
Cost($)

AnnualSales($000)

Total
Gross
Margin($000)

MarketShare(%)

President’s Choice

2.50

1.95

1,542

339

5

No Name White

1.75

1.15

3,084

1,052

10

No Name Coloured

1.80

1.35

386

96

1

5,012

1,487

16

Loblaws 2

Loblaws Total
Royale
White

1.85

1.55

10,795

1,751

34Coloured

2.00

1.60

3,855

771

12

14,6502,522

46Royale Total
Cottonelle
White

1.85

1.45

4,627

1,000

15

Coloured

1.95

1.50

4,627

1,068

15

9,254

2,068

30

Cottonelle Total
Other Brands
Capri

1.50

0.90

945

378

3

April Soft

1.40

0.95

721

232

2

Jubilee

1.35

0.70

386

186

1

Dunet

2.45

1.60

405

140

1

White Swan

1.55

1.00

463

164

1

Other Brands Total

2,920

1,100

8

Total

31,836

7,177

100

1 Statistics for the prices, costs, and sales have been collapsed over the various sizes and reported in equivalent four-roll packs. Total unit sales were 17,125,000 (four-roll packs).
2 With respect to colors and sizes, Loblaws offered six varieties, Royale (eight varieties), Cottonelle (eightvarieties), Capri (four varieties), April Soft (three varieties), Jubilee (two varieties), Dunet (one variety), andWhite Swan (eight varieties).

maintain good margins; or it could be priced ashigh as Kellogg’s Corn Flakes at $2.30 and generate superior margins.
Having reviewed the three proposals, Scott began
the process of preparing his recommendations. “I’llstart with the financial projections,” thought Scott,“then consider the pros and cons of each proposal.
Then it’s decision time.”

599

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Loblaws

CASE 5595

Loblaws

EXHIBIT 6
Family Cereals (1989)

President’s ChoiceBran with Raisins
Honey Nut Cereal
Toasted OatsCorn Flakes
Crispy Rice

Average Retail
Price*($)

Average
Cost($)

AnnualSales($000)

Total Gross
Margin($000)

Market
Share
(%)

2.35
3.00
3.00
1.75
3.20

1.50
1.40
1.45
1.20
1.50

1,051
324
221
193
263

380
173
114
60
139

7.4
2.3
1.5
1.4
1.8

2,052

866

14.3

1,436
1,236
460
899
433
326
309
258

312
324
141
315
167
129
105
87

10.1
8.7
3.2
6.3
3.0
2.3
2.2
1.8

5,357

1,580

37.5

2,725
169
139

754
57
50

19.1
1.2
1.0

3,033

861

21.2

1,171
1,017

370
339

8.2
7.1

2,188

709

15.3

389
358
281
92

139
119
89
36

2.7
2.5
2.0
0.6

1,120

383

7.8

573

227

4.0

14,323

4,626

100.0

Loblaws Total
Kellogg’s
Corn Flakes
Raisin Bran
Honey Nut Corn Flakes
Rice Krispies
Common Sense
Mini-Wheat
Variety Pack
Other Kellogg’s

2.30
2.75
3.95
3.95
4.40
3.30
5.90
3.41

1.80
2.00
2.70
2.52
2.70
2.00
3.90
2.26

Kellogg’s Total
NabiscoShreddiesApple/Cinnamon
Raisin Wheat

2.35
2.25
3.30

1.70
1.50
2.10

Nabisco Total
General Mills
Cheerios
Cheerios/Honey Nut

3.80
3.90

2.60
2.60

General Mills Total
QuakerCorn BranLife
Oat Bran
Muffets

3.50
3.15
4.10
2.65

2.25
2.10
2.80
1.60

Quaker Total
Others
Total

2.40

1.45

*Based on 500-gram size. Total unit sales were 4,950,000 (500-gram size).
Cereals are packaged in several different sizes. Some brands, such as Kellogg’s Corn Flakes, could have four different sizes (e.g., 350g, 425g, 675g, 800g) on the shelf at one time. To facilitate comparisons, all figures have been converted to a standard 500g size; where brands had multiple sizes, the figures are reported as averages, weighted by
the sales volume of the size.

C A S E 6 CIBC
INTRODUCTION
The morning meeting was on her mind as Pat
Skene, vice president of the Consumer Credit
Division of the CIBC Personal and Commercial
Bank, entered her office on June 5, 1995. Pat was not
sure if her department had the time, energy, orbudget to continue promoting Bankware II.
Bankware II was a software diskette that provided
users with information on CIBC products and services and allowed users to do financial planning,
including calculating mortgage and loan plans.
While Bankware had been well received by customers, Pat wondered whether the software contributed to the new strategic direction in which thebank was moving. Hopefully, the meeting would
decide once and for all what to do about Bankware.
THE COMPANY
Over the last 125 years, CIBC had grown to become
North America’s fifth largest bank and the second
largest bank in Canada.1 Consumers were mostfamiliar with CIBC’s Personal and Commercial Bank,
which provided a full range of financial services to 6
million Canadian customers. Personal banking
involved basic transaction services, deposits andinvestments, consumer loans, residential mortgages,
VISA issuing and merchant services, and otherrelated financial services. The CIBC Personal andCommercial Bank provided Canadians with these

1 CIBC was the corporate identity for a number of related
corporations and operating units. These included the Personal
and Commercial Bank, the Investment and Corporate Bank,CIBC Development Corporation, CIBC Finance, CIBC
Mortgage, CIBC Trust, CIBC Insurance, CIBC Wood Gundy
Securities, and foreign subsidiaries throughout the world.

24banking services through its network of 1,428
branches, 2,887 automated banking machines(ABMs), and 40,800 full-time personnel. Services
such as CIBC LinkUp, CIBC Contact, and Commcash
augmented the delivery network.2 In fiscal year 1994,
CIBC managed $115,462 million in deposits and$99,938 million worth of loans for individuals, businesses, governments, and banks. In 1994, CIBC had
its best year ever, with a net income of $890 million, a22 percent increase from 1993.3 (Exhibit 1 provides
selected financial information for CIBC.)
In recent years, CIBC had increased its liquidity,
improved the quality of its lending portfolio, andrefined key business strategies as the bank moved
toward its goal of becoming the preeminent
Canadian financial services company. CIBC strove
to accomplish this initiative by focusing on meetingthe needs of its customers, and by building a corporate culture that encouraged employees to maintain this focus. The CIBC 1994 Annual Reportcontained the following statement by A. L. Flood,
Chairman and Chief Executive Officer:
In the Personal and Commercial Bank, we are working
to better align our services and delivery systems withcustomer preferences. We want to ensure that we canmeet our customers’ basic banking needs in efficientand accessible ways. At the same time, we will
enhance how we deliver, value-added service to customers with more complex financial requirements.

2 CIBC Contact provided toll free telephone access to staff
able to provide information on CIBC products and services.
The telephone lines were open Mon.-Fri. 8a.m.-9p.m. and Sat.
8a.m.-6p.m. (Eastern times). CIBC LinkUp was a service available to customers wishing to use their telephones to transact
banking activities. Commcash was a similar service offered tocommercial customers.
3 All corporations and operating units.

This case was prepared by Ian McKillop, Gordon McDougall, and Natasha White, School of Business & Economics, Wilfrid
Lauirer University, Waterloo, Ontario, Canada. The case was written solely for the purpose of stimulating student discussion. The
assistance provided by the Consumer Credit division of CIBC is gratefully acknowledged. Certain data have been disguised. Allamounts are in Canadian dollars unless indicated otherwise. It is reprinted here by permission. Copyright © 1996 by the Case
Research Journal and Ian McKillop, Gordon McDougall, and Natasha White.

596

601

602

CIBC

CASE 6 CIBC

597

EXHIBIT 1
CIBC Selected Financial Results 1990–1994(Dollar Figures, Canadian $, in Millions)
1994

1993

1992

1991

1990

Net income
Net income applicable to common shares
Total assets

$890
749
151,033$730
599
141,299$12(108)132,212$811
710
121,025$802
709
114,196

Loans
Residential Mortgages
Personal and credit card loans
Business and government loans

32,225
16,80750,90630,72014,65051,811

28,927
14,31851,682

25,616
14,60846,137

24,196
14,71544,420

Deposits
Individuals
Businesses and governments
Banks

59,04036,313
20,20957,26534,357
19,28354,233
26,873
15,91250,412
34,095
10,96447,53431,605
10,971Return on Assets, %Return on common equity, %Ratio of Noninterest expenses to revenue
Ratio of net nonperforming loans to loans and acceptances
Ratio of credit losses to loans and acceptances
Earnings per share
Book value per common share

0.60
11.7
61.2
1.4
0.8
$3.52
31.18

0.53
10.6
61.5
2.3
0.9
$2.99
28.9

0.01
9.68
(2.0)
13,9
64.6
N/A
3.0
2.0
1.8
N/A
$(0.59)
$3.93
27.44
29.41

0.74
15.8
N/A
0.9
N/A
$4.03
26.90

THE INDUSTRY
Collectively, Canada’s banks had assets in excess of$777 billion. There were nine domestic charteredbanks in Canada and 51 foreign bank subsidiaries
in Canada. Canadian chartered banks managed liabilities of $642,126 million, demand deposits of$41,332 million, notice deposits of $141,420 million,
and loans worth over $470,464 million. There were
7,971 domestic bank branches across Canada.
The Royal Bank of Canada was the largest financial institution in Canada, with assets of $173,079
million and a net income of $1,169 million for fiscal
year 1994, up from $300 million in 1993. The RoyalBank served more than 9.5 million personal andbusiness clients through its 1,600 Canadianbranches, 3,900 ABMS, 442 account updaters, and
30,000 point-of-sale merchant terminals. The Royalmanaged $135,815 million in deposits and $115,386
million worth of loans for Canadian individuals,
businesses, governments, and banks.
The second largest financial institution in
Canada was CIBC; the Bank of Montreal—withassets of $138,175 million and a 1994 net income of$825 million, up from $709 million in 1993—was aclose third. The Bank of Montreal had 34,769
employees, 1,248 branches, and 1,708 ABMs in
Canada and managed $98,241 million in deposits
and $88,634 million worth of loans.
Collectively, Canada’s six largest domestic
banks, which controlled over 80 percent of all bankassets in Canada, had net income of $4,266 million
in 1994, up from $2,903 million in 1993 and $1,844
million in 1992. The increase in net income
reflected, in part, the improvement in the Canadian
economy, which had experienced a deep recession

CIBC

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CASE 6 CIBC

up to 1992 but had begun a recovery in 1993 which
had continued in 1994 and 1995.
CONSUMER BANKING IN THE NINETIESThe delivery of banking services had changed considerably in the past 10 years. Automated banking
machines and other on-line processing technologies
had allowed banks to move work out of branches
and into the “back room.” This had freed branchstaff to concentrate on providing improved customer service and marketing the bank’s deposit
and credit products.
For many consumers, “convenience” was thewatchword of the ‘90s. Consumers increasingly
counted on their banks to provide basic transaction
services quickly, cheaply, and accurately. Drivethrough banking machines, telephone banking systems (such as CIBC LinkUp), 800 numbers thatprovided 24-hour access to personal banking representatives, and self-serve passbook updatingmachines were examples of technologies introduced by banks to offer customers increased levelsof convenience and service.
Banks had also recognized that, for some customers, additional levels of personalized service
might be more appropriate. These customers often
had more complex banking needs and might lookto their bank for investment counseling and otherforms of asset management services. These customers were often highly profitable because they
made use of a wider range of bank services andthus contributed to the bank’s profits through fees
and interest earnings to a greater degree than customers who relied on their banks only or primarily
for automated services related to individual transactions. One study of bank customers indicatedthat “transaction-oriented” customers were marginally unprofitable while “personalized service”
customers were very profitable. Another study ofbank customers revealed that, on average,
Canadians dealt with 2.2 banks, 26 percent used
one bank, 37 percent used two banks, and 37 percent used three or more banks. Multiple bank users
tended to have more complex banking needs. At

many banks, customers with complex or extensive
banking requirements were assigned a personalbanking representative or “account manager”
incentives or premiums were sometimes offered to
reward these customers for their loyalty to a specific bank. For example, at one bank, if a customer
had at least three products in his or her portfoliothat together added up to $50,000 the client automatically received a 1/4 percent discount on a credit
product such as a car loan. if the client’s bank portfolio exceeded $100,000, the client received an automatic 1/2 percent discount on a loan. Similar
premiums were offered for deposit products suchas Guaranteed Investment Certificates. There wasintensive competition to attract and hold the more
profitable customers.
HOW CIBC COMPETEDThe CIBC’s Personal and Commercial Bank competed on quality, service, and personal relationships with its customers. The bank’s corporate
philosophy was best illustrated by Holger Kluge,president, Personal and Commercial Bank:
We’re not in the business of selling financial products.
We’re in the business of helping our customers
achieve their financial goals.

Over the past year, the CIBC had completely
repositioned itself to respond to the needs of its
customers. In the past, the bank had been very
focused on products which were sold based on
price and product attributes. Now, CIBC’s corporate strategy was based on two fundamental concepts. The first was relationship banking: a focus
on serving the ‘whole client’ instead of a focus on
selling products. The second component of thestrategy was customer segmentation: grouping
customers according to similar needs and expectations and then tailoring the way in which services
were delivered to meet these needs.
Relationship banking encouraged bankers tomove away from a product-focused marketingstrategy (e.g., selling car loans, term deposits,
mutual funds, etc.) and to concentrate instead on

603

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CIBC

CASE 6 CIBC

providing an integrated, tailored package of banking services designed to meet the needs of individual clients and households. For example, a clientwith $20,000 in a checking account (which had low
interest rates) might be encouraged to invest in amoney market fund (which had higher interest
rates). The customer profited from the increased
interest earnings, and the bank profited because thefunds were now co-mingled with other monies
with which the bank could pursue various investment strategies of its own.
CIBC grouped its customers into two broad segments: customers who valued convenience andcustomers whose banking needs caused them to,value personal service. The customers who valued
the convenience of “anywhere” banking counted
on the bank to provide quick, efficient, economical,
and accurate handling of their transaction-oriented
activities. The advanced features available throughABMs and CIBC’s LinkUp service met many of thebanking needs of these customers. Personal banking representatives were available in every branch
to assist with transactions that could not beprocessed through an ABM.4
Customers who valued personalized service
made up about 10 percent of a typical branch’s clientele and about 20 percent of the bank’s overall clientbase.5 While many of these customers also valued
convenience (in that they also wanted their banking
activities handled quickly, efficiently, and costeffectively), customers in this category usually had
more complex banking requirements. These cus-

4 Applying for a term loan or arranging for a Guaranteed
Investment Certificate were examples of services with whicha Personal Banking Representative could offer assistance.
Customers who valued convenience were also able to call
CIBC Contact to access a Personal Banking Representative,
freeing the customer from the need to actually come into a
branch.
5 The segmentation ratios are slightly different between atypical branch and the bank overall because there is a highconcentration of customers with extensive banking requirements at main branches in major centres such as Toronto,
Montreal and Vancouver.

599

tomers typically purchased a wider range of bankproducts. In addition, many had Hearings withCIBC partner organizations such as CIBC Trust or
CIBC Wood Gundy Securities, or might be expected
to have such needs in the future. To meet the needsof these clients, CICB had created the position of“relationship banker.” Relationship bankers were
specially trained personal banking representatives
with good product knowledge, excellent moneymanagement skills, and a strong people-oriented
service focus. They worked closely with clients toprovide a comprehensive and personalized packageof banking services. A relationship banker in a typical branch might have 200 clients.
CIBC’s emphasis on personal relationships wasreflected in the bank’s advertising. The bank nolonger advertised individual products such as car
loans. All advertising and promotional materials
now reflected the changing needs of the customer
and the customer’s family. Instead of a brochure carloans that featured an illustration of a new car on
the cover, a customer might find a brochure thatoffered comprehensive guidance to home ownership with a picture of a family on the cover. Insidewould be descriptions of CIBC products applicable
to home ownership such as mortgages, credit cards,
and personal lines of credit.
In a service industry where it was becoming
more and more difficult to differentiate throughproducts, CIBC was differentiating itself based on
its relationship with the client. CIBC believed that
customers were more concerned with how well afinancial institution helped them meet their needs
and realize their financial aspirations than withwhat products the bank had for sale.
SYSTEMS SUPPORTFor relationship banking to succeed, bankers
required access to a completely integrated, comprehensive customer database that consolidated all ofa customer’s interactions with the bank into asingle client portfolio.
Relationship bankers at CIBC had access to anumber of software products developed by the

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CASE 6 CIBC

CIBC’s Information Technology division to help
with this task. These software products could: (1)track the various banking services used by a household, (2) help bankers process credit applications
and monitor credit products currently “on thebooks,’ and (3) help bankers assess customer profitability (a banker could see the current contribution to branch operations generated by a particularhousehold, including information on the total valueof deposits and loans held by the household).
In the near future, a new software system currently under development would allow personalbanking representatives not only to process
deposits and withdrawals, but also to determine
the profitability of each client and even identify
clients who were good candidates to approach
about investment or lending opportunities.
CONSUMER CREDIT
The Consumer Credit Division was one of anumber of divisions within the Personal andCommercial Bank.6 Consumer Credit, located in
Toronto, had a staff of 120 employees and six
regional consumer loan departments acrossCanada. Vice President Pat Skene managed a $10
billion portfolio of consumer credit products andwas responsible for the marketing, operations,credit policy, and head office administration for allof Consumer Credit’s products and services whichwere sold by CIBC branches across Canada.
Products Sold by the Consumer Credit Division
Overall, CIBC marketed 106 different products,
which included various types of deposit accounts,
investment instruments, RSPs, VISA cards, loans,and mortgages. The average client made use of
three of the 106 products sold by the bank.

6 Some of the other divisions included VISA, Retail Deposits,
Mortgages, Private Banking, Investments, Marketing,Commercial Banking, Collections, and Delivery Network.

The Consumer Credit Division was currently
responsible for managing all retail loans, which
included three of the bank’s main product lines:
personal loans, personal lines of credit (PLCs), andoverdraft protection. (Exhibit 2 provides an
overview of these product lines.)
Deposit instruments (including money lining
dormant in transaction accounts) were the bank’s
most profitable product line, followed closely bymortgages.7 Credit products (such as those managed by Consumer Credit) came in third. In recent
years, there had been an increase in personal linesof credit, while the number and dollars of personalloans issued had been decreasing. Banks (and theircustomers) were turning more and more to PLCs
alternative to the personal loan. PLCs required lesspaperwork than personal loans, and were generally less intimidating for the customer. (Consider
that with a PLC, customers only had to apply forcredit once. Thereafter, they were free to use thecredit as they chose without having to explain theirpurchase wishes to a banker.) CIBC had more than17 percent of the Canadian market in PLCs and22.5 percent of the market in personal loans.
About one quarter of households in a typicalbranch purchased a PLC product, while 13 percent
of households in a typical branch had overdraft
protection. About 11 percent of PLC users chose to
secure their PLC in order to take advantage oflower interest rates. A typical PLC customer had acredit line of $20,000 with an outstanding balanceof $15,000.
Pricing and Costs Associated with Personal Loan
Products
Credit products were priced in relation to thebank’s cost of funds—the rate that the bank paid to

7 While deposit instruments in general were very profitable,
customers who maintained chequing and savings accounts
with balances of less than $100 were generally unprofitable.
Customers with very small chequing or savings account balances could represent up to 20 percent of a typical branch’s
clientele.

605

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CASE 6 CIBC

601

EXHIBIT 2
Main Credit Products Managed by the Consumer Credit Division
Personal Loans
There are two types of personal loans: demand loans andterm loans. Demand loans must be repaid immediately
upon request by the bank. Term loans must be repaid infull by an agreed upon date, although the loan can be
paid out at any time without penalty. Term loans typically run less than 72 months, but can go as long as 300
months in special circumstances.
Term loans require the borrower to make regular(usually monthly) payments during the period of theloan. The payments are designed to “pay out” the loanin full during the period of the loan. Payments consist ofboth an interest and a principal portion. The amount of
the payment is determined using annuity formulas fordaily compounding interest.
Demand loans are similar to term loans except that inreturn for the customer agreeing to repay the bank
immediately upon its request, the customer is charged
an interest rate less than that charged for a similar termloan. In order to ensure that the customer has the ability
to honour a possible “demand” for payment, customers
seeking demand loans must usually have liquid assets
equal to the amount of the loan.
Typical uses for personal loans are to purchase a car,consolidate debt, or finance minor home renovations.
Once a personal loan is paid off, the customer needs toinitiate a new application should financing be required
for another purpose.

Personal Lines of Credit (PLCs)
A line of credit allows customers to establish a set lending limit against which they can borrow by simply writing a cheque on a special “line of credit account.” Writinga cheque has the effect of establishing a loan on the datethe cheque is processed by the bank. Interest charges
begin on that day, and interest rates are similar to thoseoffered on term loans. Once the loan is paid off, however,the credit line continues to be available for use by theclient without a subsequent application to the bank.
Many customers choose to “secure” their line ofcredit by offering their house or other forms of equity as
collateral. In return for the reduced risk that this form ofcredit line presents to the bank, the bank usually offers a
discount on the interest rate charged.

purchase the money it wanted to lend. The difference between the bank’s cost of funds and the interest rate charged to a customer determined therevenue stream the bank would receive from thesale of the credit product.
Branches had total price discretion on loans.
Personal banking representatives examined the
profit in relation to the customer’s financial
strength and the total relationship with the client
when making pricing decisions on credit products.
Personal banking representatives might even granta customer a loan at a rate slightly over the bank’s
cost of funds if they felt that the overall relationshipwarranted such a step.

The Past Four Years in Consumer Credit

Overdraft Protection
Overdraft protection provides customers with theknowledge that should they inadvertently write chequesfor which there are insufficient funds in their accounts,
the bank will honour the cheques up to the amount of
the pre-established overdraft protection limit. Overdraft
limits could be anywhere from $100 to $5,000 dependingon the customer’s needs and credit worthiness.
The customer is not charged for overdraft protection
until the overdraft position is required. Interest charges
are then hefty, often 21 percent.

In 1991, the Consumer Credit division was suffering from the effects that the recession was havingon CIBC’s client base. A strong focus on marketing
CIBC credit products, combined with a lack ofsophisticated risk management and assessment
tools accessible to branch staff, compounded the
problem. Although Consumer Credit had a large
number of loans under administration (which
under normal circumstances would have been very
profitable), arrears, delinquent loans, and loan
writeoffs were having a significant impact on profitability (Exhibit 1).

CIBC

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CASE 6 CIBC

Pat Skene mid the Senior Vice President, Brian
Cassidy, both joined the division in 1991 andassumed responsibility for turning things around.
Credit policies needed to be revised and better risk
management tools needed to be developed. In the
short term, credit-granting procedures were tightened and branch staffs were encouraged to avoid
extending loans of marginal quality.
Resources were dedicated within Consumer
Credit to enhancing existing credit scoring systems
and implementing new on-line credit administration systems. Significant enhancements to software
were made during this period to assist in new
application assessments and portfolio management. Organizational improvements were also
made. For example, a “line of business” approachto management was introduced. Bottom-line
responsibility was given to cross-functional teams
responsible for specific product lines (like PLCS.)This was in contrast to the previous organizational
structure built around three functional areas: marketing, operations, and credit management. A special risk management unit was added to oversee
the new Consumer Credit teams who now had abottom-line responsibility for their product line.
At the same time, however, loan products wereassuming a less significant role in the activities of
CIBC branches. With stringent controls placed on
the granting of credit, many bankers had moved
on to marketing other products (such as deposit
instruments, RSPs, etc.). It was hard to find abanker who considered himself or herself to be alender during this period. It had been said thateven a creditworthy customer had to “come out
and ask, and then insist” to get branch staff to sit
down and consider selling a credit product.
THE NEW CAMPAIGN
By late 1992, Consumer Credit was ready to begin
the process of attracting new, quality loans. A significant challenge lay ahead. Branch staff, who
was once empowered to make credit decisions,
had that authority reduced during the restructuring process. Now the Consumer Credit wanted toconvince branch staff that the appropriate systems, policies, and controls were in place toactively meet customers’ credit needs. Threethings were needed: to disseminate the new
approach throughout the organization, to explain
the new software, and to find ways to differentiate
CIBC products from the competition.
The first step was to communicate to branch
staff(Personal
Banking
Representatives,
Managers, etc.) what had happened and to sharewith lending staff that CIBC wanted to write new
personal loans. To accomplish this, two senior
executives from the Consumer Credit group (Brian
Cassidy and Pat Skene) set out in November 1992
to travel across Canada meeting with front-line
bankers in every district. Their message was clear:“We are changing the loan experience.” A second
step was to share with branch staff how the newenhancements to the software system would help
them better serve their customers. Training andeducation seminars on the new credit scoring
system were held across the country.
The last step was to find ways to differentiate
CIBC loan products from competitors’ products.
This was important because loans were a commodity. Unless CIBC loan products had valueadded features that somehow distinguished themfrom those of the competition, CIBC bankers
would have difficulty attracting customers awayfrom the other sources of credit that they had discovered during the previous year and a half.
The Consumer Credit team met in 1992 to brainstorm ideas that would add value to the personalcredit products, and that would help differentiate
CIBC loans from those offered by other banks.
Many innovative ideas emerged from these sessions. Six of these ideas were implemented as apart of a campaign targeted at branch staff called“We’re Changing the Loan Experience.” The six
main elements of this campaign were as follows.
1. Roadside assistance. Lenders were able to offer
one year of roadside automobile assistance (atno cost) to customers taking out a new loan. This
was a great selling feature for car loans, although

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2.

3.

4.

5.

Roadside Assistance could be offered as a premium with a loan taken out for any purpose.
Discount coupon for loans. Bankers were provided with a promotional tool designed to
thank customers and reward them for theirbusiness. After making the last payment on aloan, customers would receive a thank-you notefrom a personal banking representative. A
coupon for a 1/2 percent discount on the customer’s next loan with CIBC was included with
the note. There was also a place for the banker
to include two copies of his or her card. One
card could be kept by the customer, and the customer was encouraged to pass the second cardalong to a friend.
This promotional item was well received byboth lenders and customers. Bankers liked how
they could formally thank customers for theirbusiness with a small token of their appreciation(the discount coupon) and, in the process, possibly attract new business in the future.
Customers liked the fact that the bank had
rewarded them for their business with a coupon
that could save them hundreds of dollars on
their next loan.
Bankware. A software diskette was developed
containing information about products and services offered by the bank. The diskette also
included credit planning tools such as a mortgage payment calculator and a budgeting template. Customers could even use the diskette tolearn how much credit their income and current
lifestyle could support.
An informational booklet. A well-written, informative booklet, “Credit Smart,” was developedthat answered questions people commonly ask
about credit and how credit is granted. Much of
the contents of the booklet could also be foundin the Bankware software. However, unlike thesoftware, the booklet did not have automatedscenario calculation capabilities.
Free VISA Classic card for a year or Free CIBC
LinkUp for a year. For customers applying for a
CIBC consumer credit product, bankers could
provide vouchers waiving the normal fee for a

603

CIBC Classic VISA card for a year, or they could
provide one year’s free CIBC LinkUp service.
6. The “valued customer” portfolio. A burgundy
slipcase with a gold elastic binding was introduced that branch staff could provide to customers when a loan was approved. The
slipcase contained slots to store loan documents, informational brochures, a copy of the
Bankware disk, and the banker’s businesscard. While this seemed like a value-added
idea, branch staff never warmed to the concept.
Thousands of the burgundy slipcases languished in the Toronto warehouse.
In March 1993, an additional promotion was
introduced called Last Payment on Us. The Last
Payment on Us program offered customers theopportunity to have the bank make the final payment on their personal loan (up to $500), provided
that the loan was kept up to date with regular payments during its amortization period. This program
was enthusiastically received by branch staff andcustomers appeared to respond positively.

Bankware I and Bankware II
While the idea for Bankware came out of the brainstorming sessions at Consumer Credit, the seed forthe idea had been planted in Brian Cassidy’s mind
when he saw a similar, but simpler, product from
Wells Fargo, a large U.S. bank, at a U.S. trade show.
The Wells Fargo diskette had been developed byInteractive Media from San Francisco. CIBC contacted Interactive Media to see if they could produce an enhanced diskette for the Canadianmarket. The resulting software, Bankware, allowed
users to explore features of CIBC loan, mortgage,and other credit products. Consumer Credit paid
for the software development and distribution
costs from its own operating budget. Total cost for
Bankware was US$250,000.
Bankware was introduced to the Canadianpublic in early 1993. Using Bankware, customers
could calculate a budget, determine their net
worth, apply for a mortgage or loan, and learn how

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to save on interest costs. The software, was distributed to branch managers, who, in turn, gave
copies to interested customers. A full-page advertisement was run in Globe & Mail, Canada’s
national newspaper, encouraging people to mailin a coupon in response to which the bank would
send out a copy of Bankware. Over 144,000 copiesof the software were produced and distributed.
Customers (and potential customers) could now
explore the various options open to them before
entering a branch to apply for a loan, mortgage, orline of credit.
As Brian Cassidy observed:
Bankware was a great idea. As an advertising andpromotional tool, consider its staying power. You giveaway a brochure and it gets thrown out. You giveaway a diskette and it gets copied.

Bankware was well received, but many people,
including customers, had ideas for additional features that should be incorporated into the software. The Consumer Credit division decided tocommit resources to develop an improved version,
Bankware II.
While Bankware concentrated on services andproducts offered primarily by the Consumer
Credit group, Bankware II showcased the muchwider range of products and services available
from CIBC. Features of deposit accounts, investments, VISA, mutual funds, mortgages, and loans
were all to be added to the software to present acomprehensive overview of products offered by
CIBC. A section targeted at introducing children to
the world of banking was planned. The new version was to have a strong customer focus.
Other divisions of the bank (such as VISA, CIBC
Wood Gundy, etc. were invited to participate in thedevelopment of Bankware II. Although coordinated by Consumer Credit, the division looked forward to being able to include promotional
materials submitted by the other divisions.
However, most divisions chose to have Consumer
Credit staff prepare the marketing material todescribe their products. As Consumer Credit prepared materials, they were sent to the other divi-

sions for their review and approval. Despite thefact that Bankware II would promote products
from many other divisions and entities within
CIBC, the full cost of the software’s development
was sponsored by Consumer Credit.
Consumer Credit had initially planned to contract out Bankware II’s development (as had been
done with Bankware), but soon found it necessary
to produce the script for the disk themselves, andthen work with an outside programmer to complete the disk. Working as a team, Consumer
Credit’s product staff created the diskette’s content, while Consumer Credit’s marketing staff handled packaging and distribution. From start tofinish, Bankware II cost $250,000 to produce. The
direct production costs were as follows:
Software development
Disk duplication(including virus scanning)
Jacket printing
Assembly(insert disk into jacket, collate, wrap)
French translation$100,000.00
88,000.00
19,000.00
23,000.00
20,000.00

The indirect costs were 462 person days of effort
from Consumer Credit staff time committed tomeetings, product brainstorming, developing
scripts, testing, etc.
Bankware II was launched in September 1994.
Among other features, the new version offeredusers the ability to print personalized mortgage
amortization tables and to compare cash back caroffers with discounted loan interest rate offers.
There was even a section designed so that children
could explore the services offered by a major bank.
Bankware II allowed customers to learn, explore,
compute, make decisions, and print out information on virtually any of CIBC’s products and services. A total of 150,000 English and 25,000 Frenchcopies of Bankware II were produced.
Competition for Bankware II was minor. The
Toronto Dominion Bank and the Bank of Montreal
had information diskettes, and the Royal Bank had
a small business diskette. As far as anyone knew,

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no other bank had a promotional product similar to
Bankware II.
Two focus groups were held to gain insight into
customer perceptions of the original Bankware.
Results from the focus groups suggested that customers might be undervaluing the true value of
Bankware because it was being given to them forfree. The groups suggested that the bank charge a$15 fee for the disk in order to increase the perceived value of Bankware II to the customer. Bank
officials disagreed. They thought that Bankware II
was a promotional tool to help the customer andshould not be seen as a way to generate revenue.
Branch managers had been given 100 free copiesof the first version of Bankware, after which they
were able to obtain additional copies from Head
Office for $0.50 each. This charge was debited to thebranch’s marketing budget, just as the branch paid
for posters and other promotional items such as
certain brochures and CIBC crested pens. Branches
were encouraged to load Bankware on their personal computers so that staff could familiarize
themselves with the product and be able to demonstrate it to clients. No free copies of Bankware II
were given to branches. Given the penetration of
the first version of Bankware, it was thought thatbranch staff would know the product well enoughto order copies of Bankware II from Head Officewith their regular promotional items order. Over85,000 copies of Bankware II were ordered bybranches, but it became clear by early 1995 thatbranches were shying away from ordering
Bankware II. Head Office then removed the nominal fee ($0.50), and almost overnight the branches
requested another 41,650 copies. Clearly, there wasa pent-up demand for the diskette. It was estimatedthat 80 percent of the Bankware II diskettes distributed to branches were passed along to customers.
As with the first version of Bankware, many ofthese diskettes were copied by customers andpassed along to friends.
Bankware II was available free of charge to CIBC
customers. Unfortunately, many of the bank’s customers were unaware that the product existed.
Branch managers often kept copies of Bankware II605

in their desk drawer, and only distributed thediskette to customers upon request. This might
have been a hold-over from the days of the We’re
Changing the Loan Experience campaign when thediskette was considered to be a premium to beoffered to customers to thank them for their business. Other than at one Toronto branch, thediskettes had never been left out on a table for customers to pick up as they passed by. The reason forthis given by one banker was, “If you were to leavehuge piles of diskettes on a table some people
might scoop up a whole bunch to take home andreformat as blank floppies!
Many bank managers and personal banking representatives were enthusiastic about Bankware II.
One Montreal bank manager raved:
Bankware II is one of the best promotional tools thebank has developed. . . . It helps the customer help
themselves. Customers can see what they, qualify forand become a better educated consumer by exploring
the various options available to them. This knowledge
reduces the customer’s feelings that the bank works in
mysterious and unpredictable ways. Designing a loan
to meet the needs of a customer is hard. Bankware II
makes it easier for me to serve my customers because
the customer is already aware of his or her options.

An Edmonton branch manager agreed:
Bankware II is great! A good customer is an informed
customer, and Bankware II helps to show customers
what their best options are. For ourselves, Bankware II
not only provides control, but has the potential tolower the cost of dealing with a transaction in the
future. Right now all inquiries generated in response
to fax-back screens in Bankware II8 go through CIBC
Contact, but in the future I could see the customer
bringing me an electronic file all ready for processing.
This would reduce paperwork and data capture time

8 One of the features added to Bankware II was the ability
for customers to automatically fax their completed loan applications to CIBC Contact. Customers whose computers did nothave built-in fax capabilities could print a copy of their loan
application and either mail it to CIBC Contact or take it into a
local branch. Bankware II did not include the ability to directly
connect via modem with CIBC's information system.

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CASE 6 CIBC

at my end, freeing me up to spend more time with thecustomer on other financial planning issues.

At other branches, few disks were distributed.
One problem was that CIBC’s Information System
Division had changed the operating system at thebranches from DOS to OS/2 just before the releaseof Bankware II. For integrity and security reasons,only software developed or supported by the
Information System Division was loaded on the
network servers. This meant that Bankware II
could not be loaded at the branch level and customers could not be shown how to use it at thebranches.
Within the Consumer Credit division, the staff
felt that the need for Bankware was apparent. In
the opinion of one Consumer Credit employee:
Sometimes bankers don’t realize that some customers
feel incredibly intimidated when seeking a loan.
Approval of a loan is an everyday occurrence fromthe bank’s perspective while it is a rare occurrence forthe customer. Furthermore, bankers often feel that
customers are aware of the various financial options
while customers themselves feel that they have noother options. The bank’s offer is often seen as a “takeit or leave it” situation. With Bankware II, the borrowing transaction is not such a ordeal for the typicalcustomer.

Pat Skene had her own interest in promoting
Bankware II. She knew first-hand the tremendous

job that her staff had done in developing andputting Bankware II together. She was, moreover, atrue believer in Bankware II’s advantages:
Customers really need Bankware II. If the bank wants
to build strong, binding relationships with customers,
it must look to customer needs. Bankware II helps thebank address these needs, allowing customers tomake informed decisions about their finances.

THE TEAM MEETINGThe managers and staff from all of Pat Skene’s
Consumer Credit departments were chatting about
Bankware II around the boardroom table as Pat
arrived. The agenda for the team meeting had been
set for weeks. (See Exhibit 3.) In attendance were:
Pat Skene

Vice President,
Consumer Credit
Rita Ripenburg
General Manager,
Retail Lending
Catherine GardnerSenior Manager,
Personal Loan Portfolio
Warren Wood
Product Manager
Rosemary Naltchadjian Product Manager
Michelle Thomas
Secretary to Pat Skene
Denise Fawcitt
Manager, Marketing(Consumer Credit)

EXHIBIT 3
Notice of June 5, 1995, Board MeetingTo:
All CC Staff Involved in the Development of Bankware or Bankware II
When:
June 5, 1995, 10:00 a.m.
Location: 1st floor conference room—CC operations Centre
Coffee available.
Agenda:• Welcome and Introduction• Review of Bankware Project• Future Plans
Bring your thinking cap and your coffee mug!
Telephone regrets to Michelle at ext. 8501.

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CASE 6 CIBC

Ming Wong
Sherwin Lui

Systems Manager(Consumer Credit)
Manager, Office Systems

and seven representatives from the operations andthe risk management groups.
Pat opened the meeting, “I would like to begin
by thanking everyone for the countless hours thatyou have all put into the development of Bankware
II. I am extremely proud of the Consumer Credit
department and all of the innovative work thateach of you has put into Bankware II.”
Pat: When we started working on Bankware II
we thought branch staff would love the productand could not help but get excited about all thecapabilities Bankware II gives our customers. But
since the launch of Bankware II, the product hasn’t
taken off as we had anticipated. Warren tells methat we still have 48,350 copies in inventory

607(Exhibit 4), and this is after we told the branches
that they could have copies for free. We need tomake some tough decisions.
Consumer Credit launched Bankware back in ‘93
as a part of our initiative to regain a dominant position in the personal credit marketplace. We haveaccomplished this. In fact, as you know, we havejust finished our best year ever. Bankware was apart of that turnaround. Now we have to decide
where we want to go in the future.
Depending on what happens next with
Bankware II’s development, some people have suggested that the software has the potential to change
the way the bank operates and interacts with its
customers. Maybe we could begin with some general discussion.
Denise: As Pat has said, our We’re Changing theLoan Experience campaign combined with the Last
Payment on Us campaign was extremely successful.

EXHIBIT 4Inventory Status of “We’re Changing the Loan Experience”
Campaign Items Central Stores Inventory Report 3420-B-332
Inventory Status of Campaign Promotional Materials
Campaign 34F-CC: We’re Changing the Loan Experience
Report Created: June 1, 1995
Run By: JSM
Forward To: Denise Fawcitt, Consumer Credit
Item CodeDescription
CC3453-1
THANKYOU BROCHURE—ENGLISH
CC3453-2
THANKYOU BROCHURE—FRENCH
1
CC3488-3/2 OFF COUPON—BILINGUAL
CC3493-1
CREDIT WISE BOOKLET—ENGLISH
CC3493-2
CREDIT WISE BOOKLET—FRENCH
CC3498-3
VISA CLASSIC FREE YEAR
CC3499-3
LINKUP FREE YEAR
CC3520-3
VALUED CUSTOMER PORTFOLIO
CC3532-1
BANKWARE 3 1/2 ENGLISH
CC3532-2
BANKWARE 3 1/2 FRENCH
CC3576-1
BANKWARE II 3 1/2 ENGLISH
CC3576-2
BANKWARE II 3 1/2 FRENCH

Instock
12,0003,000
15,3300130217,320
257,870
60,000560
430
33,65014,700

Backordered

0

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CASE 6 CIBC

We have increased our portfolio by over $2 billion
since the start of these programs. Some of you havebeen asking about how much the premiums costthat we used during these campaigns. I’ve put
together some numbers and you will find themattached to your agenda (Exhibit 5). Don’t forgetthat for many branches, the budget out of which
they pay for these promotional items might only be$2,500. If a manager has to choose between hosting
an investment seminar at a local hotel for $500 andbuying 100 Valued Customer Portfolios or 1,000
Bankware disks, she might be inclined to host theseminar. The “payback” is probably faster in that

she’ll make some RSP sales for sure after the seminar. The irony is that while it may take longer incoming, the return to the bank will be much larger
from a customer who uses Bankware II to choose
one of our mortgage or loan products.
Papers rustled as team members flipped
through the agenda looking for Denise’s memo.
Someone asked about how many loans were a partof the Last Payment on Us campaign.
Warren: It is hard to know how many people
will be taking us up on our Last Payment on Us
campaign, as the loans involved in this campaign

EXHIBIT 5
Cost Premiums for We’re Changing the Loan Experience Campaign
Memo from the Desk of Denise Fawcitt, Manager, Marketing
Consumer Credit—Operations Centre, North YorkMay 31, 1995
Details on premiums used for the We’re Changing the Loan Experience campaign.
Roadside Assistance
Cost is $25.00 per membership. Consumer Credit buys the memberships as needed. (Branch isn’t charged.) No figures are available on how many Roadside Assistance memberships have been purchased for customers.
1/2% Off Coupons + Thank You Brochure
Coupon + Thank You brochure costs $0.35 per set to print. 210,000 units have been ordered by branches. No data isavailable on how many coupons have been used. (We can’t spot this because Personal Banking Reps simply adjust
the interest rate in CLASS to account for the coupon.) We provide these items to branches free of charge.
Credit Wise Booklet
The booklet costs about $0.95 to print. Branches are charged $0.75 each. We printed 250,000.
VISA Classic Card
Coupon has a value of $12.00 (1 year’s VISA Classic fee). The coupon itself costs us hardly anything to print.
Branches aren’t charged for the coupons or for the cost of the forgone VISA fee revenue.
Free LinkUp Service
Situation is similar to that for the VISA Classic card coupons. CISC LinkUp is worth $2.25 per month, and the
coupon is good for one year’s service.
The Valued Customer Portfolio
Cost to us was $5.50 each. We charged branches $5.00 each. 100,000 were printed.
BankwareWarren previously provided you with information on Bankware’s development costs.

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are just beginning to reach their term. First impressions, based on the amount of voice mail I’m
receiving from branches asking how to process the
final “free” payment, suggest that the campaign
was very successful. I think the neat thing about
this campaign is how it attracted the very customers we wanted . . . people who keep their loans
up to date, pay them out on time, and never get
into arrears.
Rosemary: And I’m sure that astute Personal
Banking Reps are making sure that every one ofthese customers gets a “1/2% off” coupon alongwith a thank you note at the end of their loan. These
are just the customers that a branch will want tohang onto.
Rita: Wouldn’t it be interesting to know how
much loan business we attracted because of
Bankware II? Remember how in Bankware II wehave that great feature where customers could compare a CIBC loan with a loan offered by a car dealership at a seemingly unbelievable interest rate? By
the time you factored in the “cash back” option,
which you usually had to give up to get the “unbelievable” rate, our loan almost always came out as
the cheaper one. Imagine the edge we’d have if we
updated Bankware II to show the additional effecton the total loan cost of having the bank make thefinal payment!

609

Warren: Rita has a good point, but the Last
Payment onUs promotion is no longer offered tocustomers. But what Rita has pointed out is that thestatic nature of Bankware II doesn’t allow it toreflect the new innovations and campaigns wedevelop both here in Consumer Credit and elsewhere in the bank.
Pat drew everyone’s attention to the memo
(Exhibit 6) she had received from the Strategy
Planning Group in the Marketing Division regarding the promotion and distribution of Bankware II.
Pat: I think this memo is along the lines of
Warren’s comment. It basically says that Bankware
II is now “off strategy” because the diskette’s
strong product focus is not in keeping with thebank’s current strategic thrust of enhancing relationships with our clients.
Denise: But Bankware II is much more than aproduct-focused advertisement. It’s an educational
toot that provides consumers with the very information they need so that we can form an informed andmutually beneficial relationship with each customer.
A number of silent nods signaled unanimous
agreement. She continued,
Denise: In fact, I think Bankware’s strength lies in
its ability to better inform clients about our services.

EXHIBIT 6Interoffice Memorandum to Pat Skene from Marketing Strategy Planning GroupTo:
Pat Skene, VP Consumer Credit
From: Marketing-Strategy Planning GroupRe:
BankwareDate: April 28, 1995

As you are aware, the bank recently launched a major repositioning of itself in the marketplace. The cornerstones of
our new strategy are relationship banking and customer segmentation. We want to provide the right services at theright place at the right time, tailored to the needs of each customer.
While we think that Bankware is an innovative product, we are not sure that it fits well with the bank’s current
strategy. The diskette is completely product focused. While we think that CIBC products are very well presented in
Bankware II, the diskette is not a good fit with our current relationship-focused strategy.
We would like to suggest that you hold off further development of Bankware until we have a chance to meet to discuss this issue.

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The software allows customers to interact with thebank in a manner that is convenient, quick andtechnologically advanced. Heck . . . that is part ofthe bank’s strategy! I think that our next version of
Bankware, and I want to go on record as thinking
there should be such a product, should bedesigned to do just that . . . make banking eveneasier for the customer who values convenience.
Pat: What do the rest of you feel that it will taketo make Bankware a success in the future?
Rita: I think we need to focus on four dimensions of competition in the ‘90s. Where does
Bankware fit in terms of price, cost, quality andtimeliness?
Warren: I think that we need to put more effort
into the technological development of the productbefore we can look into promoting Bankware III
effectively. Although released in 1994, Bankware
II’s interface is already becoming dated. We should
also look into making the product available on CDROM. Bankware III should have a full featured
graphical user interface, and we need to upgrade
Bankware to work with the bank’s PC system.
Did you know that while bankers were able toexplore the features of the first version of
Bankware, many bankers have never seen how
Bankware II works because they can’t load a copyon the network. It is impossible for Personal
Banking Representatives to show customers how
to use Bankware II.
Ming: The Information Systems division is concerned about maintaining the integrity of ourcross-Canada network. I’ve heard suggestions that
we should allow customers to have direct access tothe network. Wow. Then we’d really have to makesure that we have the right security in place.
Sherwin: I agree, and yet this seems to be theway of the future. Everyone talks about the information superhighway. Did you see the full-colour
advertising supplement the Royal Bank ran in the
Globe & Mail few months ago? RBC even has theirown “home page” on the World Wide Web.
Rita: That’s true, but they don’t have a productlike Bankware II to give to customers. Right now,
we are at the leading edge of technology withrespect to how banking will be done in the next
century. We cannot afford to let go of this opportunity. I think we need to decide when to expand andwhere to expand. I think we should develop
Bankware III and distribute it in an all-out nationwide campaign. What does everyone else think?
Rosemary: What’s our goal here? Are we trying
to attract new customers to the bank, or to sell
additional products to the customers we alreadyhave. My friends in Delivery Network tell me that
it is expensive to attract business from other banksparticularly profitable business. We end up giving
so many interest rate concessions that it’s hard to
make a profit. Why not focus Bankware so that ithelps cement relationships with existing clients?
Catherine: Look, Bankware is a great product,
and along with the other initiatives that we put inplace as a part of the We’re Changing the Loan
Experience program, it helped contribute to our
success in attracting new loan business. But let’s
not forget that Bankware II was expensive to produce, and took a huge amount of personal commitment on the part of everyone around this table.
We’ve got lots of people who love Bankware.
People also love our “1/2% off” coupons and thefree Roadside Assistance program. How do weknow where we’re getting the best bang for the
buck? I bet we’ve spent thousands buying
Roadside Assistance memberships for customers.
Warren: I think what we really need to do is to
get the other divisions as excited about Bankware
as we are. Think of what Bankware could do topromote an understanding of CIBC Insurance
products, or of brokerage services available
through Wood Gundy. If Bankware III is going tosucceed, it can’t be as a Consumer Credit initiative,
it’s got to be as a CIBC initiative.
A voice piped up from the back of the room.
Voice: Great idea. But we’re a huge corporation.
That’s like asking Prince Edward Island lobster
boat owners on the East Coast to help plan salmon
quotas on the West Coast. They might be interested. They might have lots of experience. But,

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bottom line—they’ve got too much to take care of in
their own backyard to be able to spare the time.
Warren tried to see who was talking, but couldn’t.
Rita: Let’s get back to what Catherine was talking about. While some of the other premiums are
expensive, the per unit cost of Bankware is peanuts
in the big scheme of things. We are a multibillion
dollar bank. What I think is important to recognize
is that if the software is not able to do everything acustomer would like it to, then Bankware is uselessin promoting CIBC’s products and services.
For example, Bankware III should have the ability to do more financial planning. We could use thesoftware to show people the value of contributing
regularly to their retirement savings plan. The planner should show the impact of various interest ratescenarios. Instead of showing how much yourmoney will grow to at, say 10 percent, show comparative columns with a low, medium, and highrate of return.
I disagree with Denise on who the target audience for Bankware III should be. If we develop
Bankware III, it should be aimed at customers whoare profitable to the bank and who have more comprehensive banking needs than those clients wholook to us to help with their transaction-oriented
requirements.
Rosemary: Remember that the focus groups told
us that customers would perceive Bankware to be amore valuable tool if they had to pay for it. Somecustomers might be willing to pay $15.00 for afinancial planning tool, but would everyone? What
we really need to decide today is who should
receive I Bankware. I think every customer should
be given a copy of Bankware free of charge.
Ming: It would be very expensive for the
branches to give every customer a copy. The average branch has about 2000 customers. Bankware III
would cost much more than Bankware II if this is
our strategy.
Pat decided she should focus the discussion.
Pat: We’ve had a lot of discussion about how we
can improve Bankware, but we haven’t really611

talked about whether we should improve
Bankware.
Rita: Marketing has correctly identified that thediskette is product focused. How appropriate is thisgiven that we are encouraging our branch staff tomove away from a product focus toward a more
integrated client service approach?
Catherine: Let’s also not lose track of the factthat while the branches are adopting a more integrated, total customer focus, the organizationback here at Head Office is still functionally oriented. We have done a great job reorganizing ourselves so that we have product teams withbottom-line responsibility, but in the end, we arestill product focused. If a branch offers RSP loans
at prime to encourage investing in CIBC Mutual
Funds, the mutual fund division watches theirprofits soar, while we end up booking a bunch ofloans with no profit, and therefore no contribution to our division.
Denise: What really matters is that the personalbanking rep made a good decision from the bank’s
standpoint. That’s because once the loan is paid off,
profits will continue to be made from the RSP
investments. This is why I think that it is so important that all the other players be invited to sit at thistable and decide what to do with Bankware.
Pat: Let’s think “big picture” for a moment. We
had a real problem in 1992. Through the efforts ofeveryone here, together with our retail delivery network, we accomplished a remarkable turnaround.
Maybe Bankware helped with the turnaround.
Maybe it didn’t. Bottom line . . . we did change theloan experience.
The bank’s profits are higher than they’ve everbeen. The loan portfolio is growing every day. We
are the number two bank in Canada. I guess myquestion is, where do we go now? What do we donext? I’ve heard the following points this morning.
1. We could either develop Bankware III or
devote resources elsewhere.
2. If we think it’s worthwhile to develop Bankware
III, should Bankware III be . . . aimed at providing financial planning tools for customers who

CIBC

612

CASE 6 CIBC

count on CIBC to provide support and guidance in managing their financial affairs ordesigned to make it even easier for convenience-oriented customers to interact with thebank? The features needed in Bankware III
would be very different under each option.
3. If we choose to devote resources elsewhere,
what are examples of value- added initiatives
that we could undertake instead of Bankware
III to help promote and support the sale ofConsumer Credit products?

4. What role can we play in the development of a
relationship-focused approach to banking
given that we are product focused?
Warren, I wonder if you and three or four
people could get together to examine and reportback on these issues? There might be some otherpoints that also deserve attention. If everyone isfree on Friday morning, why don’t we meet backhere to review what Warren and the smaller grouphas come up with.

617

The Nottoway Plantation,
Restaurant,and Inn: The White
Castle of Louisiana

In early 1994, Faye Russell, marketing director,
and Cindy Hidalgo, general manager, considered
the future of Nottoway Plantation of White Castle,
Louisiana. Nottoway, which was listed in the
National Registry of Historic Places, was an enterprisein the hospitality industry, attracting visitors to tour
the mansion that contained many original furnishings. In addition to tours, the plantation offeredovernight accommodations, dining and banquet
facilities, and a gift shop. Nottoway competed withseveral other plantations for tourist trade along theMississippi River, seven of which provided similar
tours and elegant bed-and-breakfast facilities.
Although Cindy and Faye felt that Nottoway
was operating “in the black,” they thought they
were missing an opportunity; tour groups visitedthe plantation homes, but stayed overnight in the
nearby cities of Port Allen or Baton Rouge in a
Holiday Inn or similar facility. Couldn’t Nottoway
expand its facilities to provide enough overnightaccommodations for bus tours and other groups?
BACKGROUND
Nottoway plantation home, constructed in 1859,
was the largest existing Southern antebellum residence in 1994. John Hampden Randolph, the son ofa prominent man from Nottoway County, Virginia,
built Nottoway plantation to house his growing
family. Randolph, who left Virginia in 1841, was an

25
CASE 71enterprising businessman. He first settled inWoodville, Mississippi. Six years later he moved to
lberville Parish, Louisiana, where he built a sugar
empire on the Mississippi River. A series of expansions resulted in a plantation of over 7,000 acres. The
crown jewel of the plantation was the magnificent
home Randolph built for his wife, Emily, and theirfour sons and seven daughters, six of whom would
later marry there. The complete home consisted of a
53,000 square foot, 64-room mansion surrounded bygraceful grounds, including formal gardens, a carriage house, and a caretaker’s cottage (20 years older
than the mansion itself). Nottoway was a gem of
Italianate and Greek Revival style. The mansion
reflected the splendor, luxury, and innovation of its
time, featuring coal fireplaces, gas lighting, andindoor plumbing with hot and cold running water.
As Union troops approached during the Civil
War, Randolph, who never officially declared allegiance to the Confederacy, left Nottoway for Texas,
taking his slaves. During his exile, his wife
remained at Nottoway. Despite a shelling from agunboat on the Mississippi, the plantation home
was spared from total destruction by a Union officer who had been a guest of the Randolphs.
However, Mrs. Randolph did endure a three-weekencampment by Union troops.
Randolph died in 1883 at age 70. Mrs. Randolph
continued to run the plantation until she auctioned
it for $100,000 in 1889.

This case was prepared by Caroline M. Fisher, Loyola University New Orleans, and Claire Anderson, Old Dominion University.
This case was originally presented at the annual conference of the North American Case Research Association. Management cooperated in the field research for this case, which was written solely for the purpose of class discussion. All events and individuals
are real, but financial data has been disguised at the request of the organization. The authors thank Brandi Abraham, Tricia
Bollinger, and Jason Murphy for their assistance in collecting information for this case. Copyright (c) 1996 by the Case Research
Journal and Caroline M. Fisher and Claire Anderson. It is reprinted here by permission.

613

619

620

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

614

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

RESTORATION
Nottoway remained in private use until 1980, when
Arlin Dease purchased and restored it. As part ofthe purchase agreement, the prior owner negotiated the rights to continue to live in a suite in the
mansion until her death; she was still living there in
1994. In 1981, Dease opened the plantation to the
public for the first time in its 122-year history. In
1985, Paul Ramsay of Sydney, Australia, acquired
the property and continued the restoration.
Ramsay grew up in Australia. After attending auniversity for a year, he left school to join his father
in a series of real estate ventures. Over the years,
he acquired many different types of real estate, andby 1985 he had become a wealthy man. He also
owned a large health care company in New
Orleans, which included a medical center. By 1995,
he was highly respected in the health care community, and had received an honorary doctorate inmental health from Louisiana State University.
Ramsay bought Nottoway, a small investmentby his standards, with plans to restore and expand
it. As general manager of Nottoway, Ramsay
brought in Cindy Hidalgo, who had been assistantadministrator of the medical center owned byRamsay for the prior three years. They both feltthat the transition from managing the medical
center to managing Nottoway would be easy.
Hidalgo perceived the two operations to be “verysimilar” since both were service organizations andoffered gift shops, food service, and overnightaccommodations. Together Ramsay and Hidalgo
made significant changes in both the physical plant
and the operations of the plantation.
First, they constructed a new building to house agift shop and restrooms. Previously, the only gift
shop was operated by the former owner in a small
room on the first floor of the plantation home itself,
where it was frequently missed by visitors. The
new building, which was strategically placed
between the parking area and the mansion, provided greater space for display of the gift inventory.
To further encourage its use, Cindy decided tosell tickets for the mansion tours in the gift shop.

The new building also served as a gathering area
for tour groups at both the beginning and the endof their visits.
Another significant change was the upgradingof the menu offered at the restaurant. Under theprior management, the restaurant offered threemenu choices at both lunch and dinner: chicken,
shrimp, or jambalaya. Cindy hired an executive
chef John Percle, away from a competitive plantation, and brought in the chef’s wife, Terry Percle, tomanage the restaurant. Under their management,
the restaurant flourished and developed an outstanding reputation for fine food and service.

TOURISM IN LOUISIANAThe state of Louisiana had suffered severely fromthe oil-patch depression of the 1980s; the economic
downturn continued well into the 1990s. One industry that withstood the spillover effects from the oil
industry was tourism. While New Orleans was awell-established international attraction, Louisiana
conducted a nationwide media promotion in the
1980s and 1990s to lure additional leisure trade to
the rest of the state with appeal to such attractions
as Cajun cuisine and the “Bayou lifestyle.”
The heart of tourism in Louisiana in the 1990s
remained New Orleans. Over 7.6 million visitors
flocked to New Orleans in 1992, attracted by its
charm, its festivals, and its superior convention
facilities. October through May was the peak time
for conventions, but individual tourists, combinedwith a smaller number of conference attendees,
kept the city busy throughout the year.
For the visitor satiated with the attractions ofdowntown New Orleans, an alternative side trip
was to visit the nostalgic, historic plantations along
the “mighty Mississippi.” A number of antebellum
homes competed for the tourist trade through tours
and overnight accommodations. (See Exhibit 1 fora listing and a map of the major plantation homes
near New Orleans.)
Visits to these plantations required special
efforts. Tourists who owned or rented a car had to

621

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

615

EXHIBIT 1
Map of Plantations in Southeast Louisiana

plan their excursions carefully. The plantations were
not located near expressways, and required considerable backroads driving. A map, like that shown in
Exhibit 1, was a necessity. For tourists without theirown transportation, organized tours were the only
way they could get to the plantation homes.
A visitor could obtain specific information about
the plantation tours in two basic ways. First, thetourist might contact a travel agent either specifically inquiring about a plantation visit or wanting
general information on the attractions available in
the New Orleans area. The travel agent would thenprovide information and make reservations for the

tourist. Second, upon arriving in New Orleans, thevisitor might pick up information on the plantation
tours from a hotel concierge or a tourism office.
They could then contact the tour agencies directly
to make reservations.
The 1994 New Orleans Yellow Pages contained
40 listings under the “tour” category, and anotherfour listings under limousines mentioned plantation tours. Most of those offering tours were small
local organizations that contracted with groups
which wanted to offer tours to their members.
Convention organizers who wanted to include
plantation tours among the activity choices for

622

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

616

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

attendees were important customers. Two organizations offered regularly scheduled tours which
individuals could join. New Orleans Tours offered
two half-day plantation tours seven days a week.
These $24 bus tours visited the Destrehan,Ormond, and San Francisco plantations. Whilecapacity on the bus was 49, the tours averaged
about 35 people, with the number varying depending on the convention activity in New Orleans.
Grayline Tours offered two different plantation
tours. The first, an all-day tour, cost $35 and visited
Nottoway Plantation and Houmas House. The
second was a half-day tour for $27 to Oak Alley
Plantation. The full-day tour ran three days a week;
the half-day tour ran four days. Both operated all
year. Bus capacity was 43 passengers.
NOTTOWAY PLANTATION, 1994
Nottoway was located 18 miles (about 30 minutes)
south of Baton Rouge and 69 miles (approximately
1.5 hours) from New Orleans. Facilities were open
daily all year, with the exception of Christmas Day.
Plantation tours provided Nottoway’s prime
source of profit. Other sources were its elegant
dining, overnight accommodations, and gift purchases. (See Exhibits 2, 3, and 4 for financial data.)
Exhibit 5 shows a diagram of the facilities.
Tours
Nottoway was open for public viewing withguided tours available from 9 A.M. to 5 P.M. sevendays a week. Evening candlelight tours required
reservations. The guided tour lasted 45 minutes.
Visitors entered the mansion, just as in John
Randolph’s time, through immense 11-foot doors
into a spacious entrance hall with a 16-foot-high ceiling. Looking at Nottoway’s original intricate lacy
plaster friezework, hand-painted Dresden porcelain
doorknobs, and hand-carved marble mantels, visitors could sense the splendor of a bygone era in theold South. The grand white ballroom and dining
room, which contained a 17-foot-long American
Empire table with Chippendale chairs, attested to

EXHIBIT 2
NOTTOWAY PLANTATION
Budget July 1, 1993–June 30, 1994
(Dollar Figures in Thousands)
Revenues
Rooms
Tours
Restaurant
Gift Shop

$
$
$
$

439
742
964
373

Total Revenues$2,518
Expenses

Rooms
Salaries
Housekeeping
Other
Total Rooms

$
$
$

38
56
52

$ 146

Tours
Salaries
Landscaping

$
$

64
5

Total Tours$

69

Restaurant
Salaries
Food
LiquorLinen
OtherTotal Restaurant

$ 279
$ 231
$ 32
$ 29
$ 26
$ 597

Gift Shop$ 249

Overhead
Administrative Salaries
Maintenance Salaries
Advertising
Insurance
Credit Card
Property Tax
Security
Benefits
Utilities
Maintenance
Other

$ 164
$ 74
$ 62
$ 120
$ 25
$ 25
$ 29
$ 86
$ 69
$ 38
$ 76

Total Overhead
Total Expenses
Source: Nottoway Plantation.

$ 768$1,829

623

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

EXHIBIT 3
NOTTOWAY PLANTATIONEXHIBIT 4
NOTTOWAY PLANTATION

Income Statement
Year Ending June 30(Dollar Figures in Thousands)

Balance SheetYear Ending June 30(Dollar Amounts in Thousands)
1994

IncomeRestaurant
Guest Rooms
Tours
Gift Shop
Revenue from Operations
Other Income

$
$
$
$

852
410
648
316

1993
$
$
$
$

844
405
740
351

$2,226$9$2,340$ 45

Total Income$2,235$2,385

Expenses
Cost of Sales
Operating Expenses$ 455$1,994$ 471$1,929Total Expenses$2,449$2,400Net Gain (Loss) before Taxes($214)($15)

Income Taxes
Current
Deferred

$
$

31
31

Net

$

0

($1)

($214)($14)

Net Gain (Loss)

$
$

37
38

Source: Nottoway Plantation.

Randolph’s commitment to opulence. Most of themansion’s furnishings were authentic period pieces,many of them original pieces that Arlin Dease had
retrieved from around the country.
Accommodations
The Nottoway Plantation Restaurant and Inn
offered accommodations in the mansion itself and in
the overseer’s cottage (circa 1839). The visitor could
choose among six rooms and three suites in the mansion and four rooms in the overseer’s cottage. Guest
rooms were individually decorated with period

AssetsCash
Accounts Receivable—Trade
Accounts Receivable—Insurance
Inventory
Prepaid Insurance
Total Current Assets

617

1994

1993

$ 399
$ 41
$
0
$ 130
$ 33

$ 348
$ 71
$ 79
$ 128
$ 27

$ 603

$ 653

Buildings
Building Improvements
Furniture and Fixtures
Automobiles
Accumulated Depreciation
Net
Land
Restricted CashDeferred Income Tax
Other Assets$3,595
$ 424
$ 323
$ 12
($1,013)$3,341
$ 323
$
7
$ 69
$
3

$3,559
$ 413
$ 302
$ 27
($ 893)$3,408
$ 323
$
7
$ 38
$
0

Total Noncurrent Assets$3,743$3,776$4,346$4,429Total Assets

Liabilities and Stockholders’ Equity
Liabilities
Accounts Payable—Trade
$ 52
$ 50
Accounts Payable—Affiliates $ 150$ 83
Room Deposits/Gift Certs.
$ 59
$ 52
Notes Payable—Affiliates$3,660$3,406
Income Tax Payable
$ 21
$ 35
Other Accrued Liabilities
$ 100
$ 114
Notes Payable with 1 Year*
$ 797
$ 172
Total Current Liabilities
Notes Payable Over 1 Year$4,839$0$3,912$ 797

Total Liabilities$4,839Stockholders’ Equity
Common Stock (100 Shares @$1)
$0
Additional Paid in Capital$ 445
Accumulated Deficit($ 938)$4,709$0$ 445($ 725)

Total Net Equity($ 493)($ 280)Total Equity and Liabilities$4,346$4,429*Represents money owned to Paul Ramsay which will
be rolled over.
Source: Nottoway Plantation.

624

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

618

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

EXHIBIT 5
Nottoway Plantation Ground and Facilities

furnishings, each unique. (Exhibit 6 describes theserooms and their rates.)
Room rates included sherry (champagne in thebridal suite), a tour of the mansion, an in-roomwake-up breakfast, and a full plantation breakfast
served on the veranda. The plantation breakfast
consisted of “pain perdu” (French toast), eggs,
ham or sausage, grits, toast, and fresh fruit.
Swimming and tennis facilities were available.
Nightly room prices ranged from $95 to $175 for asingle; $125 to $175, double; and $155 to $190,
triple. Suites ranged from $200 to $250.

Dining and Banquet Facilities
Randolph Hall, a 300-seat dining facility, provided
on-site dining services, and was also available forbanquets and receptions. Other banquet facilities
included the Magnolia and the Camellia Rooms on
the ground floor of the mansion, which seated 50
and 20 respectively. Randolph Hall was open forlunch 11 A.M. to 3 P.M., and dinner, 6 P.M. to 9 P.M.
Reservations were recommended for dinner.
The cuisine included Cajun and other traditional
local dishes. Among the specialties were alligator

625

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

619

EXHIBIT 6
Nottoway's Rooms and Rates
All rooms include sherry, tour of the mansion, full plantation breakfast, and use of the pool. Rates are effective
January 1, 1992 and do not include 7.66 percent tax.
Mansion and Wings
Room 1* Cornelia’s Bedroom: Third floor of mansion overlooking the river, mahogany four poster double bed andthree-quarter day bed. $175 single or double; $190 triple.
Room 2* Third floor of mansion, mahogany half-tester double bed and three-quarter day bed, view of the gardensfrom the veranda. $175 single or double; $190 triple.
Room 3* Second floor of boy’s wing, queen size bed with canopy, view of the gardens from the veranda. $95
single, $135 double.
Room 4* Second floor of boy’s wing, antique brass double bed, view of the gardens from the veranda. $95 single,$135 double.
Room 5* Ground floor of girl’s wing, antique double sleigh bed. $95 single, $135 double.
Room 6* Ground floor of girl’s wing, antique walnut double bed, twin day bed. $95 single, $135 double, $155
triple.
Overseer’s Cottage (Circa 1839)
Room 7* Ground floor of cottage, antique brass queen bed, twin day bed, view of duck pond. $95 single, $135
double, $155 triple.
Room 8* Ground floor of cottage, antique brass queen bed, three-quarter day bed, view of patio with fountain. $95
single, $135 double, $155 triple.
Room 9* Second floor of cottage, antique brass queen bed, three-quarter day bed, view of duck pond, private
veranda. $95 single, $135 double, $155 triple.
Room 10* Second floor of cottage, rosewood double bed, overlooks patio and pond, private veranda. $95 single,$135 double.
SuitesMaster Bedroom† Third floor of mansion, only bedroom furniture original to Nottoway, rosewood half-tester
double bed, twin bed in sitting room. Room is on tour. $200 single or double, $215 triple.
Randolph Suite† Third floor of mansion, wicker morning room, four poster double bed, overlooks the river. Roomis on tour. $200 single or double.
Bridal Suite†
Ground floor of boy’s wing, three-room suite with half-tester canopy queen bed, parlor, wet bar,
sleeper sofa, jacuzzi, and private pool. $250 single, double, or triple.
*Check in: 2:30 P.M.; check out: 11:00 A.M.
†Check in: 5:00 P.M.; check out: 9:00 A.M.

sauce picante, medallions of veal, prime rib,
homemade gumbo, and a “Cajun two-step: alevee of jambalaya surrounded by a river ofshrimp creole.”
Dining was leisurely and elegant. Guests sat on
hand-carved mahogany chairs, and light was provided by crystal and bronze chandeliers. A regularpianist performed on a hand-carved concert grandpiano produced by Webber of London in 1896.

Other Offerings
Hidalgo offered a variety of other activities at
Nottoway to attract and satisfy visitors and supplement revenues. After the guided tour, besides
enjoying a meal at the restaurant, visitors could
stroll on the levee (the protective barrier between
the Mississippi River and the plantation grounds),
picnic on the grounds, or visit the gift shop. The

626

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

620

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

gift shop offered antique accessories, Louisiana
specialty foods, books, and other fine gifts.
To attract visitors other than tourists, the facilities
were available for receptions, dinner parties, banquets, business meetings, or other special events.
Weddings were performed in the Ballroom followed
by a reception in the mansion or Randolph Hall.
ORGANIZATION
When Cindy Hidalgo was hired as general manager in 1985, she was 27 years old with an accounting degree, a start on an MBA, and three years ofmanagement experience. She did not become a
CPA because she “felt that it would be a waste oftime to study for the exam” while she could beconcentrating on climbing the corporate ladder.
Her goal for Nottoway was continual improvement. Ramsay essentially left the running of
Nottoway to Hidalgo, visiting four to six times ayear for reports.
Hidalgo directed a staff of five: an assistantmanager/marketing director, Faye Russell; arestaurant manager, Terry Percle; an executive chef
John Percle; a maintenance engineer, Randy
LaPrairie; and a gift shop manager, Susan
Rockforte, who also acted as bookkeeper. Threeothers reported to the marketing director: a housemanager who was responsible for tours, a housekeeping supervisor, and a sales manager. Assistantrestaurant managers (maître d’s), reporting to therestaurant manager, supervised the bellmen andthe wait, banquet, and service staff.
Faye Russell, the assistant manager and marketing director, had been with Nottoway since 1987.
She came to Nottoway with a degree in communications and 7 1/2 years of experience with theLouisiana Office of Tourism. Her experience in thedestination marketing field included meeting andconvention planning, managing special projects
and trade shows, and developing brochures.
The administrative offices were housed in theattic of the overseer’s cottage above the two floorsof rooms rented to the public for overnight accommodations. The offices were cramped, with Cindy

sharing one office with the reservationist, files, anda microwave oven. Faye shared the other officewith the sales manager and another salesperson. In
total, Nottoway employed 85 people in the restaurant, gift shop, and mansion.
OPERATIONS
Like much of the hospitality trade, Nottoway’s
business was seasonal, reflecting the locale’s tropical climate. (Although the home was not air-conditioned, it did benefit from breezes which came inthrough large windows.) Room occupancy ranged
from less than 45 percent in January up to 90 percent in the peak months. (See Exhibit 7.) Tours,
accommodations, and the gift shop experienced
peak months in March through May; January was
the slowest month. Exhibit 7 shows projected visitors by month. In addition to the March throughMay peak, the dining facilities also enjoyed asecond peak in October. The dining business, andthe tours, died off in January.
The largest revenue producer was the restaurant. Lunch and special events (weddings, receptions, and business meetings) made up most of its
income; dinner accounted for only a small portion,
mostly generated by overnight guests. Tours were
the second most important source of revenue.
Budgets were determined from historical data andconventions scheduled for the coming year in New
Orleans and Baton Rouge. (Exhibit 2 shows thebudget for the fiscal year ending June 30, 1994, andExhibits 3 and 4 provide financial statements.)
COMPETITION
Several historic Louisiana plantations, inns, or cottages vied for the bed-and-breakfast trade. The
famous Oak Alley Plantation of Vacherie (just outside New Orleans) featured overnight cottages on
its grounds, which included a quarter-mile alley of
28 sheltering oaks that were over 250 years old.
Rosedown Plantation in St. Francisville included
magnificent formal gardens. Tezcuco in Burnsideoffered bed and breakfast in one two-bedroom

EXHIBIT 7
Nottoway Plantation—Pr ojected Visitors by Month, 1994
Sept.

Oct.

Nov.

Dec.

Jan.

Feb.

March

April

May

June

Total

Tours
(Number of People)
Group
Individual
Candlelight
Weddings

2150
7850
75
50

2330
7450
250
200

3020
4825
50
0

5550
6050
450
200

4000
5350
300
200

2600
4950
600
0

1550
3725
50
150

2950
5000
200
0

4250
7800
200
0

5400
7675
500
100

6100
7550
600
350

2700
6250
350
100

42600
74475
3625
1350

Total

10125

10230

7895 12250

9850

8150

5475

8150

12250

13675

14600

9400 122050

Weddings(Number of Guests)

50

200

0

200

200

0

150

0

0

100

350

100

1350

Rooms
(Number
Rented)

260

285

230

330

300

200

175

200

330

345

350

275

3280

Meals
(Number Served)
Lunches
Dinners
FunctionsWeddings

3275
750
300
50

3050
620
400
200

3250
550
400
0

4350
700
450
200

3550
700
525
200

3600
850
1000
0

1900
450
175
150

3200
600
600
0

4500
750
400
0

5100
700
900
50

5300
800
800
400

3475
700
500
100

44550
8170
6450
1350

Total

4375

4270

4200

5700

4975

5450

2675

4400

5650

6750

7300

4775

60520

Source: Nottoway Plantation.

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

Aug.

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

July

621

627

628

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

622

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

suite in the main house or one of ten cottages on
the plantation estate, which also included a chapel,
blacksmith shop, museum, and gazebo. (Exhibit 8
lists the major competitors and their features.)Cindy and Faye considered the competition to
be a challenge. While the elegance of the mansion

itself was a distinctive feature, the two women also
tried to provide first-class service. For example,
weddings were limited to no more than one a day,even on Saturday, to make the wedding party feelthat they were special, that this was their “mansion” for the day.

EXHIBIT 8
Major Competitors
Destrehan Plantation. Destrehan is the oldest plantationin the Mississippi valley, originally constructed in 1787.
Tours daily 9:30–4:00. Nominal admission fee. Group
tours welcome, gift shop. Closed holidays. 22 miles fromNew Orleans.
Houmas House. Houmas House is one of Louisiana’s
most imposing Greek Revival plantation homes; known
for its distinctive three-story spiral staircase. Tours withcostumed guides 10:00–5:00. Fee: $6.50 adults, $3.25 children, $4.50 13–17 years. Special arrangements for large
groups. Gift shop. 60 miles from New Orleans.
La Branche Plantation Dependency House. La Branche
Plantation is known for its exceptional display ofFederal woodwork and its rarity as a plantation dependency. Grounds tour includes slave quarters, gazebo,
restaurant, and more. Fee: $5 adults, $3 children, $4
seniors. Open all days except major holidays, 10:00–4:00.
20 miles from New Orleans.
Longue Vue House and Gardens. Greek Revival stylemansion, original furnishings, 8-acre garden, changing
exhibits. Self-guided tour of gardens. Guided tour of thehouse. Fee: $6 adults, $3 children, $5.40 seniors. Open
Mon.–Sat. 10:00–4:30, Sun. 1:00–5:00. Closed major holidays. In New Orleans.
Madewood Plantation. Magnificent 1846 Greek Revival
style home with period furnishings. Group lunches anddinners can be arranged. Overnight guests sleep in
canopied beds and dine by candlelight in formal family
dining room. Scheduled tours. Fee: $5 adults, $3 children,$3.50 seniors. Open 10:00–4:30 daily; closed Thanksgiving
and Christmas. 72 miles from New Orleans.
Nottoway Plantation. Largest plantation home in theSouth. Daily tours, gift shop, weddings, award-winningrestaurant serving lunch and dinner. Fee: $8 adults, $3
children, $8 seniors. Group rates available. Open
9:00–5:00 daily except Christmas day. 69 miles from New
Orleans.
Oak Alley Plantation. Antebellum home and grounds
famous for its alley of 28 evenly spaced live oaks.
Overnight cottages. Scheduled tours. Fee: $6.50 adults,$3.50 13–18 years, $2 6–12 years. Group rates available.
Open 9:00–5:30 daily. 60 miles from New Orleans.
Ormond Plantation. Colonial plantation furnished withvarious periods of antique furniture. Available for private parties. Scheduled tours. Fee: $5 adults, $2.50 children, $4 seniors. Group rates available. Dining on-site.
Overnight accommodations. 23 miles from New
Orleans.
Rosedown Plantation Home and Gardens. Antebellum
home restored to museum quality with original furnishings and 28 acres of formal gardens. Scheduled tours
9:00–5:00. Fee: $9 adults, $4 children. 110 miles fromNew Orleans.
San Francisco Plantation. One of the most elaborate
homes of the period. Guided tours daily 10:00–4:00. Fee:
$6.50 adults, $2.50 6–11 years, $3.75 12–17 years. Grouprates available, gift shop. Closed main holidays. 45 miles
from New Orleans.
Tezcuco Plantation. One of the last plantations built
before the Civil War in 1856, Tezcuco is a Greek Revival
style raised cottage. Tours daily 9:00–5:00. Closed major
holidays. Fee: $5.50 adults, $2.75 children, $4.50 seniors
and teens. Group rates available; bed and breakfast cottages. Antique and gift shop. Restaurant open daily
8:30–3:00. 60 miles from New Orleans.

629

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

Similarly, they wanted all of their guests to feel
special, even those receiving a discount as part of atour group. “I tell my people that there are nosecond-class citizens at Nottoway, even though
they aren’t paving full price,” declared Cindy.
MARKETING
Cindy and Faye were concerned with Nottoway’s
ability to serve the tourism market, their main
source of guests. “We’re looking at where we want
to go to fully serve our clients,” stated Cindy. “Wewant to provide a well-rounded, balanced product.
Currently, we can’t fully service motor coaches orbusiness groups.”
Faye had no data concerning the source of individual visitors (local, out of state, etc.) or how visitors learned of Nottoway, but she believed thatmost people learned about the plantation directlyfrom prior visitors. They did know, however, thatslightly over 96 percent of tour visitors were
adults. The majority came by private automobile,
although all the major tour lines offered trips toNottoway. Grayline, the prime tour line thatbrought visitors to Nottoway, offered the only regularly scheduled tour which included the plantation. Grayline’s tour was offered three times aweek.
Walk-in guests, including both tourists andpeople who worked in the area, made up approximately 65 percent of the luncheon trade; tour
groups accounted for the remainder. Special event
promotions for holiday meals such as Easter
Sunday and Thanksgiving dinners were directed
at local residents, who were also thought to be asignificant part of the lunch and dinner trade.
Promotion was primarily aimed directly at theend consumer, although Nottoway was also promoted to tour operators. Advertising budgets were$59,000,$61,000, $73,000, $55,000 and $62,000 for
fiscal years ending June 1990 through June 1994,
respectively (exclusive of salaries and travel).
These costs included advertisements in local media
such as New Orleans Magazine, the Baton Rouge
State-Times/Morning Advocate, the Acadiana Dining

623

Guide, LeGuide—What’s Happening in Acadiana , andvarious American Automobile Association publications. The Nottoway plantation was listed in the
promotional materials of the Greater New Orleans
Tourist Commission; national publications such as
The Annual Directory of American Bed & Breakfasts
and the Christian Bed & Breakfast Directory; andbooks such as Plantation Homes of Louisiana andNatchez Area (David King Gleason, Baton Rouge:Louisiana State University Press, 1982). Brochures
were provided to all New Orleans hotels andtourism offices.
Advertising materials billed Nottoway as “Thelargest plantation home in the South!” The message
in the print media was one of refinement and elegance. Print advertisements appealed to customers
to “step back in time and marvel at how the ravagesof war and time could not mar the beauty of theWhite Castle of Louisiana–Nottoway.” Anothersuggested “19th Century charm and elegance forall bridal celebrations,” offering bridal luncheons,honeymoon accommodations, rehearsal dinners,
weddings, and receptions.
FUTURE PLANS
Cindy and Faye realized that tour operators represented an essentially untapped market for
Nottoway. While many groups stopped to tour themansion, few actually dined at Nottoway or
stayed overnight. Most group tours required significantly more rooms, usually 22 to 24 rooms tohandle 44 to 46 passengers, than were available at
Nottoway or any one plantation for overnightaccommodations. “We just can’t service the motor
coaches with our current facilities,” stated Cindy
in frustration.
Other groups required larger facilities as well.
“Why just last week I had to turn away three reservations from groups who needed rooms for 40
people,” noted the reservationist.
Small business meetings were one other type ofgroup needing more rooms. “We’re in the middleof the oil industry; they are our potential clients
too. They look for facilities for housing visitors

630

The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisiana

624

CASE 7 The Nottoway Plantation, Restaurant, and Inn: The White Castle of Louisianaand conducting off-site meetings and retreats,”
Faye stated.
One option that they were considering was to
add another building on the mansion grounds thatwould provide 22 to 28 additional units.
Construction costs typically ranged from $30,000
to $50,000 per room, according to industry statistics. They felt that they needed to make somestrategic decisions before they could present theiridea to the owner, Paul Ramsay. Faye and Cindy
investigated small hotels that serviced motor
coaches and business meetings, and found thatmost of the rooms in these hotels had two queensized beds, and a few had king-sized beds.
A motel-quality building would be the lowestcost alternative. The units could be rented slightly
below the low end of their current rate schedule to
the general public, and at even lower rates to thetour operators. Many tour operators were looking
for discounts and lower room rates; Faye thought
they might need to offer tour operators rates in the$50 to $70 range to attract any significant businessaway from similar facilities in nearby cities.
To stay with something closer to their current typeof accommodations would require considerably
more capital; based on some preliminary discussions with an architect, Cindy estimated a cost of$1.5 million. just obtaining period furniture would
be very expensive, and they didn’t know if they
could attract tour operators if they charged eventhe low end of the current rate structure.
The additional building could also house officespace and “meeting rooms designed to be meetingrooms.” With the existing facilities, meetings had
to be held in Randolph Hall or in rooms in thebasement of the mansion. Neither option was fully
satisfactory to Faye and Cindy.
While the grounds surrounding the mansion
were spacious, the most likely place to build the
additional rooms was on the far side of the poolfrom the mansion, running from Randolph Hall tothe pond. Initial consultations with an architectsuggested that three connected buildings could
easily house the needed rooms.
Cindy and Faye wanted to develop a marketingstrategy and plan for the additional rooms thatthey could present to Ramsay. They did not want
to destroy the image of Nottoway in the process oftrying to create additional business. Could they
develop a reasonable plan to add rooms? What sortof rate structure would be needed to cover thecosts? Were they missing some alternative way toincrease revenues? The challenge of developing aworkable plan excited them.

FarggiIt was early 1995 and Margarita Farga, Farggi’s
marketing director, was turning over in her
mind the situation of her company’s different
businesses. The Farga/Farggi Corporation was agroup of family companies, whose annual sales
were expected to amount to between 2.8 and 3.0
billion pesetas in 1995 (1 U.S. dollar = 130 Spanish
pesetas).
From its humble beginnings as a small traditional cake and pastry shop in 1957, its businesses
had been expanded and diversified. By the end of
1994, it had three traditional cake shops operating
under the name “Farga.” It also manufactured andsold ice cream and frozen cakes for the catering
market under the “Farggi” brand name.
However, its latest “great leap forward” hadbeen in 1993, when it started to manufacture andmarket luxury ice cream for sale in “Farggi” stores—either owned by the company or franchised—
and in supermarkets and other non-exclusive
shops. As a result of the latter activity, their positioning was now very similar to that of the famous
Häagen Dazs ice creams. In fact, it was rumoredthat someone had heard an unidentified Häagen
Dazs manager say that, of all its competitors in theentire world, Farggi had been the one most able toadopt its concept, positioning, and way of sellingpremium ice cream with the greatest speed andprecision.
In July 1993, the first exclusive “Farggi Tub’s &Ice Cream” parlour was opened in Barcelona’s
upmarket Paseo de Gracia and, by the end of 1994,
13 such parlours had been opened, five owned by
the company and eight franchises.
While she reviewed everything that had beenachieved so far, Margarita tried to think what her
company’s action priorities should be, both in the
short and in the medium term. Jesús Farga, herfather and the company’s president, insisted that all

26
CASE 81these questions needed to be clearly defined, as the
future consolidation of the company depended on it.
HISTORY OF THE COMPANY
In 1957, Jesús Farga opened a traditional food retailstore on Mayor de Gracia Street in Barcelona, near
Plaza Lesseps. About five years later, after attending occupational training courses in cake making,he turned his food shop into a cake shop, keeping
the same name “Farga.” With the cake shop operating, he married Magdalena Bertrán and had fourchildren: Elena, Margarita, Luís and Eduard.
About five years after that, Jesús Farga opened
his second cake shop, on the Paseo de San
Gervasio, in a neighborhood with a higher socioeconomic level, manufacturing and selling fresh
cakes and pastry.
The First Diversification: “Tartas y Helados Farga”
With both cake shops operating at full capacity, inthe late 1960s, Jesús Farga started to sell cakes outside of his shops, delivering them frozen to nearby
cafeterias and restaurants, where they were thawed
in a refrigerator or at room temperature before
being served to customers.
Jesús Farga and his employees managed to perfect their formulas and processes to such a pointthat it was impossible for the end customers in therestaurants and cafeterias to tell that the cakes
they were eating had been frozen and thawed
beforehand.
The transportation and delivery service was carried out by José Manuel Garrido. In the course oftime, he was to become one of Jesús Farga’s righthand men and, in 1994, he was still sales director.
Also, at about that time, Farga started to make andsell ice cream.

This case was prepared by Professor Lluis Renart and Francisco Parés, lecturer at IESE, Barcelona, Spain. Copyright © 1995,
IESE. Reprinted by permission.

625

631

632

Farggi

626

CASE 8 Farggi

Thus, slowly but surely, a second business activity, separate from that of the retail stores, came into
being and consolidated itself under the name of“Tartas y helados Farga.” Legally, both activities
continued to be a single business activity owned by
Jesús Farga.
The “Farggi” Brand
In spite of the excellent performance of both activities (sales in the cake and pastry stores, and the saleof frozen cakes and ice creams by delivery to cafeterias and restaurants), close monitoring of the secondof these two lines of business convinced Jesús Fargaof the need to use a different brand name.
Shortly before, during a trip to Italy, his friends
and travelling companions had jokingly called him“Comendatore Farggi.” Jesús decided to use his
own italianized name to give a distinctive identity
to his second business activity.
When, in 1974, he started to use the name
“Farggi,” the business’s name was extended to“Farggi: tartas, helados y sorbetes de lujo” (Farggi:
luxury cakes, ice creams and sorbets), to prevent
any connotation of a second, lower quality brand
name.
The First Factory in Badalona
In 1975, Jesús moved production to a factory measuring just under 1,000 meters in Badalona. One of
the innovations at that time was the production
and sale of individual portions of frozen cake andice cream, with the same “luxury” quality.1
Jesús Farga observed with satisfaction that when
he sold portions of ice cream or cake of between 100
and 150 millilitres, priced by the portion and in amarket niche which he had practically all to himself, his sales revenues were substantially higher
than when he sold by the litre. Although the pro-1 Individual portions of sorbet or ice cream were alreadycommon in Spain, but only in the impulse sale market segments and/or in the medium- 10” quality segments.

duction process had a somewhat higher skill andlabour content, his margins improved considerably.
With the opening of the new factory in Badalonaand due to the sudden economic downturn as aresult of the oil crisis, Jesús Farga decided to legallyreform his business as a limited company under thename Lacrem, S.A. At the same time, he brought his
brother-in-law into the business as financial director and minority shareholder. For many years, thecompany’s management team consisted of Jesús
Farga, Miguel Bertrán, and José Manuel Garrido.
As a result of the increase in production capacity,
the company was now able to sell its products virtually throughout Catalonia, although still basically focused on the catering sector.
Farggi’s products and salesmen consistently
used the image of the Farga cake retail stores as
their reference point, quality guarantee, and visiting card. This enabled them to gain entry in restaurants and cafeterias with relative ease, smoothing
their path in a market that was coveted by manyother companies. Farga’s guarantee also gave thema solid argument for defending higher sales prices.
Often, the “secret weapon” used by Farggi’s
salesmen and distributors was to get a foot in a newcustomer’s door by first offering him the more typical frozen cake products, i.e., apple, chocolate,almond cakes, and the like. Once the restaurant orcafeteria had become a customer for the cakes andtrusted the salesman, the service, the products andFarggi in general, the salesmen gradually introduced new articles, particularly ice creams.
This process was also facilitated by the fact that
Farggi always differentiated itself from its possible
competitors in the way it did things: it offeredhigher quality products, with a more craftlike
appearance and a more attractive presentation, amore extensive and creative collection, etc.
Therefore, it was usual for restaurants and cafeterias to always have some Farggi products in stock.
Regarding distribution and logistics, Farggi had
its own distribution organization, delivering
directly to the restaurants in Barcelona and its metropolitan area. In the rest of Catalonia, Farggi soldthrough independent distributors.

633

Farggi

CASE 8 Farggi

These distributors were almost always small
local companies, enabling distribution to be fragmented into small units. The distributors wererequired to have their own warehouse, equippedwith cold-storage chambers suitable for handlingfrozen products, a fleet of delivery vehicles and aminimum sales team. However, they were notrequired to work exclusively for Farggi, so it wascommon for Farggi’s distributors to distributeother brands of ice cream such as Frigo, Camy, orMarisa, which targeted other market segmentswith less demanding quality requirements.
When it started to sell through distributors,
Farggi offered them a 28 percent discount on ice
creams and a 26 percent discount on cakes, appliedon their own direct sales price, so that the distributor could sell to its restaurant customers at thesame prices that Farggi would have charged if they
had been direct customers. Following an “oil stain”
strategy, distribution was gradually extended toother parts of Spain, using the same system of independent distributors.
The New Factory in Montgat and the Third Cake
Shop in the Avenida Diagonal in Barcelona
In 1982–83, the new Montgat factory was opened.2
With a floor area of 8,000 meters, it completely
replaced the previous Badalona factory, which wasclosed. With the new factory operating, both capacity and service were improved.
Almost at the same time, Jesús Farga had theopportunity to rent premises on the prestigious
Avenida Diagonal, in Barcelona, between the Paseo
de Gracia and the Rambla de Cataluña, where it
opened its third Farga cake shop, with restaurant
service. A veritable flagship, it consisted of aground floor, a mezzanine, and two basements
where the kitchen and the workshop were
installed. In total, it measured about 1,500 meters,in one the best locations in Barcelona.

2 Small coastal town located to the north of Barcelona andadjoining Badalona.

627

After opening the new factory in Montgat,
Farga’s turnover amounted to about 400 million
pesetas between the three cake shops, whose
workforce now stood at 45 employees. For its part,the Farggi business was billing another 600 million pesetas, with 60 employees and 18 independent distributors. With its present distribution
network, its ice creams and frozen cakes now
reached cities as far afield as Madrid, Malaga, andCorunna.
The new shop, large and well-located, enhanced
the reflected glory of the Farga cake shops that was
projected on the Farggi brand, and increased general brand awareness.
The years until 1987–1988 were the company’s
period of greatest prosperity. It had excellent sales
margins and was able to sell without any major
marketing or advertising efforts, as it was virtually
the sole player in the high quality ice cream andfrozen cake segment in Spain.
Farggi was, and defined itself as, “luxury cakes,
ice creams and desserts for restaurants.” It utilized
a single product concept, with about 250 products
or stock keeping units, serving a single market: thecatering trade.
COMPETITION GETS TOUGHER AND IT
BECOMES NECESSARY TO INSTALL
FREEZER CABINETS IN RESTAURANTS
Unfortunately for Farggi, in the late 1980s and early
1990s, the big Spanish ice cream companies, manyof them owned by multinationals, started todevelop their own ad hoc product lines for the catering segment.
Companies such as La Menorquina (previously
Marisa), Frigo, and Miko started to launch products with formats (sizes and appearance) similar to
those of Farggi, although without seeking to position themselves on the same high quality level.
They sold at lower prices, with advertising backing, and provided the restaurants with menu cards
showing the desserts.
One of the consequences of the stiffening in competition was a fashion whereby a manufacturer had

634

Farggi

628

CASE 8 Farggi

to install a freezer cabinet on deposit in the restaurant in order to be able to sell ice cream to it. Eachfreezer cost the ice cream manufacturer about
100,000 pesetas. The restaurants’ order of priorities
when buying ice cream now became freezer-pricequality-service.
Faced with this new market situation, Farggi
had to invest considerable sums in installing freezers: 40 million pesetas in 1989, 70 million pesetas in1990 and between 80 and 100 million pesetas in1991.
An Offer to Buy Farggi
In 1989–90, Camy (Nestlé) started talks with a view
to buying Farggi. At that time, Farggi was billing
about 800 million pesetas and the entire group,
including the cake shops, had a turnover of about
1.5 billion pesetas. It appears that the purchaseoffer was considerably above this figure and wastherefore very tempting. Finally, it was decided toturn the offer down.
The Second Generation Joins the Company
In June 1989, Margarita Farga, the second daughter of Jesús Farga and Magdalena Bertrán, graduated in business studies from ESADE.
Immediately afterwards, she went to Boston, in
the United States, where she stayed until March
1990, following an extension management studies
course at the renowned Harvard Business School.
Margarita would be the first daughter to join thecompany.
In addition to her formal studies, Margarita
recalled having accompanied her father on manybusiness trips; he made her visit supermarkets andrestaurants in various countries in order to find out
about the prices, the products sold, who boughtthem and how, and other details.
First Awareness of the Existence of Häagen Dazs
When she was in Boston, Margarita first saw a
Häagen Dazs ice cream parlour:

I was struck by the fact that it sold a much more
expensive ice cream and that it used the word
“luxury.” The containers seemed very unsightly to me,
but when I tried the ice cream, I realized that it tasted
different, although I did not know why.

Another detail that caught her attention wasthat Häagen Dazs also sold ice creams on a stick.
In Spain, this sort of ice folly or Popsicle had traditionally been little more than “a chunk of ice
with some sort of flavoring” (usually orange orlemon), and occupied the lowest quality segments; one did not think of an ice folly as a“luxury” product.
The Häagen Dazs stores that Margarita saw
seemed unappealing to her, and also fairly empty,in spite of the fact that they sold a good productwhich could be served with toppings. In her opinion, they lacked “a touch of European design,”
which would give them more class.
Margarita’s reaction could be summed up by
saying that she noticed and appreciated the containers3 and the presentation of the ice creams,
their taste and the variety of flavors offered, theuse of the word “luxury” and of the color gold in
the materials and designs (although accompanied
by other decorative details in black which she did
not find so pleasing). At the same time, the stores,
which she felt could be improved on in several
respects, showed her “what Farggi would like tobe when it was grown up,” as a commercial mechanism for reaching the end consumer more
directly (selling ice cream for consumption in thestore itself, strolling along the street, or to takehome).
Although Margarita felt that “it could be doneeven better,” she was well aware that in Spain the
few retailers who specialized in the sale of ice
cream were almost without exception open only in

3 For example, she observed that, in the United States in general, round tubs were generally accepted as indicating that theice cream they contained was higher quality and were labeled“super premium,” whereas the lower quality, lower price ice
creams were sold in square-shaped packs.

635

Farggi

CASE 8 Farggi

summer, with inadequate fluorescent lighting,white tiles on the walls, and, as the only form of
decoration, posters showing the various ice creams
on sale and rows of glasses upside down on the
shelves. With very few exceptions, the stores wereindependent, family-run businesses. Consequently,
the staff usually wore no uniform or each person
wore his own; and obviously, each store used its
own name and had its own sign, with very poor
quality lettering.
For Margarita, the concept of the Häagen Dazstype ice cream parlour was “love at first sight.”
However, if she was to introduce similar ice cream
parlours in her own country, the first problem
would be to find the way to make them viablethroughout the year, since ice cream consumptionin Spain had always been highly seasonal, falling toalmost zero during the winter.4 Also, unlike in the
United States, there was very little ice cream consumption at home.
Margarita invited her parents to visit her, among
other reasons so that they could see the Häagen
Dazs ice cream parlours and share with her allthese opinions and concerns. Jesús Farga decided
that the matter had to be looked into in greater
depth and that the first thing to do was to thoroughly analyze the product. So, when he went backto Barcelona, he took several samples of ice creamwith him in his hand luggage.
By then, Farggi’s ice cream was already being
manufactured without stabilizers and with low aircontent. This was stated in the sales brochures asfeatures indicative of its high quality.
The results of the analyses carried out inBarcelona showed that half a litre of Häagen Dazs
weighed about 470 grammes, while the same
volume of Farggi ice cream weighed between 300

4 According to some estimates by industry sources, in 1989,
80 percent of ice cream consumption in Spain took place
between May and October. The statistics indicated that ice
cream consumption in Spain was about three litres per inhabitant per year, whereas in the United States it was about 15
litres.

629

and 350 grammes, and the ice creams of the majordomestic brands weighed between 200 and 250
grammes. This was because Farggi had always
sold ice cream with a low air content; in fact, every
100 litres of solid ingredients used to make Farggi
ice cream yielded only about 150 litres of ice cream.
From the same quantity of solid ingredients, themajor Spanish brands might obtain about 200 litresof finished ice cream ready for consumption.
Another significant difference was that the Häagen
Dazs ice creams (and most of the North American
ice creams) had a fat content of 16 percent, whereas
the norm in Spain was 5 to 6 percent, including
Farggi.
Margarita Returns to Barcelona
By the time Margarita returned to Barcelona
in March 1990 and joined the company as “head”
of marketing, Farggi’s managers had realized that,
if in previous years they had grown at annual
rates of up to 30 percent, now they were growing
more slowly and they had to invest more to obtainthat growth. Also, because of the economic recession, restaurants were buying less, which made it
even more difficult to recoup the investment infreezer cabinets, which the company bought on alease.
The first thing Margarita did was to spend six
months riding in the delivery trucks, crossing
Barcelona from one end to the other, accompanying
the company’s salesmen and visiting distributors
throughout Spain. This enabled her to acquire acertain degree of authority both inside and outside
the company.
At about this time, it was also observed that thecompany’s mousse cakes were very popular andhad relatively little competition. Furthermore, inthe course of his travels to other European countries, Jesús Farga had noticed that this was a
widely accepted product in many of the moredeveloped countries’ markets. They were soldfrozen in supermarkets in somewhat smaller sizes
than those normally sold by Farggi to Spanish
restaurants.

636

Farggi

630

CASE 8 Farggi

CONCERNS IN 1991, LEADING TO THE
LAUNCH OF “PASTIMÚS” AND“CHEESECAKE,” FROZEN CAKES TARGETING THE HOME CONSUMPTION MARKETAND SOLD IN FOOD RETAIL STORES5
By 1991, the entire management team in Farggi
was reflecting on what seemed to them to be theirchief strategic dilemma: whether to try to maintaingrowth in the catering market or to try to expand
their market by entering another distribution
channel with products for consumption in thehome. All were aware that they had to find something that would enable them to achieve two objectives at the same time: to preserve and improvetheir image; and to sustain and improve the company’s profitability.
One of the fruits of this search for new openings was the idea of launching frozen cakes targeted at the home consumption market, to be soldin supermarkets, select food shops, and the like,offering to install a Farggi freezer cabinet. They
would be the first to launch this type of product inSpain.
It seemed to them that the traditional cake shop,
although it continued to play a very important role,
had probably entered a phase of gradual decline.
An extensive survey was carried out from the
supply of frozen cakes in Europe and the UnitedStates.
While the frozen cakes made and sold by Farggi
on the catering market measured 26 centimeters indiameter and 4.5 centimeters in height, the new
cakes for home consumption would measure 19 centimeters in diameter and 3 centimeters in height,
giving a net weight of 550 grammes. However,being mousse cakes, because they had light, airy
bodies, it was considered that they were large
enough to serve between six and eight portions.

5 Throughout this case, we will call these shops nonexclusive retail stores because they sell Farggi products
together with other food products, possibly including otherice cream brands.

A range of nine flavors was defined; five mousse
flavors and four cheesecake flavors.6 Following theserving recommendations for the products used by
the catering market, on the packs of these cakes forhome consumption it was clearly stated that theyshould not be eaten frozen but that they should betaken out of the freezer about two hours before
serving to allow them to thaw. The names“Pastimús” and “Cheesecake de Farggi” were registered as trademarks, and all the other details
regarding finish, formulas, processes, packaging,etc. were defined.
Farggi’s sale price to the retailer was set at 920
pesetas, plus VAT, per unit, so that retailers, inturn, could sell them to the public at 1300 pesetas
per unit; that is, with a gross margin of 380 pesetas. This retail sale price was higher than that of
the ice cream bars and frozen cakes sold by the
major national ice cream manufacturers but significantly lower than a fresh cake bought in a traditional cake shop.
Everyone was aware that, in some way which
was still not clear at that time, the mousse cakes
were laying the foundations for opening the distribution channel to ice cream for home consumption. Consequently, in 1991, it was decided
to build a new cold storage chamber with acapacity of 10,000 m3 on a piece of land adjoining the Montgat factory. With this decision,
Farggi took a step forward, anticipating futureneeds, whereas in the past its decisions toincrease production and storage capacity had
almost always been reactive. They had not
expanded capacity until they had first createdthe market and the need.

6 Mousse flavors were fresh pears with truffled chocolate;fresh lemon; vanilla and Irish coffee; dairy cream and fresh
strawberries; and chocolate with walnuts. The cheesecake
flavors were bitter orange, cranberries, pineapple, andraspberries. In total, there were nine Stock Keeping Units(SKUs).

637

Farggi

CASE 8 Farggi

LUIS FARGA ALSO GOES TO HARVARD.
FIRST DIRECT CONTACT WITH HÄAGENDAZS MANAGERS
In June 1991, Luis Farga, Jesús Farga’s third childand Margarita’s brother, graduated in economics.
Then, like his sister, he went to Harvard University
to follow an extension management course. Once
there, he too was fascinated by the quality of North
American premium ice cream and, like Margarita,
insisted that Farggi should start to make and sell itin Spain.
During a visit made by his father, they decided
to make an appointment with Häagen Dazs inorder to explore the possibility of doing something
together in Spain. The meeting took place at theend of 1991 and was rather cold. The Häagen Dazs
executive they spoke to told them that any matter
related to a European market should be discussed
at Häagen Dazs’ European headquarters in Paris.
In January 1992, they had another meeting witha senior Häagen Dazs manager in Paris, but there
did not seem to be any possibility of collaboration
between the two companies. In fact, the only clear
impression they got from the meeting was that
Häagen Dazs had not yet decided whether or not to
try to penetrate the Spanish market.
He visited the Häagen Dazs parlour in the Av.
Victor Hugo, where he saw that the company had
managed to improve the appearance of their ice
cream parlours, giving them more class. Jesús
Farga traveled on to Brussels and London, where
he observed and gathered information on the
Häagen Dazs parlours open there.
In March 1992, Alimentaria (Food Industry TradeFair) was held in Barcelona. Farggi was present witha stand of its own, where they were visited by the
manager responsible for Häagen Dazs parlours in
all Europe. He told them that Häagen Dazs was
about to open their first ice cream parlour inBarcelona and that he wished to explore the possibilities of cooperation between the two companies.
In August 1992, while the Olympic Games werein fall swing in Barcelona, the first Häagen Dazs
ice cream parlour was opened at number 85 in the631

centrally-located and classy Rambla de Cataluña.
On their packaging, it was stated that the productwas manufactured in France and imported by
Helados Häagen Dazs, S.A.
MEANWHILE, THE “PASTIMÚS” PROJECT . . .
A few months earlier, in January 1992, Farggi hadvigorously launched the frozen cakes “Pastimús”
and “Cheesecake” on the Spanish market, targetingthe home consumption market.
In a period of only three months, they installedabout 300 freezer cabinets in supermarkets andother select food shops in Barcelona and the surrounding area, where Farggi continued to havedirect physical distribution, and a further 500 freezers, through its distributors, in the rest of Spain.
The new range of frozen cakes for home consumption was readily accepted by this kind ofretailer. However, the sales volume grew at a rate
substantially lower than forecast. Farggi’s managers considered that this was because fresh cakes
were withstanding the incursion better than
expected, and that the habit of buying their cakes
fresh in the cake shops, rather than in supermarkets
and food shops such as bakeries, delicatessens, orfrozen food shops, was deeply ingrained in the
public.
In any case, the market and customer surveys
seemed to indicate that the low turnover was notdue to the product itself, which people liked when
they bought and tried it. They thought that perhaps
it was because the Farggi trademark, traditionallycentered on the catering market, was not sufficiently well known and did not have enoughstrength to persuade the final consumers to try the
new cakes.
The lower turnover of frozen cakes for homeconsumption led Farggi to speed up the project tolaunch the ice creams —which were to be displayedin the same freezers—as soon as possible in orderto recoup the heavy investment made in freezer
cabinets. However, it should be pointed out that, atthat time, Farggi’s managers had not yet decided
whether the launching of ice creams through the

638

Farggi

632

CASE 8 Farggi

freezers already installed in retail outlets would beaccompanied by the opening of exclusive Farggi ice
cream parlours or not.
FURTHER CONTACT WITH HÄAGEN DAZS:POSSIBLE COOPERATION IN LOGISTICS
In September 1992, right after having opened theirfirst Häagen Dazs parlour in the Rambla deCataluña, in Barcelona, the multinational company’s management took the initiative to contact
Farggi again in order to explore the possibility of
the Spanish company taking care of the physicaldistribution of its ice creams to the freezer cabinets
it intended to install in supermarkets throughout
Catalonia.
In the ensuing discussions, Häagen Dazs’ managers provided the necessary detailed informationon the number and foreseeable location of theirfreezers, the expected turnover, ice cream SKU
numbers, restocking frequencies, etc. to enable
Farggi’s managers to study the foreseeable workload volumes, compatibility with their delivery
schedules, etc.
For their part, Farggi’s managers informed themof the areas and types of outlets that they could
cover with their logistics distribution system,
including the fact, which apparently seemed to becompletely new to Häagen Dazs, that they werealready distributing their frozen cakes in bakeries,
delicatessens, and the like, in addition to selling insupermarkets.
Margarita Farga remarked:
I had my eyes and ears wide open because they were
telling me the story I had dreamed of doing with ourbrand. The fact is that we were very unsure whether
we should agree to carry out the physical distributionof Häagen Dazs. We knew that the company belonged
to the extremely powerful Grand Metropolitan Groupand its enormous economic potential inspired a certain amount of awe.

The talks went on, with both parties exploring
the projects viability until, on a certain day in
November 1992, something unexpected happened:“We had already explored all the data and details of
the proposed cooperation,” said Margarita, “and wewere relatively close to an agreement. But at thatmoment, the Häagen Dazs manager we mainly spokewith (a delightful person and very competent), possibly carried away by his enthusiasm at the way things
were starting to come together, exclaimed, “Fantastic,
we’ll install the first Häagen Dazs freezers in the three
Farga cake shops!” That sentence, no doubt utteredwith the best of intentions, made something snap
inside us. It came as a thunderbolt! As if suddenly aveil had fallen from our eyes and it was crystal clear tous what we should not do!”There were at least another three reasons against
closing the physical distribution agreement. First,
Häagen Dazs offered to pay Farggi only 13 percent
on its list price to the retailer, while the latter, justfor selling the product to the public, had a grossmargin of more than 38 percent on the retail saleprice.7
Furthermore, in the event that Farggi was tophysically distribute Häagen Dazs ice creams outside of the metropolitan area of Barcelona, its direct
distribution area, the money received would haveto be shared in some way between Farggi and its 30
independent distributors.8 In any case, taking into

7 A food shop equipped with a freezer cabinet (belonging to
Häagen Dazs) bought the ice creams at 440 pesetas + 6% VAT
and resold them to the public at 675 pesetas, with a grossmargin of 235 pesetas per 500 ml tub. From the supermarket's
point of view, this was not only an excellent gross margin in
absolute terms, but was even more so when the fast turnoverand small area occupied by the freezer in the shop (approximately one meter) were worked into the calculation.
8 The logistics process that had been designed would havebeen the following: Häagen Dazs would be responsible, on the
one hand, for placing its ice creams (manufactured in France)in Farggi’s central cold storage warehouse in Montgat, which
would act as central warehouse. On the other hand, Häagen
Dazs, through its own team of sales representatives, would
carry out all the initial sales work with the supermarkets andwould install the freezer cabinets. It would then notify Farggiof the new customer. Farggi would serve the initial order toload the freezer. From then on, Farggi’s delivery/salesperson
would visit the sales outlet at least twice a week. At each visit,

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Farggi

CASE 8 Farggi

account the direct costs of storage, delivery, administration and control, Farggi estimated that 13 percent was not a very good rate for them.
The second, and perhaps most important anddecisive reason against a logistics cooperation
between Farggi and Häagen Dazs, was that José
Manuel Garrido, Farggi’s sales director, was neverquite sure that the distribution of Häagen Dazs
products was really compatible with the delivery of
Farggi products, from the commercial and image
viewpoints (signage on the vans, etc.).
Finally, Farggi’s managers also thought that, if
they acted merely as a logistics service for storage
and delivery, any time that Häagen Dazs received amore attractive offer from another logistics company, they could decide to discontinue their relationship with Farggi, which could leave Farggi
with excess storage and transport capacity, which it
would not be easy to reoccupy.
In the end, the negotiations were broken off and,almost without giving it a second thought, Farggi’s

he would verify stock status, replace the sold articles (placing
the ice creams inside the freezer), and obtain the retailer’s signature on the delivery note, which detailed what had beendelivered. Farggi’s delivery person would not collect payment,
but would hand in the signed delivery notes at his operations
base at the end of the day’s work for verification, control, andsubsequent dispatch to Häagen Dazs, who would issue the corresponding invoice and take care of collecting payment.
(Apparently, it was Häagen Dazs’ intention to issue only one
monthly invoice, summarizing everything that had been delivered to a particular shop during each calendar month.) In
return for its cooperation in this process, Farggi would receive
13 percent of Häagen Dazs’ selling price to the retailer. It wasestimated that the average order per visit and delivery would
be at least about 12–14 “pints” (500 ml tubs). In autumn 1992,
Häagen Dazs’ selling price to the retailer was 440 pesetas (+ 6%
VAT) per “pint.” Consequently, Farggi’s average revenue pervisit would have been 13 percent of this amount, or about 744
pesetas per visit made by its own delivery personnel (13 pints
sold per visit x 440 pesetas/pint x 13%). Obviously, the more
successful and better accepted Häagen Dazs’s ice creams
became, the higher the average sale per visit. At that time,
Häagen Dazs had installed only three freezers, but it intended
to initiate an aggressive sales and freezer installation campaign
as soon as it had solved the physical distribution issue.

633

management team took the momentous decision:“We must open our own Farggi parlours as soon as
possible!” Initially, the plan was to open five
Farggi-owned ice cream parlours, the first of which
had to be open by June 1993 to gain maximum benefit from the summer season. They knew that theywould need bank financing for this. Consequently,
right from the start, they planned and executed theentire project on the understanding that subsequent growth of the number of exclusive Farggi
parlours would be by franchising.
Farggi’s managers were well aware that both
Farggi, through its Farga cake shops, and Häagen
Dazs created and developed their image throughestablishments that bore their name. Thus, one of
the key success factors would be to get customers
to buy the luxury ice creams in the supermarket
thanks to the memory and image they took awayfrom their visit to the exclusive ice cream parlour.
A FEW MORE MONTHS OF FRENETIC
ACTIVITY: THE DESIGN OF “FARGGI TUB’S& ICE CREAM”
Once the decision to open their own parlours had
been made, there began a frantic race against time.
Numerous operational details concerning the newice cream parlours and the range of ice creams had
to be decided.
They designed a new logo with the “Farggi”
brand name and considered different names fortheir new establishments (they did not want to callthem “ice cream parlours”). They did not knowwhat name to give their ice cream containers either.
Finally, they decided that the formal namewould be “Farggi Tub’s & Ice Cream.”9 Generally,
they referred to them as their “shops.”
In addition, they had to resolve, decide, anddefine a large number of operational details, suchas:9 ”Tub’s” is a registered trademark of Farggi.

640

Farggi

634

CASE 8 Farggi

1. Find a container manufacturer who could
supply food-quality printed cardboard tubs.
Apparently, there was no such manufacturer
in Spain. It was also difficult to find a suitablesupplier of plastic lids for the tubs. Then, thetub had to be “dressed.” Its decoration had to
be designed so that it conveyed the idea of“luxury ice cream,” using gold and navy blue,
which became the “corporate livery.”
However, there was another problem: thetub manufacturer (which was not a Spanish
company), stipulated minimum runs of
100,000 units for each model or type of decoration. The solution was to print and manufacture a standard or universal tub model, apreprinted base to which two labels would be
added: one on the tub front or side, with thename of the flavor (and stamped with the outline of the object defining the flavor, for example, a strawberry), and another with thebarcode, which would be stuck on the tub
base. Likewise, it was decided to buy lids
made of white plastic, to which a roundsticker was added. Initially, on a temporary
basis, these labels would have to be stuck onby hand, which would slow down andincrease the cost of the production process.
The primary goal was to get the product on
the market as soon as possible. These production details could be improved at a later date.
2. Define the range of ice cream flavors to sell.
Then, develop the corresponding formulasand production processes. For this purpose,
besides using the knowledge and experienceof Farggi’s production and management
team, numerous trips were made to theUnited States to make contact with various
manufacturers of machinery for making ice
cream. Jesús Farga also contacted experts informulas and production processes for North
American-style ice cream.
During these months, Farggi’s management
team and technical and production staff, withoutside help when necessary, developed theformulas and processes for the 25 flavors10
that made up the new range of ice creams forsale both in Farggi’s exclusive ice cream parlours and through the 800 freezer cabinets thatwere already installed in supermarkets andother non-exclusive food shops to sell the“Pastimús” and “Cheesecake” frozen cakes.
Establishing the formulas and production
processes for the new range of ice creams
involved serious technical difficulties because
Farggi wanted to use only absolutely naturalingredients and because the new ice cream
had to meet the following specifications: about
16 percent fat content (instead of the 5 to 6
percent that was usual in Spain, even in theice cream previously manufactured by Farggi),
a very low air content, and no stabilizers or
artificial coloring.
In fact, so great were the technical difficulties that the formulas and processes were notconsidered to have been finalized until June
1993, when the opening of the first Farggi ice
cream parlour was imminent.
These formulas produced ice creams thatwere very similar to those of Häagen Dazs.
On the other hand, both companies’ premium ice creams were clearly different fromany other ice creams manufactured at thattime in Spain.
3. It was necessary to purchase, install, and start
up a number of new machines in the Montgat
factory in order to manufacture and/or package the new types of ice cream.
4. It was also difficult to find a manufacturer
who could supply the 9.5-litre cardboard
cylinders that were required as bulk containers for use in the glass-fronted freezer cabinets
in the Farggi parlours, for serving to the
public in individual scoops. In Spain, the

1 0 Of these 25 flavours, at least three were typically Spanish
and therefore had no Häagen Dazs counterpart: milk meringue
streaked with cinnamon, mandarin sorbet, and Spanish nougat.

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Farggi

CASE 8 Farggi

normal size was five hires, but Farggi’s managers wanted them bigger, so that they would
not have to be changed so often and so thatthey would fit better in the freezer cabinet.
5. Much to their surprise, they also found that
there was no Spanish manufacturer capable ofsupplying freezer cabinets with the machines
and thermostats needed to keep the ice creamprecisely between -18°C and -20°C. This wasan essential detail, not only to keep the ice
cream in perfect condition (manufactured
with a high milk solids content), but also toensure that the consumer would find it coldenough when he ate it. Finally, after a hardsearch, they managed to locate a manufacturerof freezer cabinets in the United States, towhom they sent their first orders.
However, a surprising incident occurred:
when these freezer chests were ready, theNorth American manufacturer shipped themto Europe. When Farggi’s managers asked forthe address and telephone number of the collection point, they discovered to their horrorthat the North American manufacturer had
assumed that they were Häagen Dazs
licensees and had sent the freezer chests to the
Häagen Dazs warehouse in Paris! So, in March
1993, Häagen Dazs found out that Farggi wasplanning to open its own ice cream parlours.
6. The interior of the freezer cabinets installed in
the retail outlets where the frozen cakes werebeing sold had to be redesigned so that they
could also be used to store the new tubs insuch a way that customers could help themselves directly from the freezer.
7. A large number of decisions had to be maderegarding the range of products to be sold in
the Farggi ice cream parlours, the functional
design of the parlours, and their decoration.
For example, one of the key decisions waswhether only ice creams would be served, as
seemed to be the case in Häagen Dazs, orwhether coffee, soft drinks, and pastries would
also be served. If coffee was to be served, the635

establishment’s decoration depended, among
other things, on whether the coffee machine
would be located in a place where it was visible to the public, as in most bars and cafeterias, or not. If they served coffee and pastries,
would the typical bar counter be installed orwould they only be served to be taken away or
to be eaten sitting at the tables?
There was never any doubt that portions ofPastimús and Cheesecake would be served in
Farggi’s parlours, and this feature would
clearly differentiate them from Häagen Dazs.
In the end, it was decided that coffee, softdrinks, and pastries would be served, in addition to ice creams and cakes. There were atleast two reasons for this decision: on the one
hand, Farggi’s managers were continuallyconcerned about ensuring their parlours’ commercial and economic viability during thewinter months, when ice cream consumption
drops off considerably. In fact, the thoughtprocess followed by Farggi’s management
team had been the following: “Our growth
will necessarily depend on granting franchises. Therefore, inevitably, the exclusive
Farggi parlours must be profitable for our
future franchisees. Consequently, the parlours
and the range of products served in themmust be designed so that they make goodbusiness sense in their own right, even if westay with the idea that most of their sales
should be ice creams.”
Secondly, by offering and serving combinations of scoops of ice cream with portions ofcake (possibly with toppings, such as whippedcream, melted chocolate, caramel sauce, orother fruit sauces), the aim was to inspire consumers to imitate them and prepare similar
dessert combinations in their own homes, after
purchasing the ingredients in the Farggi parlours or from the freezers at the supermarkets.
As Margarita Farga added “. . . by this means,
we wanted to get the final consumer to identify with the sweet world of Farggi.”

642

Farggi

636

CASE 8 Farggi

8. It was also decided that they would manufacture and sell three varieties11 of premium ice
cream on sticks, to be called “batonets,” aname that was unique in Spain.
9. Having established the products and services
to be sold in their own parlours, menus wereprinted so that customers wishing to consume the products sitting at the establishment’s tables could choose in complete
comfort and ask the waiters to bring them
what they wanted.
10. Regarding the decoration of the first Farggi
parlour, it was necessary to contact a numberof contractors and interior decorators. One ofthe prerequisites was that these companies
should be organizations large enough to beable to fit out and decorate other exclusive
Farggi parlours (either owned by Farggi or
franchised) in any part of Spain. Also, rightfrom the start, there was a serious and persistent effort to define designs that used standard measurements and specifications, so thatthey could easily be reproduced in otherpremises of a different size, in different locations and with different floor layouts.
The idea was that Farggi parlours would
have two parts: the entrance had always to be“very Farggi,” with a more striking and direct
style of decoration, lighting and signage.
Further inside, on the other hand, in what
Farggi’s managers called the “tea room,” thestyle of decoration would be softer and more
flexible, and could vary from one parlour toanother, although they would always use finematerials such as marble and wood.
11. The last three important decisions were, first,
to run a number of blind tests of the ice creamdeveloped at the Montgat factory, comparing
them with Häagen Dazs’ ice cream. Farggi’s
managers reached the conclusion that, at least
when the test was carried out blind, when the

1 1 Swiss chocolate with black chocolate, vanilla with mild
chocolate and almonds, and vanilla with milk chocolate.

customer did not know which brand of ice
cream he or she was tasting, the result was adraw between the two companies. In actual
fact, what happened was that with certain flavors there was a preference for the ice creamsof one manufacturer, while in other flavors
there was a preference for the ice creams of
the other manufacturer. There was a thirdgroup of flavors where there was no significant preference in either direction.
Encouraged by this result, Farggi’s managers then decided that their ice creams would
be sold at exactly the same retail price as
Häagen Dazs’ products, both in their parlours
and in the freezer cabinets installed in supermarkets and other sales outlets. First, thiswould give them the same (substantial!) unit
margins that Häagen Dazs enjoyed. Second,selling at lower prices could have been interpreted by the consumers as an indication that
Farggi’s ice creams were lower quality. Finally,
they did not have any wish or intention to starta hypothetical price war with Häagen Dazs.12
The final decision concerned the location of
their first parlour. After considering various
options as regards site, size and rent, it was
decided that their first parlour would be atnumber 94 of the stately Paseo de Gracia, a few
yards along the street from Saudis world
famous building “La Pedrera” and a few blocks
from Häagen Dazs first parlour on the Rambla
de Cataluña.
THE FIRST “FARGGI TUB’S & ICE CREAM”
PARLOUR IS OPENEDThe first Farggi parlour opened its doors to the
public in July 1993, almost one year after Häagen

1 2 This price policy would be continued during the following
months: Farggi accepted a role as price “follower” with respect
to Häagen Dazs, so that when Häagen Dazs took the initiative
to increase prices, Farggi followed suit, raising prices by thesame amount.

643

Farggi

CASE 8 Farggi

Dazs opened its first parlour. A few months later, inNovember of the same year, the second Farggi parlour was opened in the Rambla de Cataluña, barely
three blocks away from the first Häagen Dazs parlour and on the same side of the street. A few weeks
later, on 2 December, the third parlour was openedin the “L’Illa Diagonal” shopping centre, on the
Avenida Diagonal.
These three parlours were owned and operated
by Farggi.13 The necessary investments had been
made by the company itself and they were run by
Farggi personnel. Responsibility for the day-today management and supervision of the parlours
was assigned to Marcos Serra. Eduard Farga wasmade responsible for planning and initiating relationships with franchisees: identification of future
franchisees, negotiation, implementation, start-up
and monitoring.
On his return from the United States, Luís Farga
had also joined the company as assistant sales
director, with direct responsibility for the distribution of Farggi products in supermarkets and othertypes of non-exclusive food shops. His first task
was to study the performance of each of the freezers where frozen mousse cakes were sold. Any
freezer that did not reach certain minimum sales
levels was reinstalled in a different shop.
The opening of these first three Farggi-owned
parlours—true flagships for “Farggi Tub’s & Ice
Cream”—attracted a lot of attention and the company started to receive unsolicited requests to open
franchised Farggi parlours.
This fitted in perfectly with the company’s intentions and plans, since they had all been aware, rightfrom the start of the new project, that franchises
would be indispensable if they were to continue

1 3 All Farggi parlours are exclusive, that is, they only sell
products made by Farggi. In this text, we use the expression“Farggi-owned parlours” to refer to the parlours in which theinvestment and operation are Farggi's responsibility, using theexpression "franchised parlours” when the investment andoperation are the responsibility of an independent licensee,
although always under Farggi’s control and supervision.

637

growing at a high enough rate. Indeed, opening thefirst three parlours had required an investment of
about 140 million pesetas, which the company had
financed with bank loans.
Therefore, in early 1994, on the basis of the experience acquired during the first months of operation of
the three Farggi-owned parlours and other sources of
information, Margarita Farga drew up an operating
manual running to more than 200 pages detailing,from A to Z, the operation of a Farggi parlour.
THE FIRST FRANCHISED FARGGI PARLOUR
IS OPENED; THE OTHER PARLOURSOPENED IN 1994
With the manual now available, in February 1994
the owner of a restaurant that was a customer for
Farggi products opened the first franchised Farggi
parlour in Vilanova i La Geltrd.14
The agreement initially took the form of a precontract, while Elena Farga, who had a degree inlaw and worked in a law firm unrelated to the company, worked against the clock to draw up a highly
detailed franchise contract that eventually ran toover 40 pages.
In May 1994, the fourth Farggi-owned parlour
was opened in the Port Olimpic in Barcelona. A
trial run had been carried out beforehand by opening a corner franchise, almost a window franchise,in “El Túnel del Port,” one of the many restaurants
in the area. In view of the enormous success of thewindow, it was decided to open the parlour while
maintaining the corner franchise. This “doublesale” in the same area was still operating at the timeof writing this case
In May 1994, the seventh exclusive sales outlet
was opened (the third of the franchised outlets) in
Conde de Penalver Street in Madrid, near the El
Corte lnglés department store. In this case, thelicensee was Farggi’s own distributor in Madrid.

1 4 A coastal town with about 40,000 inhabitants locatedabout 40km south of Barcelona.

644

Farggi

638

CASE 8 Farggi

In June, the fifth Farggi-owned parlour was
opened in the heart of Barcelona: the Plaza deCataluña. Located between El Corte lnglés and thehead of the Ramblas, Barcelona’s most famous
boulevard, this parlour would benefit from highvisibility and high pedestrian traffic. With this parlour, Farggi’s management team had a certain sensation of having achieved, in barely one year and ahalf, the objective that they had set themselves in
November 1992 of opening five Farggi-owned parlours. They were frankly pleased with the impact
they had in Barcelona and on the ice cream market.
In the same month, the fourth franchised parlour
was opened in Salou, a well-known coastal town
located a few kilometers to the south of Tarragona.
Finally, in the next few months, another three franchised parlours were opened: in the port of Mataró,
in Malaga, and in Calella de Palafrugell, on the
Costa Brava.
Thus, the first full year of activity of Farggi Tub’s& Ice Cream (July 1993–July 1994) ended with 12
parlours open: five Farggi-owned in the city ofBarcelona, and seven franchises (one corner franchise in Barcelona’s Port Olimpic, four in towns on
the Catalonian coast, one in Madrid and another in
Malaga). After the summer, in September 1994, asecond franchised parlour was opened in Madrid(Pintor Sorolla–Santa Engracia).
In order to make sure that the franchisees properly complied with the conditions contained in
Farggi’s manual, the services of an independentcompany that specialized in the control and monitoring of food franchises were hired. This company used the “mystery buyer” method, whichbasically consists of visiting the establishments
without any prior announcement or identification
to verify the level and quality of service to customers, the establishment’s cleanness and appearance, and other details.
New Parlours that Would Be Opened in 1995 andAfter
In February 1995, the third Farggi franchised parlour would be opened in Madrid. A further nine

new franchised Farggi parlours were scheduled: inthe “Maremagnum” shopping and entertainment
complex in the port of Barcelona; in the Calle del Pi,
also in Barcelona; in Vic (province of Barcelona); in
L’Escala (province of Gerona); in Benidorm(province of Alicante); in Puerto Banús (province ofMalaga); in Marbella (province of Malaga); in
Lloret de Mar (province of Barcelona); in Corunna;in Las Arenas, near Bilbao; and in Ciutadella, inMenorca
In short, if these plans worked out, by the endof 1995, Farggi would have a chain of 25 exclusive
ice cream parlours, five owned by the company
itself and located in the city of Barcelona, and 20
franchises.
By the end of the fifth year of operations, Eduard
Farga expected to have about 100 exclusive Farggi
parlours open, of which 90 would be franchises andperhaps 10 Farggi-owned.
EVOLUTION OF THE SALE OF FARGGIPRODUCTS IN SUPERMARKETS AND
OTHER TYPES OF NON-EXCLUSIVE SHOP
FOR HOME CONSUMPTION
The first Farggi products for consumption at home
had been the “Pastimús” and “Cheesecake” cakes,
which were distributed and sold frozen, but were tobe eaten after thawing. They had been introduced inearly 1992 by installing about 800 freezer cabinets insupermarkets and other types of retailers.
Even back then, Farggi’s management team had
guessed that this range of cakes would eventually becomplemented with another range of ice creams tobe eaten at home, possibly taken from or based on
the range of Farggi ice creams sold to restaurants.
Unfortunately, sales of this range of frozen
cakes were growing at a much slower rate than
expected. Margarita Farga attributed this slowness
to the need to induce and allow time for a doublechange in the end customers’ purchasing andeating habits, since, in Spain, it was not the custom
for people to buy frozen cakes in the supermarket.
Normally, people either ate fresh cakes bought in a
traditional cake shop, or ice cream bars and frozen

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Farggi

CASE 8 Farggi

cakes bought in supermarkets and eaten while stillfrozen.
In spite of this difficulty, Farggi had never advertised its frozen mousse cakes in the mass media.
As a result of all this, sales of the Pastimús andCheesecake range in some of the freezers were justabove 100,000 pesetas per freezer per year, at
Farggi’s selling prices to the retailer. Although thiswas a minimum figure, the company’s managers
admitted that the project would only have been
profitable in the long term. There were even cases
where some freezers had to be relocated, installingthem in restaurants and cafeterias.
Throughout 1992, these freezers were installedin various kinds of sales outlets. From November
1992 onwards, the attention of Farggi’s management team was concentrated on preparing thelaunch of “Farggi Tub’s & Ice Cream,” so little
attention was paid to the Pastimús and Cheesecake
range during that period.
Of course, these cakes were included in therange of products to be sold in the Farggi ice cream
parlours.
However, once the first Farggi parlour had been
opened in Paseo de Gracia, modifications weremade to the freezers’ shelving to be able to display
the ice cream “Tub’s” in them, starting with thefreezers installed in Barcelona. At the same time,
Farggi’s sales teams reopened negotiations withsome supermarket chains with a view to relaunching the installation of new freezer cabinets which
would sell the ice cream “Tub’s” and the Farggi
frozen mousse cakes right from the start.
Like Häagen Dazs, Farggi’s policy was first to
open an exclusive Farggi parlour in a city, to create
the product’s image, and then start distributing ice
creams in supermarkets through the freezer cabinets. Of course, Farggi had the advantage of thefact that a large number of freezers had alreadybeen installed.
Consequently, all that was needed in order toexpand the product range was to change the inside
shelving and obtain the retailer’s agreement, which
was relatively easy as the sales turnover of a Farggi
freezer cabinet increased very substantially, almost

639

always to about 500,000 pesetas per year, at Farggi
prices to the retailer.
Although both Farggi and Häagen Dazs maintained a discreet silence regarding their costs andmargins, a number of experts in ice cream manufacture indicated that, even taking into account the factthat both brands used only top quality natural ingredients, the cost of the raw materials and packaging
would probably not be more than 35 percent of theirsale price for “Tub’s” and “pints” to retailers.
Generally speaking, although both had started inBarcelona. there was relatively little confrontation
between Farggi and Häagen Dazs. First, because
both were still in an early phase of market entry.
Second, because Farggi already had a large
installed base of freezer cabinets. Third, because
both realized that they could coexist perfectly, sharing presence in many supermarkets and even insmaller shops.
In spite of this, there were a few clashes. For
example, Farggi managed to be present in all the
Caprabo supermarkets (55 points of sale), whereas
Häagen Dazs would only be present in the 15
largest, sharing presence with Farggi. In those
supermarkets where both brands’ freezers were
installed side by side, their sales volumes werevery similar.
On the other hand, in the Pizza Hut chain, eventhough Farggi had managed to get its foot in first,
in March 1994 Häagen Dazs became the sole supplier of ice creams. However, Farggi remained as acake supplier for Pizza Hut, so the business relationship was not broken. Much the same thing happened in the Pans & Company sandwich chain,
which bought ice creams from Häagen Dazs andcakes from Farggi.
In August 1993, Farggi signed a contract with theBarcelona Football Club for the exclusive sale of ice
creams in its sports facilities. The purpose of thiscontract was to create brand impact and enable alarge number of people to taste Farggi’s products.
“Mini Tub’s” (100 ml) and “Batonets” were soldfrom 25 carts at 350 pesetas each. The contract
would run for three years, with Farggi paying 15
million pesetas/year.

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CASE 8 Farggi

MEANWHILE, HÄAGEN DAZS . . .
Farggi’s managers believed that, by the end of 1994,
Häagen Dazs had about 25 parlours operating, of
which two were actually owned by the company:
one in the Rambla de Cataluña in Barcelona and theother in the centre of Madrid.
Regarding distribution, it was estimated thatthey had about 600 freezer cabinets installed inBarcelona and a further 400 in Madrid, mainly in
relatively small outlets, but with presence in somesupermarket and hypermarket chains. The physicaldistribution in the Barcelona area was carried out
by La Menorquina, although this relationshipseemed to have ended by the end of 1994. In otherparts of Spain, they used the services of professional frozen product logistics companies.
In June 1994, Häagen Dazs had introduced arange of four varieties of ice cream under the name
“Exträas,” which it sold in its parlours but not insupermarkets. This range had a distinctive presentation and seemed to have achieved a relative success.
By the end of 1994, one or two Häagen Dazs
franchisees had raised the possibility with Farggi ofchanging flag and joining its chain.
MAIN STRATEGIC DILEMMAS FACING THE
FARGA/FARGGI GROUP IN EARLY 1995
In early 1995, Margarita Farga, as Farggi’s marketing director, was reflecting on what had been done
so far and what had been achieved.
To help her organize her thoughts about theFarga/Farggi Group’s business activities, shesometimes used the following “branch system:”
Farga/Farggi Group:
1. Farga traditional cake shops
2. Farggi businesses
2.1 Farggi products sold to restaurants
2.2. Farggi products sold to retail shops
2.2.1. Sold to non-exclusive shops (supermarkets, etc.)
2.2.2. Sold to the exclusive Farggi parlours
2.2.2.1. Farggi-owned parlours
2.2.2.2. Franchised parlours

Some of her thoughts and concerns about eachof these “branches of the Farga/Farggi tree” were
the following:
On the one hand, the three Farga cake shops (item 1)
were carrying on as usual, with 37 years of professional and trade experience, as upmarket establishments making fresh cakes and high-quality pastries,
sold directly to the public either for consumption on
the premises or to take home. There did not seem to be
any intention of modifying their activities or increasing the number of such establishments.
On the other hand, there were all the Farggi products (item 2).

First among these, both for historical reasons of“order of appearance” and because of its basic economic importance, was the sale of ice creams andfrozen cakes to restaurants and cafeterias (item 2.1),
which was still the group’s largest business interms of sales: excluding sales by the Farga cakeshops, it had accounted for 60 percent of total ice
cream and frozen cake sales under the Farggi brandname in 1994.
Margarita was aware that, since November 1992,
this “business 2.1” had been somewhat neglected
as a result of the strategic priority given by all thecompany’s personnel to designing and startingup the “Farggi Tub’s & Ice Cream” project.
Consequently, it seemed to her that the time hadcome to redefine and refocus it strategically, bothas a brand and as its product range or collection.
Restaurants and cafeterias were a mature
market, but one in which some fast food chainswere growing rapidly. However, during 1993 and1994, Margarita had not had the impression that
Farggi’s customary competitors in this field (Frigo,
Camy, Menorquina, Avidesa, etc.) were introducing
any striking novelties.
In third place was “business 2.2,” the sale of
Farggi products in shops and parlours for consumption at home, on the premises, or on the street(impulse sale). It seemed clear to Margarita that
Farggi’s management team’s chief achievement
during the previous three years (1992–1994) had
been the creation of a relatively complex strategic

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CASE 8 Farggi

platform for the sale of Farggi ice creams and frozen
cakes for consumption in Farggi ice cream parlours
and at home. Over a period of three years, they hadtaken this business from zero to 40 percent of thetotal sales of Farggi products, “business 2” in 1994.
According to a market survey carried out in
September 1994, their only competitor in this “business 2.2,” in the opinion of a sample of final consumers in Barcelona, was Häagen Dazs. It seemedthat Farggi and Häagen Dazs were the only two ice
cream brands that had really succeeded in positioning and consolidating themselves in the highquality, premium price segment of the ice creammarket in Spain. However, at the same time, it
seemed obvious to her that both “luxury” ice creambrands competed with the major brands, such as
Frigo, Camy, Avidesa, Miko, etc., given that theconsumer, when buying ice cream, had to decide
whether he wanted high quality ice cream at a highprice or medium quality ice cream at a medium
price.
Regarding sales in non-exclusive shops (item2.2.1), by the end of 1994, Farggi was distributing
its ice cream “Tub’s” and frozen cakes (Pastimús
and Cheesecake) in Catalonia, Madrid, and Malaga
through 800 freezer cabinets installed in supermarkets and other retail sales outlets. Farggi’s management team were of the opinion that, in these threeareas, the market was still a long way from being
saturated and that in Catalonia, Madrid, andMalaga-Costa del Sol, they could install up to a
maximum of 6,000 freezers.
It was also their intention to expand the distribution of “Tub’s” and frozen cakes as new exclusive
Farggi parlours were opened in other locations; theparlours would create the brand image in eachlocation, paving the way for sales in non-exclusive
shops. The brand image was also needed to justify
the price premium of Farggi ice creams, which weresold to the public in supermarkets at 675 pesetas forhalf a litre, whereas the usual price for Frigo, Camyand Miko ranged between 400 and 450 pesetas per
litre, although they often ran promotions during
which the price could be reduced to as little as 350
pesetas per litre.

641

By the end of 1994, Farggi had about 80 applications to open new franchised Farggi parlours, so
Margarita was sure that there would be no obstacle
to growth due to lack of parlours. However,depending on the rate at which new parlours wereopened and the market size and potential of eachtown or city in which they were to be opened, a limiting factor might be their financial capacity toinvest in the purchase of freezer cabinets. By the endof 1994, each freezer cost 150,000 pesetas. The
upside of this was that, thanks to the sale of “Tub’s”
and cakes in the same freezer, sales figures exceeding 600,000 pesetas per freezer per year were being
achieved, at Farggi’s sales prices to the retailer. In alarge supermarket, the figure could easily be double
this amount. When Farggi sold to retailers throughits local distributor, it granted the distributor a 20
percent discount, giving a net billing for Farggi perfreezer of 480,000 pesetas/year. Even so, with such
figures, it was possible to depreciate a freezer over areasonable period of five years, financing them bycredit lines or leasing operations.
Finally, regarding sales in exclusive Farggi parlours (item 2.2.2.), a distinction had to be madebetween Farggi-owned parlours and franchised
parlours.
As stated earlier, by the end of 1994, Farggi had
five parlours of its own (item 2.2.2.1), all of themlocated in the city of Barcelona. The parlours in
Paseo de Gracia, Rambla de Cataluña and L’Illa
had been operating for barely a year. Port Olimpic
and Plaza de Cataluña, which were opened in
mid-1994, had only been going for a few months
and had yet to pass the acid test of the winterseason.
In Margarita Farga’s opinion, these five Farggiowned parlours were “perfect as flagships,” tocreate the necessary Farggi image: (a) to sell
“Tub’s” in the supermarkets; (b) to promote sales of
new franchises; and (c) to generate a good image, in
general, with a very broad range of groups andaudiences, such as gastronomic journalists, retailers, financial institutions, etc. Their profitability
was in some cases “very high,” while in others she
considered it to be “satisfactory.”

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Farggi

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CASE 8 Farggi

The company’s immediate plans were not toopen any more Farggi-owned parlours, except incities or streets which might be considered “strategic,” necessary for the process of creating or
strengthening the company’s image.
There could perhaps be a middle road, consisting of having part-owned parlours, in which Farggi
would share ownership of the parlour with a local
partner.
Regarding the franchised parlours (item 2.2.2.2),
one point that had to be remembered was that someof them were seasonal, open to the public for only
about six months. Such was the case of the parloursin Salou, Calella, Mataró. . . . It appeared that the seasonal parlours, located in coastal resorts, were“extremely profitable.” Other parlours were open
all the year round: Madrid and Malaga. The key
profitability factor for these parlours would be theirperformance during the difficult winter months.
At least until the end of 1994, these franchised
parlours did not pay any royalties nor had they
made any initial down payment to buy their franchising rights when they signed the contract. Farggi
obtained its profits from the captive sale to its franchisees of five products or groups of products:
1. Ice cream, in 9.5 litre packs (“bulks”), which
they resold “by the scoop.”
2. Ice cream in “Tub’s” for taking away.
3. “Pastimús” and “Cheesecake” frozen cakes fortaking home whole.
4. Frozen cakes for selling in the parlour in portions.
5. Various complementary articles, such as paper
napkins, cone wafers and paper cups for serving the balls of ice cream, toppings and sauces,
uniforms, etc. . . .
The margin, the difference between the purchaseprice from Farggi and the selling price to the publicin the parlour, was very high, about 65 percent of
the retail price. To put it the other way round, thecost of the products sold to the public was 35 percent of the selling price. Of course, the parlour
owner had to pay the rent, wages and social security, financial expenses (if any), electricity, water,amortize the machinery and facilities, etc.

Farggi required that parlours which were to beopen all year round should have a minimum surface area of 100 meters. A parlour of this size
required investments of about 20–25 million pesetas in machinery, equipment, and decoration.
In the case of parlours that were open only
during the summer season, Farggi allowed them tobe smaller, with a minimum of about 50 meters. The
investment to fit out an ice cream parlour of this size
usually ran to between 12 and 15 million pesetas.
SOME FINANCIAL INFORMATION
Being a family-owned company, Lacrem, S.A. did
not publish its balance sheets. Traditionally, it had
always made a profit which had enabled it tofinance its growth from self-generated funds.
Exceptionally, in 1993, the company had recorded anegative cash flow. However, cash flow had beenmoderately positive again in 1994. The economic
forecasts for 1995 and 1996 were for a strong
increase in cash flow, which would enable the company to progressively decrease its level of indebtedness, open new Farggi-owned parlours, or buy
more freezer cabinets.
As marketing director, Margarita had a relatively modest budget of about 25 or 30 million
pesetas, which she used to carry out typical marketing activities, such as local promotional events
when new parlours were opened, tasting events,
preparing the new menus for the company’s parlours, a number of public relations activities, etc.
The Group’s turnover, which consists of Lacrem,
S.A.’s turnover plus the final turnover (sales to the
public) of the five Farggi-owned parlours, less
Lacrem, S.A.’s billing to these five parlours (so as
not to count twice), was expected to double
between 1993 and 1995, as follows:

Forecast
Forecast

1992
1993
1994
1995
1996

+5%
–15%
+40%
+30%
+30%

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CASE 8 Farggi

The investments in the factory had amounted toabout 350 million pesetas. Total investments in
Farggi-owned parlours and freezer cabinets had
amounted to another 350 million pesetas.
By the end of 1994, for all its sales activities,
including sales to restaurants and cafeterias, thecompany had an installed base of about 3,000
freezer cabinets and a further 2,000 top-opening
freezer chests, used by restaurants and cafeterias tostore their stocks of Farggi products.
SOME QUESTIONS ABOUT THE FUTURE
Faced with this situation, Margarita Farga wasturning over a number of questions in her mind.
For example:• Who were they really competing against?
Against Häagen Dazs? Against the traditional
big ice cream companies: Frigo, Camy, etc.?
Against the traditional cake shops? Were they
perhaps expanding the market, expanding consumption among people who would not otherwise eat ice cream?
• How quickly should they grow? In which cities
or geographical areas? Farggi was alreadyreceiving a large number of franchise applications from outside of Spain. Should it start tointernationalize itself? If so, which countries
should it go to first? Should they open directlyin other countries or reach an agreement with amaster franchiser who would be given exclusive rights for an entire country?
• Were five Farggi-owned parlours enough or
should they try and open more? Should they
maintain a certain percentage or proportion of
Farggi-owned parlours out of the total numberof exclusive Farggi parlours?
• Would it be enough to open exclusive parlours
to create the necessary image or should theyalso run advertising campaigns in the mass
media? In the case of the latter, what should betheir positioning and message? It was clear thatsuch advertising would have to promote highquality, premium price products, but should

643

they aim for an “adult” positioning like Häagen
Dazs? Would a more family-style positioning bebetter, with advertisements showing children
with their parents and/or grandparents or perhaps a “for gourmets of all ages” positioning?
• What things should they, try and do like
Häagen Dazs and what things should they dodifferently in order to achieve a distinct, differentiated image? For example, on the subject ofice cream flavors, should they make “international flavors” or should they differentiatethemselves by creating flavors more in tune
with the Spanish palate?
In short, what were the key success factorsof “Farggi Tub’s & Ice Cream?” What things
could Farggi do that Häagen Dazs could not or
did not want to do? Looking at it the otherway round, what things could Häagen Dazs dothat Farggi could not do, or at least could not
do so well? What things could both of them dowith more or less equal cost-effectiveness,without any differential competitive advantages on either side?
• Finally, Farggi’s management team was awareof a significant dilemma: (a) They could either
go on alone, self-financing their growth, inwhich case they might not be able to keep up
with Häagen Dazs and other competitors
might appear in the same segment;15 (b)or it
might be better to allow a non-family investor
to come in with a view to accelerating theirmarket penetration at home and abroad.
No doubt, this list of questions was not exhaustive and what most worried Margarita was the possibility that she might have left out some key
decision in this maze of decisions and opportunities.

1 5 On 5 February 1995, the newspaper Expansión publishedan article stating that the North American ice cream company
Ben & Jerry had recruited Robert Holland as its new CEO. The
article closed by quoting Holland, an ex-McKinsey consultant,as saying, “We will be in Europe next year.” According to thesame article, Ben & Jerry’s sales in 1993 totaled 140 million dollars, with a net income of 7.2 million U.S. dollars.

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Farggi

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CASE 8 Farggi

EXHIBIT 1FARGGI The Spanish ice cream market
The Spanish ice cream market had a total volume ofalmost 182 million litres (some 48 million U.S. gallons) in1994.
According to industry sources, this figure includes
only “industrial” ice cream, manufactured by companies
which were members of the Asociación Española deFabricantes de Helados. Therefore, to obtain the real total
market volume, one should add a further 20 to 25 million
litres of ice cream homemade or made by small artisanlike manufacturers, plus some 20 to 25 million litres manufactured by small industrial companies which were notmembers of the Asociación.
Bearing in mind that Spain has a permanent population of some 40 million, the annual consumption of ice
cream would be around five litres per person. It may beeven less than that, bearing in mind that Spain received
some 60 million tourists and visitors in 1994.
According to industry sources, the total market may
be broken down in the following manner:
1. Some 42 percent of the total market would bemade up of products classified as “impulse,” soldin individual portions, individually packed or
wrapped, frequently sold by street or beach standvendors, or from ice cream freezers located at thedoor of bars, supermarkets or miscellaneous foodretailers. The most common products in this category would be pre-packaged ice cream cones, small
cups, and ice lollies or Popsicles. It may be necessary to clarify that this classification refers to product categories, and not to how or where it isconsumed. In other words, whether an “impulse”
product, is bought at a bar or in a restaurant, if it isa product in an individual portion, individually
packaged, it continues to be classified as“impulse.”
In the last few years, formats of “impulse” products have appeared in the market, such as ice cream
sandwiches, or small ice cream bars, such as Crunch
by Nestlé, or frozen Mars bars.
2. A further 11 percent of the total market is made up
of “home” consumption products. These are frequently packaged in one litre packs, such as the
product ranges of “La Cremería” (Nestlé), “Carted’Or” (Frigo), or “Etiqueta Negra” (Miko). We

would also find in this group the large ice creambars or blocks which have to be cut into smaller
individual portions for consumption. as well as
frozen cakes or confections, such as “Gala,”“Comtessa,” crocanti, or whisky frozen cakes. We
also find here multipacks containing several portions usually sold as “impulse,” but in a special
multiple pack to be sold in supermarkets and foodstores, to be consumed at home.
3. A further 11 percent of the total market is made up
of products sold in “restaurants,” cafeterias, andfood service outlets. This product category is madeup of larger ice cream bars or blocks for restaurants(intended to be cut into individual portions justbefore serving), and ice cream prepared by the manufacturer in individual portions to be sold in restaurants, mostly as desserts: individual portions withfruit or packaged in ceramic terrines, bonbons,tartuffi, small cartons or plastic cups for food service
cafeterias, etc.
4. Finally, the remaining 25 percent of the total market
is defined as “blocks and bulks.” This product category would be made up of ice cream in large bars or
blocks, sold directly to consumers using the same
freezers out of which “impulse” products are sold tothe public. We would also find here the large ice
cream carton cylinders of 2, 4, and even 6 litres each,out of which ice cream parlours or restaurants serve
cones or cups by the ball. These ice cream balls will
be eaten at the restaurant or walking in the street.
These portions are never individually packed andare meant to be consumed immediately. Maybe as
much as 50 percent of the volume sold in this way isreally an “impulse” purchase, bought and consumed without any previous planning on the part ofthe consumer.
Industry sources estimated that ice cream consumption by impulse and in restaurants and cafeteriasamounted to some 75 percent of the total market, while
ice cream consumed at home would account for onlyaround 25 percent of the total volume. These same
sources expected that consumption at home would
increase in the immediate future, attaining maybe 40 percent total market volume by the year 2000.

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CASE 8 Farggi

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EXHIBIT 1FARGGI The Spanish ice cream market (continued)
Some observers said that the Spanish market had witnessed a significant improvement in the average qualityof ice cream. The traditional water-based ice lollies or
Popsicles had given way to richer and more nutritive
products. It was estimated that maybe 50 percent of thetotal Spanish ice cream market was now manufactured
with milk fats, while the other 50 percent was manufactured using modern and advanced vegetable fats.
Regarding the main competitors and their products,
Frigo (Unilever) had been the traditional leader in the
Spanish ice cream market for many years, with a market
share of around 30 percent (Source: El Pais-Negocios, 2 July
1995, page 5). In 1993, Frigo had a total turnover of some
27,780 million pesetas (1 US$ = 130 Spanish pesetas), of
which 87 percent had been by its ice cream division,
while the other 13 percent had been in frozen foods(Fomento magazine, October l994, page 260). According to“IP mark” magazine (16–30 September 1995, page 45),
Frigo was said to have spent around 1,100 million pesetas on media advertising in 1994.
However, Frigo’s leadership had just been lost to
Nestlé. After a premature announcement in August 1994,
in March 1995 Nestlé-Camy had finally bought Avidesa
and Miko. According to Carina Farreras (La Vanguardia,
July 22, 1995, Economia y Negocios, page 7), Nestlé would
now be the new leader of the Spanish ice cream market
with a total market share of around 40 percent, with its
three brands Camy, Avidesa, and Miko. According to thesame issue of IP mark magazine, Nestlé spent some 900
million pesetas on media advertising to promote their ice

cream in 1994 (presumably, just to promote their Camybrand). However, sources close to Nestlé indicated that
their media spending in that year was close to 350 million
pesetas.
In other words, some 70 percent of the total Spanish
ice cream market would now be jointly held by Nestlé(Camy + Avidesa + Miko) and Unilever (Frigo). TLC
Beatrice-La Menorquina would be the third contender,
with a total turnover of some 12,800 million pesetas in1993 (Fomento, October 1994, page 259). This turnover
was slightly less than the 13,950 million pesetas sold in
1993 by Helados y Congelados, S.A. (Conelsa-Miko),
recently acquired by Nestlé. However, Beatrice Foods
and its partner Mr. Delfín Suárez also owned Interglás,
S.A. (Kalise), which had a turnover of 7,800 million pesetas in 1993, including yoghurt.
Finally, the U.S. market was estimated to be worth
between 3.2 and 3.3 billion U.S. dollars. Out of these, the“super premium” segment had a share of about 11 percent. In the last few years, the total U.S. market was said
to have grown at an annual rate of about 3.5 percent,while the “super premium” segment would have grown
faster.
The two major competitors in the “super premium”
segment were Häagen Dazs and Ben & Jerry’s with some
40 percent each. The remaining 20 percent was in thehands of other “super premium” brands such as Frutsen
Gladge, Steve’s Homemade, some “ethnic” brands such as
Goya, or private brands such as Dag’s Select, owned by
D’Augostino supermarkets.

C A S E 9 Lever Brothers’ Introductionof Snuggle Fabric SoftenerIt was early May 1990 and Lever Brothers Eastern
Regional Sales Manager, Mr. David Lewis, waspondering his assignment. Mr. Lewis needed todevise a strategy to introduce Snuggle, Lever
Brothers’ newest entry into the fast-growing liquidfabric softener market into his region.
The product had already been successfully introduced into the Milwaukee test market, the Midwest, West, Central, Southeast, and Southwest
regions. Only the Eastern region remained. The
company believed it had the right combination ofingredients for unprecedented success—a quality
product, a lower price, and a magical “spokesbear.”Snuggle had broken all records since its introduction, and it was Mr. Lewis’s job to continue its
success.
HISTORY
Lever Brothers Company is one of the UnitedStates’ best-known manufacturers and marketersof soaps, detergents, toiletries, and food products.
It is a member of the worldwide Unilever corporation, which includes more than 500 companies andoffers one of the widest varieties of products andservices in the world.
The name Unilever was coined in 1929, when
the Margarine Union merged with Lever Brothers
and changed its name to Unilever Limited. At thesame time, the Margarine Union in the Netherlands became Unilever N.V. Unilever Limited has
its head offices in London; the offices of Unilever
N.V. are in Rotterdam.
Each Unilever director is on the board of bothparent companies and, as much as possible, bothcompanies work as one company—Unilever.

27

Today’s Unilever traces its roots to nineteenthcentury Europe. The company is a direct result of
the ingenuity and hard work of three European
families, the Lever and Jurgens families ofEngland and the Van den Burgh family of theNetherlands.
In 1885, William and James Lever founded theirsoap company. Through innovative marketing andpackaging, their soap, known as Sunlight, became
the world’s biggest selling soap by 1887.
Years earlier, Anton Jurgens and his three sonsbecame engaged in the butter trade. Unfortunately,
as time went on, they found it increasingly difficult
to obtain their raw materials. Luckily, in 1869 theyfound a way to overcome their supply problem.
They simply bought the rights to a French chemist’s latest product, margarine.
Finally, Simon Van den Burgh and his sons, rival
exporters of cheap butter from the Netherlands,
also heard about the new invention, and they alsobegan to make margarine.
All three firms grew at great rates. Each firm
expanded its product line. Jurgens and Van den
Burgh even entered the business of manufacturingsoap.
All three firms shared a great deal in common.
All relied on the same basic raw materials of oils
and fats and the same refining processes. Their production was on a large scale and their distribution
channels were alike. Their products also tended to
be ordinary necessities intended to be consumed orused in millions of homes.
With such similarities, it was logical that thesecompanies would someday come together. Througha series of mergers and acquisitions, the three grew
into today’s Unilever.

This case was prepared as a basis for classroom discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

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Lever Brothers' Introduction of Snuggle Fabric Softener

CASE 9 Lever Brothers’ Introduction of Snuggle Fabric Softener

In 1989, Unilever operated over 500 companies
in more than 70 countries, employed over 330,000
people, and had sales of over $24 billion. One of its
most important companies is the Lever Brothers
Company in the United States.
Lever Brothers started in 1895, with a small sales
office in New York. Slowly, the company grew withsuch products as Lifebuoy, Sunlight, and Welcome.
For its first 25 years, the company concentrated on
the New England market. Then in 1919, with theintroduction of Rinso, the first granulated packaged soap, the company went national. In 1924,
Lux, the first white milled perfumed soap to bemade in America and sold at a popular price, wasintroduced. By 1929, Lever Brothers became thethird largest producer of soap and glycerine in the
United States.
Through the 1930s and ‘40s, Lever Brothers
grew. It expanded its manufacturing capacity timeand again. It built or acquired plants in Hammond,
Indiana; Edgewater, New Jersey; Baltimore, Maryland; Chicago, Illinois; and St. Louis, Missouri. The
company diversified into shortening, margarine,
and toothpaste (Pepsodent).
In the 1950s, Lever Brothers introduced a procession of new products. Such products as Lux liquid detergent, the first liquid detergent to be
packaged in cans; Wisk, the first liquid heavy-dutylaundry detergent; Imperial, the first premium
margarine; Dove, the new type of toilet bar containing one-quarter cleansing cream; and Mrs.
Butterworth’s syrup, the first syrup blended withbutter, were all introduced.
Through the 1960s and ‘70s, Lever Brothers
introduced more notable new products such as a
Pepsodent denture brush, Soft Imperial margarine,
Drive detergent, Close-up and Aim toothpastes,
Caress body bar, Promise margarine, and Signal
mouthwash.
Finally, the 1980s brought us Shield deodorantsoap, Aim Mint toothpaste, Sunlight dishwashingliquid, Impulse body spray, Sunlight automatic
dishwashing detergent, Snuggle fabric softenersheets, Surf high suds detergent, and now Snuggle
Liquid Fabric Softener.

647

From its modest start in 1895, Lever Brothers hasgrown to be one of the largest soap, detergent, andtoiletry producers in the country.
LEVER BROTHERS ORGANIZATION:
HOUSEHOLD PRODUCTS
Lever Brothers was a decentralized company that
had three operating divisions. These were Household Products (HHP), Personal Products (PPD),and Foods. Each division had its own president
and officers, and each was responsible, as far as ispractical, for all resources and services necessary
for its operation. This organizational structure wascompleted in 1981.
The sales force sold Lever’s household products
throughout the United States. To facilitate this selling activity, the sales force was divided into six
regions. Each region was divided into districts, andeach district was divided into areas/units. Finally,each area/unit was divided into sales territories.
These were, in turn, headed by regional sales managers, district sales managers, area assistants, anddistrict field sales managers, who were assigned toassist district sales managers in managing some
districts.
This organization allowed maximum flexibility
when making decisions to best serve the requirements of different market zones throughout thecountry. For example, local promotions were determined by buying preferences and competitive
approaches in a particular market, and these could
be different from those in another district.
The six regions and 22 districts are listed in
Exhibit 1.
HOUSEHOLD PRODUCTS DIVISION:CHANNELS OF DISTRIBUTION
Lever Brothers used two different channels of distribution. They were as follows:
1. Manufacturer (Lever Brothers) who sold to wholesalers and chain headquarters who supplied toretailers or chain stores who sold directly to
consumers.

Lever Brothers' Introduction of Snuggle Fabric Softener

648

CASE 9 Lever Brothers’ Introduction of Snuggle Fabric Softener

EXHIBIT 1
Lever Brothers Household Products Division Field Sales Organization
Eastern Region

Central Region

Southeastern Region

Boston
New York
Philadelphia

Detroit
Syracuse
Cincinnati
Cleveland/PittsburghCharlotte
AtlantaOrlandoBaltimoreSouthwestern Region

Midwestern Region

Western Region

New Orleans
Dallas
HoustonDenver

ChicagoKansas City
Minneapolis
St. Louis

Los Angeles
San Francisco
Portland

2. Manufacturer (Lever Brothers) who sold directly toretailers who sold to consumers.

HOUSEHOLD PRODUCTS DIVISION:
CATEGORIES OF MERCHANDISE
The Household Products division sold four typesof products: laundry detergents, dishwashingdetergents, fabric softeners, and toilet bars. In the
fabric softener field, Lever offered three products:
Final Touch and two types of Snuggle, which camein liquids or sheets.
Final Touch was introduced in 1964 and was marketed as a premium fabric softener, while Snuggle
Liquid and Sheets were both priced approximately
10 percent below the premium market.
PRODUCT/MARKET INFORMATION
Product
Snuggle was a premium quality liquid fabric softener that softened the whole wash, controlled static
cling, and gave clothes a fresh smell at a price thatwas really less expensive than other premium fabric softeners. It would be available in the normal
variety of sizes—17 oz., 33 oz., 64 oz., 96 oz., and
128 oz.

crease of 22 percent since 1985. The liquid softenermarket could be expanded because 30 percent of allhouseholds still did not use a fabric softener. The
liquid fabric softener category was dominated bypremium-priced products. Each of the nationally
supported brands (i.e., Downy, manufactured by
Procter & Gamble, and Final Touch, manufactured
by Lever Brothers) had one thing in common—apremium price. An opportunity existed to expand
the choice consumers had by offering a quality liquid fabric softener at a price that was really lessexpensive.
Category Structure. Fabric softeners are primarily used by consumers to soften clothes, control
static cling, and provide a fresh scent. The fabricsoftener market can be segmented by form into twogroups—liquid softeners and dryer sheets.
• Liquid softeners are usually added to the washer
during the rinse cycle. They tend to provide superior
softening.
• Dryer sheets are pre-cut or come in tear-off fabricsheets that are tossed into the dryer along with thewash. Dryer sheets provide superior static cling control and convenience.
1989 Fabric Softener Category Share by Segment
Unit Share

Market
The liquid fabric softener category was large andgrowing. In 1989, sales were $398 million, an in-

Dollar Share

Liquids

56%

59%

Dryer Sheets

44%

41%

655

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Lever Brothers' Introduction of Snuggle Fabric Softener

649

CASE 9 Lever Brothers’ Introduction of Snuggle Fabric SoftenerCompetitive Environment.
Liquids. The liquid fabric softener category was
divided into three distinct segments: dilutes, concentrates, and super concentrates. (See Exhibit 2.)
Concentrates, which were the preferred form, currently represented 77 percent of the total liquidmarket. The three liquid forms were differentiatedby recommended usage amounts and cost per
ounce and generally competed only within theirsegment.
Nationally, regular Downy was the leading
brand with a 43.6 percent share of the liquid category, followed by Final Touch with 14.1 percent,and Snuggle with 11.3 percent of the market. In the
Midwest, Snuggle currently had a 31.2 percent
share, and in the West, the product had a 23.7 percent share.

Liquid Shares—1989
Brand
Downy Total
Regular
Super Conc.
SnuggleFinal Touch
Sta-PufAll Others

Product

Advertising Claim

Final Touch

Softness, Fragrance, Static Cling, andWhiteness

Downy

Softness, Fragrance, Static Cling

The following is market share data from threemajor cities in the Eastern Region:
SAMI Rankings—Liquid Fabric Softeners*
12 Week–Physical Case Share, Period Ending 4/26/90
Boston/Providence
Brand

Share

Downy

36.7

Final Touch

17.9

Downy T. C.

10.4

Lavender Sachet

5.2

Sta-Puf

1.1

Brand

Size

Share

National

Midwest

West

Downy

64 oz.

14.3

54.5
43.6
10.9
11.3
14.1
4.8
15.3

48.2
36.9
11.3
31.2
9.8
2.5
8.3

57.7
47.3
10.4
23.7
4.6
3.1
10.9

Downy

96 oz.

12.2

Final Touch

64 oz.

8.0

Downy

33 oz.

7.4

Downy T. C.

21.5 oz.

6.7

Final Touch

33 oz.

6.2

Lavender Sachet

46 oz.

4.3

Downy T. C.

32 oz.

3.8

Final Touch

96 oz.

3.7

Downy

17 oz.

2.8

Only Final Touch and Downy received national
advertising support. Both were premium-priced
products, but were differentiated by the whitening
ability of Final Touch.

*Private labels and generics not included.

EXHIBIT 2
Liquid Softener Segmentation
Segment

Recommended
Usage AmountPrice Per
Ounce

Cost
Per Use

Dilutes

6–8 ounces

1.4 cents

9.7 cents

Concentrates

3 ounces

3.5 cents

10.5 centsSuper Concentrates

1 ounce10.2 cents

10.2 cents

Lever Brothers' Introduction of Snuggle Fabric Softener

650

CASE 9 Lever Brothers’ Introduction of Snuggle Fabric Softener

Brand

Share

Dryer. In the dryer segment, Bounce was thedominant brand with 50.3 percent share.

Downy

35.0

Dryer Shares*—1989

Final Touch

19.3

Brand

Downy T. C.

9.1

Lavender Sachet

6.8

Sta-Puf Concentrate

5.1

Bounce Total
RegularUnscented
Cling FreeAll Others

New York

Brand

Size

Share

Downy

96 oz.

15.4

Downy

64 oz.

10.7

Final Touch

64 oz.

8.5

Downy

33 oz.

7.4

Final Touch

33 oz.

6.4

Downy T. C.

32 oz.

4.7

Lavender Sachet

46 oz.

4.6

Final Touch

96 oz.

4.5

Downy T. C.

21.5 oz.

3.9

Sta-Puf Concentrate

64 oz.

2.6

Philadelphia
Brand

Share

Downy

30.6

Final Touch

20.4

Downy T. C.

9.8

Sta-Puf Concentrate

7.8

Lavender Sachet

6.1

Share of Dryer Segment
50.3
43.1
7.2
12.1
37.7

*Excludes Snuggle Sheet Test Market

Category Pricing. Final Touch and Downy
were both premium-priced and at parity to eachother. Sta-Puf, which did not receive national
advertising support and had a national share of
only 4.8 percent, was priced at an average 10.8 percent discount to the premium brands. In general,
dryer products were priced 50 percent below comparable liquid products on a per-use basis. (SeeExhibit 3.)
Category Spending. More than half of the total
marketing support in the fabric softener category
was placed behind promotion, while the balance
was spent on advertising.
Category Spending*—1989
Promotion
Advertising

Percent$ 62,500M
46,900M

57%
43$109,400M

100%

Fabric Softener Category 1989 Advertising Spending*

Brand

Size

Share

Downy

64 oz.

13.2

Brand

Final Touch

64 oz.

8.9

Downy

96 oz.

8.8

Liquids
Downy**
Final Touch

Final Touch

33 oz.

7.6

Downy

33 oz.

5.9

Downy T. C.

32 oz.

5.5

Sta-Puf Concentrate

64 oz.

4.8

Downy T. C.

21.5 oz.

4.3

Lavender Sachet

46 oz.

4.3

Final Touch

96 oz.

3.9

Total Liquids
Dryer
BounceCling Free
Toss N Soft
Total Dryer$MM

Share of Spending

$20.4
9.0

69%
31

$29.4MM

100%

$ 9.7
6.8
1.0

55%
39
6

$17.5MM100%*Excludes Snuggle**Includes Triple Concentrated

657

658

Lever Brothers' Introduction of Snuggle Fabric Softener

CASE 9 Lever Brothers’ Introduction of Snuggle Fabric Softener

651

EXHIBIT 3
Category Pricing
Pack

Pkg. Wt.

$/Case$/Unit$Cost/Use*

12’s

33 oz.

14.04

1.17

.106

6’s

64 oz.

13.30

2.22

.104

4’s

96 oz.

13.09

3.27

.012

Final Touch

Downy

BounceCling Free

12’s

33 oz.

14.04

1.17

.106

6’s

64 oz.

17.73

2.22

.104

4’s

96 oz.

19.64

3.27

.012

12’s

20 use

12.34

1.03

.051

12’s

40 use

24.03

2.00

.050

8’s

60 use

22.41

2.80

.047

10’s

24 use

12.24

1.22

.051

6’s

36 use

10.77

1.80

.050

4’s

54 use

10.04

2.51

.047

*Liquids: 3 oz./use; Dryer: 1 sheet/use

Off Label

All the major fabric softener brands placed the
majority of their advertising weight in network
television. (See Exhibit 4.)
1989 Promotional Summaries. Final Touchoffered the highest off-label values in the category.
Sta-Puf was currently on a pre-price strategy.

Size
32 oz.
64 oz.
96 oz.
Couponing

Final Touch

Downy

Pre-Price
Sta-Puf

25 cents
50 cents
75 cents
20 cents

20 cents
40/45 cents
60 cents
20 cents

$0.99
1.89
2.79
–

EXHIBIT 4% Dollars Spending by Daypart—1989
Network TV
Total

Prime

Day

FringeSpot TV

Print

Radio

Liquid
Downy

82%

37%

45%

–

18%

–

–

Final Touch

59%

32%

27%

–

41%

–

–

Sta-Puf

–

–

–

–

–

–

100%

Dryer
Bounce

71%

26%

45%

–

29%

–

–

Cling Free

84%

46%

36%

2%

16%

–

–

Lever Brothers' Introduction of Snuggle Fabric Softener

652

CASE 9 Lever Brothers’ Introduction of Snuggle Fabric Softener

Seasonality. Overall, category sales wererelatively constant throughout the year with aslight increase in total fabric softener sales in thewinter months caused by increased dryer productsales. The Eastern region did not deviate fromthis pattern.
Miscellaneous Data.
Liquid Fabric Softeners Five-Year Volume Trends
1985

1986

1987

1988

1989

Case volume
(MM)

25.7

24.9

24.9

26.0

28.8

% Change vs.
Year Ago

–1

–3

–

+4

+11

Dollar Volume
($MM)

$325

$336

$359

$373

$398

% Change vs.
Year Ago

+7

+3

+7

+4

+7

Liquid Fabric Softeners
Five-Year Share Trends—By Size
1985

1986

1987

1988

1989

17 oz.

8%

7%

7%

6%

4%

33 oz.

26%

26%

25%

24%

21%

64 oz.

39%

40%

41%

42%

45%

96 oz.

26%

26%

27%

28%

30%

128 oz.

1%

1%

–

–

–

Eastern Region Liquid Fabric Softeners
1989 Share By Brand
Downy Regular

Boston

New York

Philadelphia

48.6

43.5

38.2

Downy Triple Conc.

5.9

5.3

5.1

Final Touch

17.2

21.0

23.1

Sta-Puf

3.9

5.4

6.7

All Other

24.4

24.8

26.9

SNUGGLE ADVERTISING
To date, Snuggle’s advertising strategy had been toconvince consumers that new Snuggle was a quality liquid fabric softener that softened the wholewash, controlled static cling, gave clothes a fresh
smell, and was really less expensive than premiumliquid fabric softeners.
Snuggle was positioned among the other premium liquid softeners—Downy and Final Touch.
However, Snuggle was priced less than thesebrands. Consumers would be able to get all thequality softener benefits they desired, but at alower price.
Snuggle was supported with unique and memorable advertising. The brand’s advertising featured
Snuggle the teddy bear—a character who represented the essence of softness.
Snuggle spent all of its advertising budget on
television, the most effective medium for reachinglarge numbers of the target audience, women 25–54
years of age. Snuggle advertising reached over 90
percent of the target audience and had twice as
many prime-time announcements as Downy. In
1989, Lever Brothers spent $17 million on advertising Snuggle while Downy spent $15 million.
SNUGGLE PROMOTION
Snuggle’s introductory program was the strongest
in the history of the fabric softener category. On anational basis, Lever spent $60 million on trade andconsumer promotions to support the brand during
its introductory year. The promotional program
was designed to:
1. Secure three size distributions.
2. Maximize trade feature and display support.
3. Generate consumer trial and repeat purchase.
4. Accelerate product movement.
5. Obtain a significant on-shelf price advantage vs.
Downy.

The following methods could be employed in
attaining the above goals:
1. Discounts off invoice price—budgeted up to $1.50.
2. Special promotional allowances—budgeted up to$1.50.
3. Extended dating—variable.
4. Carload pricing—40,000 lbs./carload—variable.
5. Mailing of free samples—70 percent of homes would
receive a free 6 oz. sample via direct mail. This

659

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Lever Brothers' Introduction of Snuggle Fabric Softener

CASE 9 Lever Brothers’ Introduction of Snuggle Fabric Softener

would be the first sampling effort in the liquid fabricsoftener category in over 20 years. Research showedthat 75 percent of consumers who tried a free
Snuggle sample would buy it.
6. Couponing—Industry norm is 20 cents per coupon.
Budgeted to spend up to 50 cents per coupon.

Flip Flop Presentation
Stencil
Ad Slicks
Combination Card
Display Banner (18” x 49”)
Plastic Shelf Talker
Spanish Plastic Shelf Talker

653

Shelf Strip
4-page Brochure2-page Sell SheetMPO Cassette
Planograms
Spanish Combination Card

SNUGGLE PRICING
Snuggle fabric softener would be priced between 11
to 14 percent less than the premium brands in theliquid fabric softener category—Final Touch andDowny.
Snuggle was not a price brand. It was positioned
in the premium segment of the liquid fabric softener market. Price brands did not provide the same
quality softener benefits that Snuggle delivered.
The trade price of Snuggle should be close to thesame margin as Downy so that Snuggle would
offer a meaningful price differential to consumers
at the retail level.
A primary part of Snuggle’s positioning was a
price benefit that provided consumers a better
value for their dollar.
Upon introduction, if Downy reduced its pricein a defensive move, Snuggle would reduce its
price accordingly to maintain the correct price differential. (See Exhibit 5.)
The following is a listing of all material available to each sales representative for the Snuggle
introduction:

SNUGGLE’S POTENTIAL
SOURCES OF BUSINESS
Category growth was one potential source of new
business for Snuggle. In the Milwaukee test market, liquid softener sales increased over 20 percent
since the introduction of Snuggle.
In every area where Snuggle had been introduced, the smaller brands such as Sta-Puf and Rain
Barrel experienced the largest percentage sharedecline. Downy and Final Touch lost a proportionately smaller percentage of their business.
Snuggle would have some impact on Final
Touch, but primarily the business would comefrom the “all other” brands. Final Touch’s whiteness benefit would still provide it with a uniquepositioning in the category.
Additionally, Final Touch instituted consumer
and trade defense plans. Snuggle was not meant toreplace Final Touch. Lever Brothers wanted to use
Snuggle and Final Touch to enhance its market
position so it could overtake P&G as the number
one liquid fabric softener manufacturer.

Lever Brothers' Introduction of Snuggle Fabric Softener

654

CASE 9 Lever Brothers’ Introduction of Snuggle Fabric Softener

EXHIBIT 5
Retail Price and Profit Margin Guide—Snuggle vs. Downy
33 oz.

64 oz.

96 oz.

Profit Margin

SnuggleDowny

SnuggleDowny

Snuggle

Downy

1%

$1.03

$1.18

$1.95

$2.23

$2.89

$3.31

2%

$1.04

$1.19

$1.97

$2.26

$2.92

$3.34

3%

$1.05

$1.21

$1.99

$2.29

$2.95

$3.37

4%

$1.06

$1.22

$2.01

$2.30

$3.98

$3.40

5%

$1.08

$1.23

$2.04

$2.33

$3.01

$3.44

6%

$1.09

$1.24

$2.06

$2.36

$3.03

$3.48

7%

$1.10

$1.26

$2.08

$2.38

$3.07

$3.51

8%

$1.11

$1.27

$2.10

$2.41

$3.11

$3.56

9%

$1.12

$1.29

$2.13

$2.44

$3.14

$3.60

10%

$1.14

$1.30

$2.15

$2.46

$3.18

$3.64

11%

$1.15

$1.31

$2.17

$2.49

$3.21

$3.68

12%

$1.16

$1.33

$2.20

$2.52

$3.24

$3.72

13%

$1.17

$1.34

$2.22

$2.55

$3.28

$3.76

14%

$1.19

$1.36

$2.25

$2.58

$3.32

$3.81

15%

$1.20

$1.38

$2.28

$2.61

$3.36

$3.85

16%

$1.22

$1.39

$2.30

$2.64

$3.40

$3.90

17%

$1.23

$1.41

$2.33

$2.67

$3.44

$3.94

18%

$1.25

$1.43

$2.36

$2.70

$3.48

$3.99

19%

$1.26

$1.44

$2.39

$2.74

$3.53

$4.04

20%

$1.28

$1.46

$2.42

$2.77

$3.57

$4.09

21%

$1.29

$1.48

$2.45

$2.80

$3.62

$4.14

22%

$1.31

$1.50

$2.48

$2.84

$3.67

$4.20

23%

$1.33

$1.52

$2.51

$2.87

$3.71

$4.25

24%

$1.34

$1.54

$2.55

$2.92

$3.76

$4.31

25%

$1.36

$1.56

$2.58

$2.96

$3.81

$4.36

661

Anheuser-Busch,Inc.

I

n 1993, Anheuser-Busch (A-B) controlled 46 percent of the U.S. beer market and had clearly
established itself as the ruler in the industry. The
self-proclaimed “King of Beers” had successfully
fought off a challenge by Miller, the second-largest
brewer in the industry, to take over the throne.
Several of the other top 10 companies in the industry were in trouble and seeking merger partners.
They, therefore, presented no threat to the firmly
placed crown of A-B, and A-B began seeking tocapitalize on its competitors’ turmoil.
August Busch III, chairman of A-B, felt very
smug about his company’s strong leadership position within the industry. He was confident that thecompany could “continue to dominate its rivals
simply by redoubling its efforts—building hugeand efficient breweries, spending heavily on advertising and promotion, maintaining price leadershipwhere it holds commanding share, and cutting
prices where needed to gain business.” According
to Dennis Long, president of A-B’s Beer Division,“If you segment this country geographically, demographically, and by competitors, it gives you great
confidence that there is still considerable room for
us to grow.”
A-B intended to increase its market share to 55
percent by the year 2000. It was seeking to increase
its capacity 27 percent by means of a five-year
capital expansion plan. This involved an investment of approximately $2 billion. A previous fiveyear expansion program costing $1.8 billion
increased the capacity of A-B by 50 percent. The
major question facing A-B and its chairman waswhether A-B would be able to achieve its objectivesof increased market share and capacity in light ofthe decrease in beer consumption growth from five
percent annually in the 1970s to less than three percent in 1992. This decrease was a direct result of the28
CA S E 10
increased popularity of other beverages and adecrease in the number of 18- to 34-year-olds.
INDUSTRY BACKGROUND
Small-scale brewing in the United States began in
1633, when the first commercial brewery was
founded in the Dutch colonial town of New
Amsterdam, now New York City. It was not until
the 1840s that large-scale brewing began to takeplace as a result of the introduction of a different
type of yeast from Germany. The 1870s saw thecontinued evolution of the beer industry when
Louis Pasteur developed the process for controlling
fermentation. This made the bottling of beer commercially feasible. During the 1900s, two events
had a serious impact on the industry. These eventswere the results of regulatory and technologicalchanges. The first, Prohibition, occurred in 1920, at
a time when the industry consisted almost exclusively of local and regional brewers, numbering
approximately 1,500 brewers. When Prohibition
was repealed in 1933, fewer than 800 of these brewers had survived. The second event, the introduction of commercial television, occurred in 1946.
National advertising began to play an importantrole in determining market leadership. Television
gave a definite edge to those brewers who could
afford to advertise by placing their brand first in
the consumer’s mind.
Consolidation of the Industry
Over the past decade, the $10.5 billion beer industry had undergone considerable change. Consolidation occurred as a result of the absorption bylarge brewers of many regional brewers. There
were 92 breweries in 1970, and in 1992 that numberThis case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

655

663

664

Anheuser-Busch, Inc.

656

CASE 10 Anheuser-Busch, Inc.

had decreased to 18. In 1992, 79 percent of all thebeer sold came from only three of these brewers,
and 69 percent was accounted for by A-B andMiller. (See Exhibit 1.)
This market dominance by A-B and Miller drastically altered the industry. A-B and Miller paid
their unionized employees more than the average
wage in the industry, took advantage of economies
of scale, and spent more than their competitors foradvertising. They gained considerable control overthe market as a result of their marketing expertise,an avalanche of money, and a great deal of animosity toward each other. The remaining brewers(except perhaps Coors) provided little challenge forthe two leaders. The smaller brewers were suffering from such nightmares as ineffective production
and pricing decisions, poor marketing, and continuous management turnover. As a result of their
weak position, the smaller brewers banded
together. It had been necessary for several of themto merge in order to survive. The long-run outlook
for the industry was even greater consolidation.
It appeared that the beer industry was headed
toward a controlled oligopoly, similar to that of thetobacco industry. Companies were dissuaded fromentering the industry because of high entry costs
and low-growth prospects. High entry costs
involved two separate considerations: (a) the
expense required to build marketing and production groups able to compete with A-B and Miller

EXHIBIT 1
Market Share in the Beer Industry
Company

Share in 1981

Share in 1992

Anheuser-Busch

30.3 %

46.2 %

Miller22.4

22.4

Heileman

7.8

5.3

Coors

7.4

10.4

Stroh

5.0

7.6

Genesee

2.0

1.2

Other

4.7

6.9

100.0 %

100.0 %

Total

and (b) the expense and difficulty involved in competing, based on product differentiation. Productdifferentiation was necessary since price competition alone was not sufficient. However, small brewers were resorting to price cutting in an effort tosimply maintain current market shares. This madethe low-growth prospects of the industry very
apparent. The only small brewer that could possibly compete with A-B and Miller was G. Heileman,because of its low-cost production facilities.
With a reduction in the number of brewers overthe long run, it was expected that the number ofbrands would also decrease. However, this could
be offset by new types of beer being offered to newmarket segments. If greater industry consolidationand stronger competition were to occur in the
future, A-B and Miller could potentially benefit
from it. A more stable industry would result in an
end to the vicious price cutting of the past, andprofits would be more easily achieved for the few
firms remaining in the industry.
Market Shifts
The existing brewers sold different types of beer inall segments of the market. In order to continue
expansion, new types of beer were continually produced. The most recent opportunity for growth hadcome from the light segment. In the 1970s, only
three percent of the total market was attributed tolight beer. By 1992, light beer accounted for almost
one-fourth of the total market. Three factors contributed to the growth in this segment. First, the 25to 34-year old age group drank the greatest amountof diet soft drinks, and their health-conscious attitudes had an effect on their beer-drinking habits.
Although the total population was growing at a rateof one percent annually, this age segment was forecast to grow at a two percent annual rate over the
next five years. The second factor involved theincreased importance of women in the light beermarket. As a group, women appeared to prefer lightbeer. The third factor contributing to the growth ofthe light beer segment was advertising. In 1992,
Miller held 40 percent of the light beer market; it665

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CASE 10 Anheuser-Busch, Inc.

had achieved its market leadership by appealing to
the more weight-conscious drinker, such as theolder male beer drinker.
Imports were another area in which the possibility for growth existed. In 1992, imported beer
represented only 4.3 percent of total beer consumption. This market segment was expected toincrease by 50 percent in size by the year 2000.
Competition in this area is a matter of taste andimage. The leading imports were marketed bycompanies that were not involved with domestic
beer products, but most of the larger domestic
brewers sold at least one import. Major brewers
obviously considered it important to be represented in all segments and regions of the beermarket. (See Exhibit 2.)
Market Segmentation
To be successful in the national market, three typesof strengths were required: marketing skill, productmix, and distribution. The current leaders in thenational beer market, A-B and Miller, were strong
in all three areas. (See Exhibit 3.) They possessedmarketing expertise, powerful wholesaler networks, and broad product lines. The strength of theirproduct lines was their focus on the high-marginand high-growth light, premium, and super-premium beer segments. In 1992, A-B and Miller held
68.6 percent of the market, and it was projected thatby the end of the decade they would hold 80 percent.
Consolidation had accelerated because many small

competitors were unable to execute effective marketing programs. It was obvious from this that marketing prowess was necessary for success. Productmix was important because the value of the productmix must be greater than the summed values of
the individual products, otherwise referred to assynergy. If this is not the case, it would be cost prohibitive to introduce a brand. Effective distribution
was also a necessary ingredient to success. There
was a tendency among consumers to purchase thebrand sold in their neighborhood tavern. In order tocapture these on-premise sales, effective distribution was essential. Although distribution strength
varied from segment to segment, A-B was strongest
in distribution overall.
As mentioned before, imported beer represented
a mere 4.3 percent of the market in 1992. This
market segment had grown slowly over the preceding five years but was expected to grow to five percent by 1995. Importers continued to expand theirmarkets by introducing new types of beers toappeal to different segments of the drinking-age
population (e.g., Amstel Light). Heineken controlled 30 percent of the imported beer market andMolson controlled 20 percent, but recently thesebrewers had been losing part of their market shareto Beck, Moosehead, and Labatt. The major U.S.
producers had only recently begun to market one ormore types of imported beers. Imported beers had adistinctive taste and were marketed to appeal toconsumers who were inner-directed, upscale, andurban. The imported segment was the sole segment

EXHIBIT 2
Principal Brands of Major Brewers
Company

Premium

Super

Light

Imported

Anheuser-Busch

BudweiserMichelob

Budweiser Light

Carlesberg

MillerMiller High Life

Lowenbrau

Lite

Molson

Stroh

Stroh

Signature

Stroh Light–

S&P Industries

Pabst Blue Ribbon–

Pabst Lite

–

Coors

Coors

George Killian’s Special Ale

Coors Light–

Heileman

Old StyleSpecial Export

Several entries

Beck’s666

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CASE 10 Anheuser-Busch, Inc.

EXHIBIT 3
Strengths of Major Competitors in the Beer Industry in Three Key Areas
Company

Distribution

Marketing Strength

Anheuser-Busch• Strongest in the industry.
• Excellent unit volume
increases.

• Superior—after the ex• The best in the industry.
penditure of considerable • Something for everymoney, time, and effort.
one, but unit volume• Benefits to both unit
predominantly in thevolume and productivity.
most profitable segment.
• A plus for productivity.

Product Mix

Miller (Philip Morris)• Far superior to the indus- • Deepest pockets in thetry average.
industry.
• Promotes good unit vol• Proven skill.
ume growth.
• Benefits to both unit volume and productivity.

Heileman• Very strong in some areas • Limited financial strength • Limited in the mostand weak in most others.
but very efficient with theprofitable; very strong in• Unit growth at industry
dollars it spends.
the least profitable.
average or slightly better. • Makes it a viable compe- • No impact on productivtitor in the industry.
ity.

Coors

• Deteriorating in traditional markets; weak in
new markets.
• Continuing declines inunit volume.

S&P Industries• Weak and getting weaker. • Ineffective and low• Continuing declines inbudget.
unit volume.
• Effecting declines in both
unit volume andproductivity.

• Limited but concentrated in the mostprofitable segment.
• A plus for productivity.

• Thus far, underwhelming. • Limited but concen• Both unit volume andtrated in the mostproductivity declining.
profitable segments.
• A potential but unrealizable plus for productivity.
• Concentrated in the least
profitable segments.
• No impact on productivity.

Source: Prudential-Bache’s Brewery Industry Outlook, March 13, 1993.

of the total beer market that could experience a sales
slowdown when the economy decelerated.
The small brewers also marketed beer that had adistinctive taste. These brewers tended to sell on aregional basis, staying in well-defined areas close
to home. They specialized in lower-priced beers
and controlled less than five percent of the totalbeer market in 1992. The number of small, local,
family-owned breweries had decreased, and it was
expected that this trend would continue. Between
1980 and 1990, this market declined substantially insize. As a result of increased fixed costs, many ofthese brewers had been unable to afford to continue
in business on their own. With those that were able
to survive, one of the key factors had been community pride and interest in the local brewery.
Competition
There are three areas in which brewers competewith one another: packaging, advertising, andprice. Packaging provides brewers with a methodof segmentation. Packaging choices include the traditional 12-ounce six-pack in bottles or cans;667

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CASE 10 Anheuser-Busch, Inc.

20-ounce cans; 40-ounce bottles; 7-ounce eight-packin bottles or cans; 12-ounce twelve pack in bottles
or cans; and various keg sizes. During 1991, 59 percent of the total beer consumed was from cans, 32
percent was from returnable bottles, and nine percent was from nonreturnable bottles. The use of
returnable bottles increased significantly since 1991
as a result of the passage of deposit laws in 43
states.
Over the past decade, advertising became themajor marketing tool. Since 1987, the advertisingexpenditures of the major brewers grew by morethan 12 percent annually. Effective advertising
increased brand loyalties. There was an understanding among brewers to advertise in a legal andmorally responsible manner. In order to promote
the image of being socially responsible, brewers
sponsored many public service commercials
involving the subjects of teenage pregnancy anddrunk driving. They did not show minors, intoxicated people, or the actual consumption of beer intheir advertising. There were several market segments that were important targets of advertising
campaigns. These included college students, sports
fans, and ethnic groups. The brewers attempted to
instill brand loyalty in college students by sending
representatives to the campuses (Miller) or by sponsoring activities with promotional samples(Budweiser). The Hispanic market was large andimportant. To appeal to this market segment, Coors
used actors of Hispanic background in its advertising, and A-B used a Spanish advertising agency topromote Michelob.
As new products were introduced, they weretargeted directly toward certain market segments.
This was achieved mainly through advertising
campaigns. Miller Lite was targeted toward oldermen; Michelob 7-ounce bottles were targeted
toward 24- to 35-year-old women. In all the advertisements, focus was placed on identification withmales, females, or couples. Beer is an extremely
image-oriented product, and advertising campaigns were using a new emphasis. Instead of promoting beer just as a beverage that goes witha simple, relaxed lifestyle, the focus was on beer659

as a reward for a job well done. In these commercials, beer was the reward after a hard day’s work or
for winning at a sport. Humor was often injected
into the commercials. Advertising played an important role in the beer industry, and it gave thosebrewers who could afford it a definite competitive
advantage.
Price was no longer the important marketing tool
it once was. It had lost its competitive importance.
The emphasis had shifted to media. Pricing policies
now depended upon product positioning. Brewers
sold a number of price-sensitive brands, including
super-premium, premium, popular-priced, light,
and generic beer. It was expected that the premium,super-premium, and light brands would seek
annual price increases of six to seven percent compared with the smaller increases of three to five percent sought by the popular-priced brands.
Environmental Factors Affecting the Beer Industry
There were certain economic and demographic factors that affected the beer industry. Two of thesefactors were the unpredictability of changes in consumer tastes and preferences, and the effect ofextended recessionary forces. If the demand forbeer was to weaken substantially, this could resultin an overcapacity in the industry. Other factors
were increased beer consumption by women andthe health-conscious attitude regarding lightness
and moderation. The potential impact of these factors would be a favoring of beer over distilled spirits that would provide opportunity for enlargement
and further segmentation of the beer market. A
final factor encompassed all future movements in
consumer economics and demographics. One ofthese forecasted trends was an increase of 20 percent in the 25- to 44-year-old age group by 1997.
This age group had a greater amount of discretionary income, tended to eat out more frequently,
and was more likely to entertain at home. Anotherforecasted trend involved the primary beer drinking age segment. The 18- to 24-year-old age group
was expected to decrease in size. These projected
trends would not be beneficial to the beer industry.

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CASE 10 Anheuser-Busch, Inc.

There were also regulatory factors that affected
the beer industry. These included stricter littercontrol requirements, additional legislation
requiring bottle deposits, the rise in the drinking
age, and increases in the excise tax. If brewers
were required to make alterations in their packaging and methods of distribution, the possible
result would be increased costs and, therefore,
lower profit margins. This also might result if
additional legislation were passed requiring bottle
deposits. Raising the drinking age would result inshrinking the number of 18- to 24-year-olds who
could legally drink, which would also negatively
affect brewers’ profits. If there was a flat increasein the excise tax, this could lead to a redistributionof profits. The hardest hit by the increase, on apercentage basis, would be popular-priced andgeneric beers. This could lead consumers tobelieve that the price differential among brands
was narrowing and, therefore, cause them tochange to more expensive beers. This might provedevastating to the small regional brewers who
specialized in lower-priced beers. Granting permission for territorial agreements between wholesalers would also affect the beer industry. The
provision of exclusive regional rights would
widen the gap between the strong and the weak
wholesalers.
Industry Financial and Operating Performance
In the past, the financial success of brewers paralleled their performance in marketing, distribution,and product mix. The brewers who displayed
strength in these three areas gained increasing control over the beer market, whereas the weaker performers had been losing market share.
Even though the gap between the strong andweak brewers had been widening, most brewers’
profit margins had been hurt by the price wars of
the past. This had somewhat limited flexibility inpricing. As a result, several other components ofprofitability had become important. These were
productivity, unit volume, and gross margin.
Productivity could be increased through changes tomore favorable product mixes. There had been ashift to brands that had growth opportunities
and/or appealing gross profit margins. The grossprofit margin of each beer segment and its three- to
five-year growth within each segment are shown in
Exhibit 4.
Both A-B and Miller had focused their productlines on the fast-growing and high-margin light,
premium, and super-premium market segments.
Light beer was a good brand to market since it wasusually less costly to produce, sold at a premium,had a high profit margin, and was, therefore, more
profitable than other brands. In 1992, another factor
of productivity, operating rate, did not look goodfor most of the producers in the industry. The average operating rate for the industry was 75 percent
of capacity, far below the optimum rate of 90 to 95
percent. A-B was the only brewer with strength in
this area; its plants were operating at approximately 98 percent of capacity.
The second important component of profitability was unit volume; the higher the unit volume,the greater the profitability. Since a flattening ofbeer consumption trends was forecast, the abilityof individual brewers to increase their unit volume would depend upon several factors. These
included their capacity to finance strong marketing programs and the presence of strong distribution systems.
The third component of profitability was grossmargin, which is equal to sales minus cost of goods
sold. This figure represented the maximum
amount that could be spent on marketing andadministrative expenditures without incurring an
operating loss. Past and projected industry grossprofit is shown in Exhibit 5. The industry grossprofit per barrel, excluding A-B and Miller,
equaled only two-thirds that of A-B. It was notwithin the financial means of most brewers toreach a competitive level of marketing, since thiswould necessitate a substantial increase in spending. There was apparently a dichotomy in theindustry that could be expressed as “The richget richer and the not-so-rich are lucky to keep
running in place.” In summation, higher gross669

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CASE 10 Anheuser-Busch, Inc.

EXHIBIT 4
Gross Margins in Different Beer Segments
Beer Segment

Gross Margin For Brewer

Gross Margin For Wholesaler% of Industry Volume

Popular-priced

10% – 16%

20% – 22%

22%

Premium-priced

28% – 30%

25% – 27%

40%

Light beer

30% – 32%

25% – 27%

28%

Super premium-priced

37% – 39%25% – 27%

2%

Sources: Beverage Industry, Prudential Securities estimates, March 13, 1993.

brands of beer, the brands marketed to the people
most affected by a recession. A good example ofthis is Miller High Life, which is strongly marketed
toward blue-collar workers. Lastly, the outlook forcosts was that (a) the costs of raw materials andpackaging would increase at a rate lower than thatof inflation and that (b) advertising would notexceed an annual growth rate of 12 percent. Such afavorable cost outlook would enable brewers tokeep operating margins within a three to five percent increase. Exhibit 6 presents a breakdown of
the costs of the major brewers.

margins represented more available funds for marketing expenditures. This in turn, led to increased
market share and sales, the results of which weregreater volume and productivity, and, therefore,
increased profitability.
The factors that would affect the future performance of the industry were a slow-growth environment, recession, and the cost outlook. The first
factor, a slow-growth environment, would necessitate that even more emphasis be placed on increasing productivity and unit volume. Recession, thesecond factor, would have an impact upon certain

EXHIBIT 5
Past and Estimated Future Changes in Industry Gross Profit (Profit and Barrelage in Millions)
1972

1977

1982

1992

Industry
Total barrelage
Total gross profit
Gross profit/barrel

131.8$1,479.5$11.23156.9$1,915.5$12.21180.0$2,454.5$13.64209.0$3,224.2$15.43

Anheuser-Busch
Total barrelage
Total gross profit
Gross profit/barrel

26.5$392.6$14.8236.6$571.1$15.6059.1$976.1$16.52

86.6$1,555.7$17.96

MillerTotal barrelage
Total gross profit
Gross profit/barrel

5.3
$71.6
$13.5124.2$368.2$15.21

39.3$580.7$14.7854.5$865.7$15.88100.0$1,015.3$10.1596.1$976.2$10.9681.6$897.7$11.0067.9$802.8$11.82

Industry—Less Bud and Miller
Total barrelage
Total gross profit
Gross profit/barrel

Source: Prudential-Bache’s Brewery Industry Outlook, March 13, 1993.

670

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CASE 10 Anheuser-Busch, Inc.

EXHIBIT 6
Estimated Cost Breakdown for Major Brewers
Packaging45 %Raw materials

15

Labor

12

Marketing20

All other

8

Total

100 %

Source: Prudential-Bache’s Brewery Industry Outlook, March 13,
1993.

ANHEUSER-BUSCH PERSPECTIVES
Company BackgroundA-B was founded in 1852. Its corporate headquarters are in St. Louis, Missouri. The present chairman is August Busch III, a fourth-generation
brewer. In 1957, A-B took the industry leadershipaway from Schlitz and has held this leadership
position ever since. During that period, A-B has
had to fend off challenges from both Schlitz andMiller. By the 1970s, A-B had grown so contented
that even a challenge by Schlitz did not elicit any
response. The brewer was running out of beer
every summer and saw no need to market aggressively. The challenge by Schlitz failed only as aresult of several marketing blunders that cost
Schlitz many loyal customers. It was a challenge byMiller, acquired in 1969–70 by Philip Morris, Inc.,
that posed a definite threat to the leadership position of A-B and prompted it to act. A-B was in the
middle of an awkward transition of management
when Miller attacked, but what made matters considerably worse was a strike the summer of 1976
that kept its beer off the shelves that summer. In
retaliation, A-B made an all-out effort to defeat
Miller and successfully retained its leadership position. The war between A-B and Miller badly crippled the rest of the brewers in the industry, whowere constantly struggling to survive.
Since 1976, A-B has increased its number ofbrands from three to 15 to target all market seg-ments. Busch and Natural Pilsner are marketed as
popular-priced brands, Budweiser and Budweiser
Light as premium brands, and Michelob,
Michelob Light, Michelob Classic Dark, and an
import as super-premium brands. All of its brands
are backed by heavy advertising and promotion
expenditures. The amount spent by A-B on media
rose 180 percent, to $643 million, between 1981
and 1990. A-B was outspending all other brewers
in the sponsoring of sporting events. In 1992, itsponsored 98 professional and 310 college sports
events.
Brewers have used “image” advertising to position their products since advertising was first
employed, but its use has been on the rise in thepast few years. The original targeted beer segmentof Budweiser had a strong, rugged image and,
therefore, from the beginning, Budweiser had been
associated with the Clydesdale horses. A team ofthese horses pulled the original Budweiser wagon,
but their use had become primarily ceremonial.
The type of people now drinking Budweiser werehigher-income, middle-aged individuals, more
likely to be men and less likely to be minorities. In
order to attract a broader market, including
women, minorities, and older and younger people,
A-B established a new campaign to promote
Budweiser based on the slogan “This Bud’s foryou.” The overall consumption of Budweiser
tended to be evenly distributed geographically. As
a result, it did not face the same problem as Miller
High Life, which tended to be skewed geographically toward the economically depressed areas of
the country. Exhibit 7 presents the estimated media
costs of major competitors.
A-B marketed three light beers, Budweiser
Light, Michelob Light, and Natural Light. These
three brands were marketed toward the premium,super-premium, and mid-price market segments,
respectively. When Budweiser Light was introduced in 1982, it met with unexpected success. This
brand emphasized sports and was marketed with asport-oriented theme, “Bring out your best. . . . ”
Budweiser Light was targeted toward the heavybeer drinker who was athletic and active, whereas

EXHIBIT 7
Comparison of Advertising Expenditures in the Beer Industry
Advertising
Expenditures

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

$351.8$406.5–15.5%$494.721.5%$575.816.4%$602.54.6%$688.814.3%$684.5–0.6%$720.4
5.2%$677.2–6.0%$643.2–3.5%

Anheuser-Busch$117.2% Change% of Total Industry
33.3%
Market Share
30.0%$164.3
40.1%
40.4%
32.4%

$197.8
20.4%
40.0%
32.9%

$245.8
24.3%
42.7%
35.0%

$270.0
9.8%
44.8%
37.1%

$337.4
25.0%
49.0%
38.6%

$339.0
0.5%
49.5%
40.6%

$369.7
9.1%
51.3%
41.9%

$346.0
–6.4%
51.1%
43.0%

$301.1–13.0%
46.1%
44.6%

Miller% Change% of Total Industry
Market Share$91.1$115.5
26.8%
28.4%
21.5%

$133.9
15.9%
27.1%
20.4%

$163.7
22.3%
28.4%
20.5%

$163.5
–0.1%
27.1%
20.2%

$201.2
23.1%
29.2%
20.5%

$170.9–15.1%
25.0%
20.8%$168.4
–1.5%
23.4%
21.5%

$149.5–11.2%
22.1%
22.2%$188.6
26.2%
28.9%
22.7%

Coors
% Change% of Total Industry
Market Share

$23.0

$22.1
–3.5%
5.4%
6.5%

$30.4
37.3%
6.1%
7.5%

$38.1
25.2%
6.6%
7.2%

$58.4
53.3%
9.7%
8.0%

$77.7
33.2%
11.3%
8.1%

$84.7
9.0%
12.4%
8.4%

$111.1
31.2%
15.4%
8.8%

$114.3
2.9%
16.9%
9.5%

$122.4
7.1%
18.7%
9.9%

Total Beer Industry% Change

25.9%
22.2%

6.5%
7.3%

Source: Beverage Industry and Leading National Advertisers.

Anheuser-Busch, Inc.

CASE 10 Anheuser-Busch, Inc.

663

671

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CASE 10 Anheuser-Busch, Inc.

Miller Lite was targeted toward the older male beer
drinker who was weight conscious.
Busch, a popular-priced beer, was targeted
toward the free-spirited man. Promotional campaigns for this brand were geared toward the hardworking blue-collar employee who headed to themountains for relaxation. The super-premium
market segment was dominated by Michelob, an
A-B brand, and close behind was Lowenbrau, aMiller brand. There had been a slowing in thegrowth of this market segment. The new promotional campaign for Michelob Light targeted
white-collar men and women who entertained,
belonged to country clubs, and could afford to
spend a little more for a special occasion beer. This
campaign centered on heritage, tradition, quality,and distinctiveness. A-B, with its many expenditures on advertising, closely followed by Miller,
was the leader of the industry.
Wholesalers have high fixed expenses as a resultof the large capital outlays required to purchasetrucks, etc. Therefore, a wholesaler depends onvolume sales for profit and concentrates effort
upon the brands that offer the greatest volume. It
can be seen in Exhibit 8 that A-B and Miller had
greater volume than competing brewers. A-B
achieved product distribution through a networkof 950 wholesalers and was reputed to have themost effective network of wholesalers in the indusEXHIBIT 8
Average Case Volume per Brand
per Distributor for Different Brewers
AnheuserBusch

859,000

Miller637,000

Heileman

108,000

Coors

438,000

Stroh

280,000

S&P Industries

154,000

Industry average

541,000

Industry average less A-B

405,000

Source: Prudential-Bache’s Brewery Industry Outlook, March 13,
1993.

try. A-B had provided considerable support to its
wholesalers, including the establishment of in-depth
training seminars on financial management andwarehousing. Wholesaler performance was evaluated on the basis of the frequency with which calls
were made upon accounts, the weekly and monthly sales of all beers, and several other factors. It
was normal for an A-B wholesaler to hold from 12
to more than 20 days’ inventory, depending on theseason. With a high inventory turnover rate, awholesaler was able to generate profits much more
quickly. The effective wholesaler system of A-B
proved invaluable since it was forecast that, in the
future, the fight between the brewers would befocused at the wholesaler level.
Company Financial and Operating Performance
A-B’s many interests include baking operations,snack foods, transportation services, a baseball franchise, and real estate development. Despite theseother interests, A-B’s beer operations dominate its
revenue base. The beer operations accounted forapproximately 85 percent of revenue in 1992. As ofJune 1992, A-B controlled 46 percent of the U.S. beermarket. It controlled 31.4 percent in 1982, 28.2 percent in 1980, and 23 percent in 1977. This was anincrease in market share of 44 percent between 1982
and 1992. The volume of beer sold by A-B also
increased significantly over these ten years. In 1982,
A-B had total sales of $5.3 billion, and its profit for
the year was $287.3 million. In 1992, A-B’s sales
amounted to more than $13 billion, while the net
income was $917 million. Exhibit 9 presents thefinancial and operating performance of A-B.
Over this ten-year period, A-B experienced anincrease in sales and profits of 150 percent and 220
percent, respectively. (See Exhibit 10.) It had a unit
profitability of approximately $3.59 per barrel ofbeer sold, greater than that of the rest of the industry. Although it was forecast that total market earnings would increase by 15 to 20 percent in 1993, it
was projected that A-B earnings would increase by
30 to 40 percent. As a result of its profit leadershipin the industry, A-B had price elasticity.

673

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CASE 10 Anheuser-Busch, Inc.

EXHIBIT 9
Consolidated Balance Sheet—Anheuser-Busch Companies, Inc., and Subsidiaries
Assets (In millions)
December 31,

1992

Current Assets:
Cash and marketable securities
Accounts and notes receivable, less allowance for doubtful
accounts of $4.9 in 1992 and $5.5 in 1991
Inventories—
Raw materials and supplies
Work in process
Finished goods
Total inventories
Other current assets

$

215.0

1991
$

97.3

649.8

654.8

417.7
88.7
154.3
660.7
290.3

397.2
92.5
145.9
635.6
240.0

1,815.8

1,627.7

171.6
164.8
356.3
505.7

116.9
159.9
365.6
519.9

1,198.4

1,162.3

Plant and Equipment:
Land
Buildings
Machinery and equipment
Construction in progress

273.3
3,295.2
7,086.9
729.7

308.9
3,027.8
6,583.9
669.0

Accumulated depreciation

11,385.1(3,861.4)

10,589.6(3,393.1)

7,523.7

7,196.5$10,537.9$ 9,986.5

Total current assets
Investments and Other Assets:
Investments in and advances to affiliated companies
Investment properties
Deferred charges and other non-current assets
Excess of cost over net assets of acquired businesses, net

A-B experienced operating and financial success as a result of both productivity gains andunit volume increases. It spent more than $2 billion over the past five years on a program toincrease capacity. This both expanded andupgraded the cost-effectiveness of the A-B plants.
Over the next five years, A-B intended to invest
another $2 billion in order to increase capacityfrom 62 million barrels to over 75 million. A significant portion of these funds was likely to beinternally generated. A-B acquired the second-largest domestic baker, Campbell-Taggert, whichshould result in an increase in the amount offunds generated internally.
A-B successfully positioned its products in thehigh-margin and fast-growing beer segments. It
also employed an aggressive marketing strategy.
As a result, A-B achieved increases in unit volume
that were greater than the growth in industry sales.
Over the next five years, it was projected thatannual unit growth for A-B would be 8 to 10 percent. In order to obtain operating flexibility, A-B674

Anheuser-Busch, Inc.

666

CASE 10 Anheuser-Busch, Inc.

EXHIBIT 9 (continued)
Consolidated Statement of Income—Anheuser-Busch Companies, Inc., and Subsidiaries(In millions, except per share data)
Year Ended December 31,

1992

1991

1990

Sales
Less federal and state excise taxes$ 13,062.3
1,668.6$ 12,634.2
1,637.9$ 11,611.7
868.1

Net sales
Cost of products and services

11,393.7
7,309.1

10,996.3
7,148.7

10,743.6
7,093.5

Gross profit
Marketing, distribution and administrative expenses

4,084.6
2,308.9

3,847.6
2,126.1

3,650.1
2,051.1

Operating income
Other income and expenses:
Interest expense
Interest capitalized
Interest income
Other income/(expense), net

1,775.7

1,721.5

1,599.0(199.6 )47.7
7.1(15.7 )

(238.5)46.5
9.2(18.1)(283.0 )54.6
7.0(25.5 )

Income before income taxes

1,615.2

1,520.6

1,352.1

Provision for income taxes:
Current
Deferred

561.9
59.1

479.1
101.7

429.9
79.8

621.0

580.8

509.7

994.2

939.8

842.4

(76.7 )––Net income, before cumulative effect of accounting changes
Cumulative effect of changes in the method of accounting
for postretirement benefits (FAS 106) and income taxes(FAS 109), net of tax benefit of $186.4 million
Net Income$

Primary Earnings per Share:
Net income, before cumulative effectCumulative effect of accounting changes$

Net income
Fully Diluted Earnings per Share:
Net income, before cumulative effectCumulative effect of accounting changes
Net income

917.5

$

939.8

$

842.4

3.48
(.26)

$

3.26
–

$

2.96
–

$

3.22

$

3.26

$

2.96

$

3.46
(.26)

$

3.25
–

$

2.95
–

$

3.20

$

3.25

$

2.95

Note: During 1992 the company elected to early adopt the new Financial Accounting Standards pertaining to Postretirement
Benefits (FAS 106) and Income Taxes (FAS 109). This decision affects the comparability of 1992 reported results with those of prioryears. Management believes that readers of the company’s financial statements need to be fully aware of the impact the adoptionof these Standards has on 1992 operating results and earnings per share. Excluding the financial impact of these Standards, 1992
operating income, income before income taxes, net income and fully diluted earnings per share would have been $1,830.8 million,$1,676.0 million, $1,029.2 million and $3.58, respectively.

675

Anheuser-Busch, Inc.

667

CASE 10 Anheuser-Busch, Inc.

EXHIBIT 10
Financial Summary—Operations, Anheuser-Busch Companies, Inc., and Subsidiaries(In millions, except per share data)
1992

1991

1990

Consolidated Summary of Operations
Barrels sold
Sales
Federal and state excise taxes

86.8$ 13,062.3
1,668.6

86.0$ 12,634.2
1,637.9

86.5$ 11,611.7
868.1

Net sales
Cost of products and services

11,393.7
7,309.1

10,996.3
7,148.7

10,743.6
7,093.5

Gross profit
Marketing, distribution and administrative expenses

4,084.6
2,308.9

3,847.6
2,126.1

3,650.1
2,051.1

Operating income
Interest expense
Interest capitalized
Interest income
Other income/(expense), net
Gain on sale of Lafayette plant

1,775.7(1)(199.6)47.7
7.1(15.7)–

1,721.5(238.5)46.5
9.2(18.1)–

1,599.0(283.0)54.6
7.0(25.5)–

Income before income taxes
Income taxes

1,615.2(1)621.0

1,520.6
580.8

1,352.1
509.7

994.2(1)

939.8

842.4

(76.7)––Net income, before cumulative effect of accounting changes
Cumulative effect of changes in the method of accounting
for postretirement benefits (FAS 106) and income taxes(FAS 109), net of tax benefit of $186.4 million
Net Income

$

917.5

$

939.8

$

842.4

Source: Annual Report of the Company.

also employed vertical integration. Many of theprocesses involved in the manufacturing of beer
were carried on in-house at the A-B facilities. These
included barley malting, metalized paper printing,and can manufacturing. Although A-B was putting
considerable effort into expansion, other brewers
were attempting to increase their return on investment by restricting capacity.
Expansion
In the 1970s, A-B was unsuccessful in its efforts tomarket root beer and a low-alcohol lemon-lime
drink. As a result of these past failures, the company
was moving into new areas more cautiously. Also,
A-B teamed up with partners for certain ventures. It

moved into the rapidly expanding “wine on tap”
business with a partner, LaMont Winery, Inc. In thisbusiness, A-B was marketing larger kegs that distributed white, red, and rosé wines under the
Master Cellars brand name. A-B also expanded
through diversification into the snack food business. Its Eagle Snacks were being distributed
nationwide through bars and convenience stores.
The company’s latest offering in the beer market
was O’Doul’s, a non-alcoholic beer. It was hopedthat this brand would succeed well in the new,emerging non-alcoholic segment.
In planning the future expansion of A-B, AugustBusch III had several strategic alternatives toconsider. These could be divided into two categories: those involving beer operations and those

676

Anheuser-Busch, Inc.

668

CASE 10 Anheuser-Busch, Inc.

EXHIBIT 10(continued)
1989

1988

1987

1986

1985

1984

1983

1982

80.7
$10,283.6
802.3

78.5
$ 9,705.1
781.0

76.1
$ 9,110.4
760.7

72.3
$ 8,478.8
724.5

68.0
$ 7,756.7
683.0

64.0
$ 7,218.8
657.0

60.5
$ 6,714.7
624.3

59.1
$ 5,251.2
609.1

9,481.3
6,275.8

8,924.1
5,825.5

8,349.7
5,374.3

7,754.3
5,026.5

7,073.7
4,729.8

6,561.8
4,464.6

6,090.4
4,161.0

4,642.1
3,384.3

3,205.5
1,876.8

3,098.6
1,834.5

2,975.4
1,826.8

2,727.8
1,709.8

2,343.9
1,498.2

2,097.2
1,338.5

1,929.4
1,226.4

1,257.8758.8

1,328.7(177.9)
51.5
12.6
11.8
–

1,264.1(141.6)44.2
9.8(16.4)–

1,148.6(127.5)
40.3
12.8
(9.9)
–

1,018.0(99.9)
33.2
9.6(13.6)–

845.7(96.5)
37.2
21.3(23.3)–

758.7(106.0)46.8
22.8(29.6)–

703.0(115.4)32.9
12.5(14.8)–

499.0(93.2)
41.2
17.0
(5.8)
20.4

1,226.7
459.5

1,160.1444.2

1,064.3
449.6

947.3(2)
429.3

784.4
340.7

692.7
301.2

618.2
270.2

478.6
191.3

767.2

715.9

614.7

518.0(2)

443.7

391.5

348.0

287.3(3)

–

–

–

–

–

–

–

–

$

767.2

$

715.9

$

614.7

$

518.0(2)involving nonbeer operations. Within the beer
operations category, there were several possible
alternatives for expansion, including the light beer
segment, acquisitions, European markets, divestitures, the Eastern bloc, and the 3.2 beer segment.
There was definitely opportunity for expansion
through the light beer segment because it was estimated that the potential for market penetration
was at least 40 percent and current penetration was
only 25 percent. It would also be possible for A-B toexpand through the acquisition of smaller brewers.
The disadvantage of A-B acquiring smaller brewers
would be that most of these brewers tended to concentrate on unique market segments that would be
too small or uneconomical for A-B to serve.
Therefore, these acquisitions might offer few
advantages. However, it might prove necessary to

$

443.7

$

391.5

$

348.0

$

287.3(3)acquire some smaller brewers in order to stop themfrom banding together and establishing a third
power in the industry.
Another way in which A-B could promote
expansion was through European markets. It
would be beneficial for A-B to explore and evaluate
untapped European markets. The question mark inthis alternative was whether A-B brands would be
able to compete successfully against the heavier,fuller European brands. It could also prove beneficial to A-B to divest its Natural Light brand of beer,
which had proved to be unsuccessful. In 1992, thisbrand was lowered in price when selling to supermarket accounts, since this was where consumers
were extremely price sensitive. It appeared that theconsumer was not attracted to A-B’s idea of a“natural” beer as A-B had expected. There was677

Anheuser-Busch, Inc.

CASE 10 Anheuser-Busch, Inc.

potential for further expansion if A-B divested its
Natural Light brand and used these brewing facilities for the production of Budweiser Light.
Another possible alternative for A-B was to put
a vigorous effort into pursuing “Eastern” markets.
It appeared that the Japanese were extremely
attracted to products that project “Western” culture. The Japanese company that marketed Suntory
whiskey was promoting the product in California
to encourage its projection of a “Western” image sothat it would be accepted in Japan. An aggressive
marketing effort in this area of the world should
promote the expansion of A-B. Expansion could
also be promoted through pursuit of the 3.2 beermarket segment. This variety of beer has half thealcohol, and thus half the calories, of regular beer.
The only problem with pursuing this market segment was that it could affect the sales of light beer,
which also has fewer calories than regular beer.
The other category of alternatives throughwhich expansion could be achieved involved nonbeer operations. The major questions concerning
Eagle Snacks and their potential for expansion
involved the growth of the snack food market, how
the product could be differentiated, and whether or
not the product could obtain a significant part of
the retail business, considering Frito-Lay’s market
domination. A-B could potentially expand throughgrowth in the snack food business.
The other area through which A-B could expand
was wine and spirits. Exhibit 11 compares the 1992
consumption of various liquids, such as beer, wine,
spirits, etc. A-B had already moved into the “wineon tap” business with a partner. There were anumber of other possibilities in this area it could
explore. One of these possibilities involved determining the feasibility of acquiring a winery andtaking advantage of A-B’s strengths in distribution
and marketing. Another possibility involved

669

exploring the potential for developing a product tocompete with “Club Cocktails,” currently marketed by Heublein, Inc. A-B has great potential forfurther expansion since its strengths allow it todiversify. It has many possibilities to consider for
future expansion.
To sum up, the future outlook for A-B is good. Its
facilities were operating at 98 percent of capacity,and the brewer was confident that it could maintain its dominance in the industry. August Busch III
was not fazed by slowing beer consumption andwas confident that A-B could achieve its objectivesof increased market share and capacity. If the company continued its aggressive marketing strategy
and capitalized upon its ability to diversify andexpand in other areas, there appeared to be noreason why it would not achieve its objectives.

EXHIBIT 11
1992 Liquid Consumption in
the U.S. (Gallons per Capita)
Soft drinks

40.1

Coffee

26.1

Beer

24.4

Milk

20.5

Tea

6.3

Powdered drinks

NA

Juices6.6

Spirits

1.9

Wines

2.3

Bottled water

2.2

Water

46.1

Total

176.5

Source: Beverage Industry, May 14, 1993.

C A S E 1 1 SR Corp:Decisions for an
Emerging Technology
INTRODUCTION
In January 1994, Darr Hastings, vice president ofMarketing for SR Corp, was flying back to Boston
from a conference in San Francisco. Hastings knewthat he had to deliver a recommendation to thecompany’s board the next day regarding a major
strategic marketing direction.
SR Corp was about to announce its new product,
the Colloquial Speech Platform 2000, a revolutionary speech recognition system that was at least
three to four years ahead of the competition.
Hastings’s research had shown three primary markets for the new technology: Fortune 500 corporations, telephone companies, and telephone switch
manufacturers. He felt that SR Corp’s products andorganization were not sufficiently mature to pursue all three market niches at once, particularly
since each niche would use speech recognition for
significantly different applications. Even within aparticular niche, Hastings believed that SR Corp
could only support the systems integration activity
in three companies during the first 18 months ofcommercialization. He thought that SR Corp’s best
hope for success would be to successfully install
the system in a first customer, and then leveragethat experience as much as possible by targeting asimilar type of company as the next customer.
Making the wrong decision with respect towhich market niche to pursue first would waste
precious time and could cost the company its leadin technology. By working directly with end-user
companies, such as Fortune 500 corporations or
telephone companies, SR Corp could capture moremargin on its product sales and have greater control
over specific accounts. On the other hand, working

29

through strong intermediaries, such as telephoneswitch manufacturers, might provide SR Corp withmore rapid market penetration and help it reach thegoal of becoming the de facto industry, standard forspeech recognition technology.
The wrong decision could easily put the firm outof business. Much larger firms, such as AT&T, were
aggressively trying to achieve SR Corp’s level oftechnical performance. The financial resources of
SR Corp, like those of most small firms, were precarious. Having been capitalized to date withapproximately $10 million in venture funding, thefirm’s investors now needed to see tangible sales
before providing additional funding.
As he leaned back in his seat, Hastings thought
about all the marketing he had recently studied in
an executive M.B.A. program. He felt insufficiently
prepared to tackle the job ahead of him: market prioritization for an innovative, preemptive technology. He thought to himself:
I’ve read Porter and many of the leading books available on positioning and competitive strategy to help
in this effort. They are great for providing strategic
recommendations for stable markets that contain clear
distribution patterns and no real threat of predatory
invasion from new technologies. However, most of theconcepts do not apply to our situation—an emerging
industry where no markets are certain and the threatof obsolescence is around every corner.

COMPANY BACKGROUNDSR Corp was formed in 1986 to develop and commercialize speaker-independent speech recognition, the ability of a computer to recognize and takeaction on the spoken word. SR Corp’s mission was

This case was prepared by Marc H. Meyer and G. Thomas Aley, Northeastern University. This case was written solely for the purpose of stimulating student discussions. All events and individuals are real but names have been disguised at the company’s request.
Copyright © 1995 by the Case Research Journal and Marc H. Meyer and G. Thomas Aley. It is reprinted here with permission.

670

679

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SR Corp: Decisions for an Emerging Technology

CASE 11 SR Corp: Decisions for an Emerging Technology

to deploy a new generation of speech transaction
technologies, products, and systems that could be
easily integrated into telephone and computer networks. The company’s goal was to become theleader in a new realm of human communication.
SR Corp had been financed over the last eight
years through a private investor who had been a successful entrepreneur in the publishing industry in theearly 1980s. By 1994, the firm had 20 employees. The
management of the firm was comprised of Dr. GaryYork (president and CEO), Hastings (vice presidentof Marketing), and Dr. Paul Schall (vice president ofEngineering). The company also had a chief operating officer, Ms. Sheila Garris, who was responsible forsystems manufacturing and finance. Most employees
were software and hardware engineers, reporting to
Dr. Schall. Dr. York was the inventor of several key
parts of SR Corp’s proprietary technology, and several of the firm’s patents were in his name. Hastings
had only one administrative assistant and knew that
he would have to expand his sales force over the next
several years in order for the firm to grow.
Between 1986 and 1994, the company focused on
developing its core technology while working withmajor telephone companies and Fortune 500 corporations to find out what they wanted in large-scalespeech recognition systems. On the basis of feedback from these organizations, SR Corp created asystem that Hastings’s competitive research had
shown to be years ahead of the industry.
THE INDUSTRY
A leading market research firm’s 1993 report on
speech recognition summarized the common
industry opinion: “Voice recognition is the least
developed of voice technologies and is widely
considered to be a technology still in its infancy.
Industry experts agree it will be at least a decade
before a mature voice recognition product is introduced in the market.”1 The power of SR Corp’s

1 Rettig, Hillary, “Not Quite the Last Word.” VARBUSINESS
Networking Annual, Oct. 15, 1993, p. 4.

671

systems, if successfully commercialized, could
shatter this perception.
Speech recognition had a history of research longon promise but short on tangible results. Bell labs
initiated work in this area nearly 30 years ago. The
initial technology worked only in the most constrained situations—understanding a few single
isolated words using a high-bandwidth microphone in a noise-free environment. Progress had
moved slowly toward the goal: computer understanding of unconstrained conversation with any
caller under difficult telephone network conditions.
TYPES OF SPEECH RECOGNITION
The most popular form of speech recognition
deployed in 1993 was called speaker-dependent
speech recognition (SDSR). The term speakerdependent referred to the fact that the person using
its first “trained” the system by loading it with hisor her own voice patterns for a selected set ofwords necessary for the application. For example,
Sprint Corporation developed a system, the Voice
FonCard, which allowed users to record up to
thirty names over the phone and store them in acentral database at the telephone company. Whensomeone wanted to place a call, he or she would
simply speak the name of the person they wanted
to call into the phone for automated dialing.
Speaker-independent speech recognition (SISR),on the other hand, would allow any person to use asystem without first training it. AT&T had recently
implemented a speaker-independent collect-callapplication in which an automated attendant
instructed the person to say “yes” or “no” in orderto accept a collect call.
Speaker-dependent systems were accurate 95
percent of the time, while speaker-independent
systems had achieved only 80 percent accuracy.
The most important factor in weighing the technical capabilities of different speech recognition vendors lay in their ability to improve accuracy levels
on an annual basis. In the past decade, it had typically taken about one year to achieve a one to two
percent improvement in accuracy.

SR Corp: Decisions for an Emerging Technology

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CASE 11 SR Corp: Decisions for an Emerging Technology

In 1994, speaker-independent speech recognition could be subclassified into two different typesof systems: discrete and continuous. Discrete
speaker-independent speech recognition was used
for command and control of speech applications
where users say one word at a time. Continuous
speaker-independent speech recognition allowed
users to speak naturally into the computer system.
Discrete speaker-independent systems werecommonly referred to as “voice-buttons” because
the technology replaced pressing buttons on thetelephone. This technology was available in 1994,
but was limited in its application because accuracy
levels had reached only 90 percent. The pressing
short-term challenge for vendors was to reach 99
percent accuracy. Following historical progress
rates, industry experts predicted that this goal
would be achieved around the year 2000.
The longer-term challenge for speech recognition was to reach 99 percent or better accuracy levels for continuous speaker-independent speech
recognition. Once again, most industry experts did
not expect highly accurate continuous speech systems to achieve this level of accuracy until after theturn of the century.
Speech recognition vendors such as AT&T and
Texas Instruments (TI) used the Hidden Markov
Method as the central process for algorithms intheir products. Programmed into software, thismethod provided voice pattern-recognition basedon complex statistical programming. These statistical patterns had been developed utilizing laboratory data and generic language models. The
resulting systems had large processing power
requirements and typically operated on workstations running in excess of 20 mips (millions of
instructions per second) for the central processor.
Each system needed at least one workstation per
telephone line of speech recognition. In addition,
an important part of any system was its ability toallow companies to build new applications.
Existing systems came with very limited softwaredevelopment environments; users were dependent on vendors for sophisticated applications
development.

SR CORP’S PRODUCT: THE
CORE TECHNOLOGY
By 1994, SR Corp developed a speech recognition
system that industry experts had not expected to beavailable until 2000: a discrete, speaker-independent
speech recognition system that operated with 99 percent accuracy for numbers zero through 10, “yes”
and “no,” and an application-specific vocabulary ofwords spoken in sequence. That vocabulary could
exceed thousands of words for complex applications, such as automating directory assistance in alarge telephone company. Like existing discrete systems, the typical application built with SR Corp’s
system would have menus to guide a user’s transactions. However, unlike these systems, SR Corp’s
technology would allow the user to speak a streamof words (with short breaks between them) to totally
bypass the application menu. This was a direct step
toward the highly accurate speaker-independent
continuous speech recognition system that SR Corp
expected to have operational within three years. The
combination of accuracy and menu bypass made SR
Corp’s current system highly distinctive; theprospect of delivering continuous speech capability
within a few years made the company even more
attractive for prospective customers.
To achieve these results, SR Corp had proceededalong a different technological path than AT&T
and other large vendors. It developed a patternrecognition approach based on a neural networkmodel, and its algorithms differed fundamentallyfrom existing approaches. Further, the company had
achieved constraint-free telephone recognition using
Intel 486-based personal computers running in the
20- to 30-mips range. Seven U.S. and foreign patents
for SR Corp’s technology had been issued and others were pending. These patents were issued
between 1990 and 1994 and would, therefore, be inforce well into the next century unless successfully
challenged in court. The company had also developed a Transaction Dialogue Authoring System thatallowed new applications to be developed by theuser in a higher level language. Exhibit 1 is a flowchart of an SR Corp conversational transaction.

681

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SR Corp: Decisions for an Emerging Technology

CASE 11 SR Corp: Decisions for an Emerging Technology

673

EXHIBIT 1
SR Corp’s Conversational Transaction Flow

CPS* LINE UNITCPSLINGUISTIC
RECOGNIZERSPEECHRECOGNIZEPHONEMESSEMANTIC
EQUIVALENT
EQUIV
ALENT
MAPPINGPHRASESPOTTING
SPOTTING

DICTIONARYDICTIONARYLOOK-UP
MATCH
MA
TCH
PHONEMESTO DICTIONARYDICTIONARYUNCONDITIONED
SPEAKER
TRANSACTION FLOWDIRECTORIDENTIFY RESPONSE,
REACT TO REQUESTSVOICEPROMPT
PROMPTACTIONS* CPS is the Colloquial Platform for Speech
Source: SR Corp Documentation

SR Corp’s product was designed to be integrated
at reasonable cost into any network, whether it be acentral office of a telephone company or a local area
network of a major corporation. The system could
be delivered in a variety of configurations, with two

PC boards supporting one telephone line of speech
recognition. The boards shipped in a chassis; eachchassis contained ten boards, and thus supported
five lines of recognition. The approximate cost of
goods sold for the five-line system was $3,000.

SR Corp: Decisions for an Emerging Technology

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CASE 11 SR Corp: Decisions for an Emerging Technology

SR CORP’S MARKETSR Corp hoped to gain a cost advantage with its
technology over Hidden-Markov based systems.
Hasting’s research had shown that the speakerindependent discrete voice recognition systems
were currently selling at an effective price of about$6,000 per line of recognition, including the cost of
the workstation itself. Hastings found that, inlarge-volume orders (10,000 units were not unusual for telephone companies), discounting drove
competitors’ pricing down to about $3,000 per lineof recognition.
Since SR Corp’s product could handle at least
two and as many as five lines of recognition per
workstation (compared to the single-line systems
of competitors), Hastings believed that SR Corp’s
product could be priced between $5,000 and$10,000, depending on the size and type of customer. Even with large-volume orders, Hastings
believed that the SR Corp’s cost advantage overcompetitors for equivalent processing process configurations would remain 3 to 1.
The 99 percent accuracy of the system would
also allow many customers to apply speech recognition to applications that they had previously
avoided due to the error rates of competitors’ systems. Further, while existing speech recognition
systems were single-application products, SR
Corp’s system could be used as a single platform
for developing many applications. For example, atelephone company using a competitor’s system
would have to develop software running on twocompletely separate sets of workstations to implement both voice dialing and voice mail. Using SR
Corp’s technology, a single set of workstations
could be used to perform both applications. For
large users, the resulting cost differential could beconsiderable. For example, if a telephone company
was to purchase a single unit for each application,
the two-application (two line) scenario would cost
approximately $12,000 with a competitor’s technology. SR Corp’s solution would cost $10,000 for a
maximum of five lines of speech recognition, for aneffective cost per line of $2,000. Therefore, the two-line scenario would be priced at $4,000, providing
SR Corp with an $8,000 cost advantage over competitors. For large-volume orders, both SR Corp
and its competitors would discount their prices by
about 50 percent. This would still yield a full system cost of $3,000 per line for competitors versus$1,000 per line for SR Corp. This was a substantial
cost advantage because large customers might purchase thousands of units for any single application.
Most companies in SR Corp’s target markets
had many potential applications for speech recognition. Hastings’s discussions with representative
customers in various market segments revealed
that the typical customer would wish to buy
between 100 and 500 systems for an initial speech
recognition application such as automating a customer service function. This would produce initial
revenues in the range of $1 million to $.5 million
per customer.
By 1994, the entire U.S. speech recognition market was a $350 million industry. Its market segments included telephony, data entry, dictation,
consumer products, computer control, and voiceverification. (Exhibit 2 shows the speech recognition market forecast through 1996, and 1992 revenue by market shares.) The VARBUSINESS
Networking Annual, a leading industry forum,
forecast that annual sales of speech recognition
equipment would exceed $3 billion by the year
2000.2SR Corp’s product was targeted at the telephonymarket segment. Telephone-based speech recognition offered great potential due to the pervasiveness of voice communication and the lack ofalternative methods for high-bandwidth input. It
was also the largest market segment, representing
27 percent of the market. Telephony applications
were expected to grow rapidly and expand to 60
percent of installed speech recognition systems by
the turn of the century, according to VARBUSINESS
Networking Annual.3
2 Rettig, op. cit.
3 Rettig, op. cit.

683

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SR Corp: Decisions for an Emerging Technology

CASE 11 SR Corp: Decisions for an Emerging Technology

675

EXHIBIT 2
Market Forecast and Segments

Source: Voice Information Associates, Lexington, Mass.

Hastings divided the telephony segment into
three major niches:
1. Fortune 500 companies
2. Telephone companies
3. Telephone switch manufacturers, which soldequipment to telephone companies

Hastings also realized that telephony applications could be difficult due to the lack of control
over the conditions of use. Problems included alarge and unpredictable user population, differences in handset microphones, the presence ofchannel noise, and low signal bandwidth. In 1994,

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CASE 11 SR Corp: Decisions for an Emerging Technology

the most successful speech recognition systems
used by large industrial, transportation, and financial firms, and by telephone companies, were limited to very small vocabularies (10 to 20 words
spoken in a discrete, noncontinuous manner). Yet
even these systems had provided substantial payback by reducing the need for telephone operators
and/or customer support personnel.
SR CORP’S COMPETITORSThe major competitors in the telephony market
segment included, AT&T, Texas Instruments (TI),
Northern Telecom, Nynex, Bolt Beranek &Newman, Voice Control Systems, and Voice
Processing Systems.
All of these companies were selling speakerdependent and limited discrete speaker-independent
systems. Each competitor had approximately 10
percent market share of the telephony segment.
None had achieved technical leadership withregard to accuracy levels, with all averaging 90 percent for speaker-dependent systems and 80 percent
for speaker-independent systems.
AT&T, the largest and most threatening competitor, had stated that it would deliver discrete,speaker-independent speech recognition reaching
99 percent accuracy no earlier than 1998. AT&T
made no claims with respect to more advanced
continuous speech recognition. Although by mid1994 SR Corp had not sold any discrete, speakerindependent systems, its internal tests proved thatthe system they developed was 98 to 99 percent
accurate.
All the competitors had been extraordinarily
secretive about their R&D. The speech recognitionindustry had been litigious: lawsuits had been initiated to challenge patents, intellectual property,
and even the loss of scientists from one firm toanother. In one case, TI had the federal government
raid Voice Control Systems three weeks after twoformer TI scientists began working for VoiceControl Systems. The case was settled out of court.
Therefore, while Hastings was ecstatic about thetechnological break-throughs achieved by his firm,

he thought that he had to be very careful about who
he talked to in this early stage of commercialization.
Hastings believed that SR Corp’s technology had tobe kept secret until market share was secured. SR
Corp had thoroughly researched existing speech
recognition patents and was confident that its
patents did not violate any of them. However, anylarge firm seeking to block SR Corp’s entry into its
market (be it a firm selling voice-button systems
that SR Corp’s technology would make obsolete, ora firm such as AT&T that was trying to develop its
own advanced system) might be a problem. In
Hastings’s view, an intellectual property suit filed
against SR Corp by AT&T or TI would consume
scarce management and financial resources andcould drive the company out of business.
STRATEGIC MARKETING ALTERNATIVES
The day after Hastings’s return from San Francisco,an executive management committee meeting wasconvened comprised of himself, Dr. York (president), Dr. Schall (vice president of Engineering),
and the lead investor. Together, they had to make adecision regarding which niche within the telephony segment to pursue during the coming year,
e.g. Fortune 500 corporations, telephone companies, or telephone switch manufacturers.
Dr. Schall described the continued positive
results of the most recent field tests of SR Corp’s
product. He was deeply concerned about selecting
the company’s first set of target customers:
This will be a critical step in our success because weneed to utilize our initial customers as references for
future sales. We also need knowledgeable customers,
or else we will never get past the first installation. At
the same time, we must try to avoid becoming entangled and delayed by the red tape of the bureaucraticorganizations of some of these customers, such as amutual fund company or a telephone company. Timeis of the essence.

Hastings concurred, and then added:
We can’t afford to pick a strategy that brings us to thewrong customers. Once we dive in with a customer,
we’ll be devoting most of our efforts toward integration

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SR Corp: Decisions for an Emerging Technology

CASE 11 SR Corp: Decisions for an Emerging Technology

and deployment. These ramp up issues are of strategic
concern because if we are six months into a project andsuddenly discover that a customer’s lack of technicalskill or bureaucratic politics will delay final implementation, we could be in serious trouble; we’ll have hired
10, maybe 15 people, set up a satellite office, and thebills will have to be paid. Further, we could have beenworking with a better customer either in the same orsome other niche in telephony.

Hastings gave examples of how the sales cycle
could be lengthened by a prospective customer’s
bureaucratic decision making. For example, a telephone company might have more than a half dozen
departments, ranging from operator services to
consumer marketing, that would be users of thesame integrated speech recognition system. Eachdepartment would have a separate budget for systems procurement, and therefore all would have toagree to “pitch in” resources for a major systems
procurement.
He also spoke about complications that could
occur after the sale was completed. For example,
several telephone companies had agreed to contracts for existing speech recognition technology
with SR Corp’s competitors only to cancel the projects after a year of effort, even though they had
already spent in the range of $1 to $2 million. The
telecommunications industry was undergoing dramatic consolidation, and these project cancellations
were dramatic evidence of how efforts involving
exotic technologies could come to naught. Further,some of SR Corp’s smaller competitors had beenstalled in their attempts to market their own technologies by intellectual property lawsuits filed bylarger, better established companies. The stakes
were high and companies played “hardball.”Both Dr. York and the lead investor wanted toforge ahead with sales. Installing SR Corp’s system
at a large customer site would require allocation ofa significant portion of the company’s resources.
While everyone believed that securing three large
accounts was a reasonable objective in the next 18
months, SR Corp’s limited resources would
require that implementation to the three customer
sites be performed sequentially. Dr. York said that677

the company would also have to create remote
offices near each major customer to provide field
support and technical training. Hastings also
believed that SR Corp would have to ramp up
investment in its marketing activities for direct
sales and trade show exhibitions.
The lead investor indicated a willingness to supply additional funding. However, he wanted to see
a clear marketing plan and customer contracts thatgarnered a significant portion of the total sale up
front to help cover systems integration expenses.
Hastings then presented the data he had gathered from company visits and industry expert
sources, addressing first the Fortune 500 niche,then the telephone company niche, and lastly, thetelephone switch manufacturer niche. From these
data, SR Corp’s attack plan would be formed.
The Fortune 500 Market Niche
The Fortune 500 niche was comprised of large corporations in a variety of industrial, consumer products, and financial industries. More than half ofthese companies had already purchased interactive
voice response and voice messaging customer
premise equipment used for customer service andordering applications. SR Corp’s product would bemarketed as the next generation of voice responseand voice messaging technology, featuring greater
accuracy, menu bypass capability, a multiapplication functionality, and at least a 3 to 1 cost advantage on an equivalent processing power basis.
In 1994, voice response systems only allowed
companies to automate certain customer service
functions. For example, callers might be greeted bymenus such as “press 1 for sales, press 2 for service,” etc. Callers navigated through menus bypressing the right buttons on their touch-tonephones. With speech recognition, the caller would
reach a truly automated “operator,” who would
ask: “Would you like sales, service . . . ?” etc. andwait for the caller to say what he or she wanted.
Voice messaging enabled callers to leave messages for employees in companies. Users pushed
buttons on their phones to manage their voice mail

SR Corp: Decisions for an Emerging Technology

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CASE 11 SR Corp: Decisions for an Emerging Technology(e.g., they would press 1 to delete a message, press 2
to go to the next message, and so on). With a speech
recognition system, users could simply say “Delete
the first message,” “Go to the next message,” etc.
SR Corp’s product was a substitute system forboth voice response and voice messaging systems.
Companies using voice response and voice messaging systems needed a gateway to voice services
that was easy and quick to use. Users often
expressed dissatisfaction with the limitations ofvoice response and voice messaging, and in particular, were annoyed by the long, cumbersome, andinflexible menus contained in these systems.
For example, a voice-button system in an airline
might result in the following dialogue:
System: Thank you for calling American Airlines.
In order to expedite your call, please press 1 ifyou’re calling from a touch-tone phone. If you havea rotary phone, please hold the line and a customer
service representative will be with you shortly.
User: Presses 1.
System: Please make your selection from the following menu:• For flight arrival times, departure times or gate
information, press 1.
• For domestic reservations and fare informationin the 50 states, press 2.
• For international travel, including Canada andthe Caribbean, press 3.
• For Fly Away Vacations, press 4.
• For Frequent Flier Mileage accounts and information, press 5.
• For all other inquiries, press 6.
• Press 7 to repeat the menu.
The user might then be able to press a button
corresponding to what he or she actually wanted.
However, if after listening to the entire menu, theuser still did not know what button to press, he or
she might press 6, calling up yet another automated menu, or 7, to hear the menu again.
With SR Corp’s system, such a call could begreatly simplified—for either a touch-tone or rotary
phone:

System: Thank you for calling American Airlines.
Tell us how we can help you. Be sure to leave short
breaks between your words.
User: I need to check my frequent flier miles.
System: The call transfers to the Frequent Flier
Division.
Hasting’s interviews with prospective customers in the Fortune 500 niche showed that theywanted a system that would allow this type ofnatural, conversational exchange with a highdegree of accuracy. These large companies needed
systems that their own customers would find easy
to use for performing automated, non-humanassisted transactions. Replacing touch-tone keypad operation with speech would accelerate user
acceptance, particularly if the user could skip
ahead through menus once they became familiar
with routine transactions. Any system would haveto function accurately with “unconditioned”
speakers, that is, speakers who were not trained
beforehand to use an artificial protocol for interacting with the system. Companies would also
require a flexible and productive software development environment so that their own computer
staffs could build customized applications without overreliance on the vendor. SR Corp believedthat it was well ahead of its competitors in providing this type of solution for the Fortune 500
market.
SR Corp could initially target industries that
had the largest number of telephone transactions
per day using voice response and voice messaging
systems. These industries included the competitive
access telephone services providers (CAPs), airlines, financial services companies, and catalog
mail order companies. (See Exhibits 3 and 4.)
Almost every major Fortune 500 company thatcompleted transactions over the phone utilized
some form of interactive voice processing andmany used an alternative access provider rather
than their local phone company to save money. In
1993, the typical CAP processed over 250,000 calls
per day. The travel industry also had high volumes. By 1989, American Airlines was taking 100

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688

Industry or
Company

No. Transactions
per Day
250,000

Extremely competitive with other CAPs,* local
exchange carriers.† Interexchange carriers.‡
Access provision 80% of business. Adoption high(50% NYC); increase new services.

Centrex services only
Voice dial
Operator services

1,000,000

Airlines hate paying commissions to travel agents,
but they represent 90% of overall business.
Volatile pricing environment, monopolisticcompetition.
Extremely competitive; razor thin margins.

Reservations, flight times,
schedules, weather, personal
flight information

Banks
Bank of America
Banc One
Chemical

65,000

Rapid consolidation and acquisitions from drop in
regulations. Savings from consolidations going into
tech spending. Intense competition, and SR tech
could give edge that would do more than justincreasing CD rates by 1%. With regs dropping,new services are the rise.

Obtain checking, credit card, stock,mutual fund info. & services
Loan/mortgage Acceptance
ATM locator service

Catalogs
Home Shopping
Network
J.C. Penney
QVC

200,000

Heavy competition.
Immense cost for customers to hold to place order,
ties up potential sales revenue; if hold is too long,customer could leave and buy product elsewhere.
Heavy automation within the industry.

Preview customer info
Automate order process
Obtain shipment status
Obtain account and billing info

Telcos (CAPs)*
Metropolitan Fiber
Services Corp.
Teleport
Inner Media
TravelUnitedAmericanAmEx TRS*Competitive access providers (CAPs) are competitors to local telephone companies in major metropolitan areas, and primarily serve
Fortune 1000 customers.
† Local telephone companies such as Regional Bells and GTE.
‡ Long distance companies such as AT&T and MCI.
Source: SR Corp Internal Document.

SR Corp: Decisions for an Emerging Technology

Applications

CASE 11

Forcing Function

SR Corp: Decisions for an Emerging Technology

EXHIBIT 3
Target Fortune 500 Industries679

SR Corp: Decisions for an Emerging Technology

680

CASE 11 SR Corp: Decisions for an Emerging Technology

EXHIBIT 4
Advantages and Disadvantages of Prospective Fortune 500 Targets
Industry or
Company

Pros for Leading Company

Cons for Leading Company

CAPS
Metropolitan Fiber
Services Corp.
Teleport
Inner Media

MFS: Highest growth rate in switches and cities.
Only CAP dedicated to operator services.
Need SR Tech for Oper Service efficiencies.
Fast, driven, innovative, $, national.
Not as large as LEC, fast sales cycle.
Only CAP going after providing LDist service.

Not adding oper service until next year;
most money comes from providing
access.
Wouldn’t be ready for us just yet.

TravelUnitedAmericanAmEx TRS

United: 4800 operators, have skipped IVR
system because transactions are not static.
Said they have been looking for effective
speech recog, but AT&T can only do 95% on
0 through 9; if anyone could get higher,“we could keep them busy just doing hundredsof apps for our company.”

Affordability a major concern.
Testing would take Approximately 10–16
months.

Banks
Bank of America
Banc One
ChemicalBank of America: The Security Pacific acquisition
brought a high tech focus to the company
operations and they are extremely committed
to technology to drive business.
Corporate clientele on rise with Continental
acquisition.

Any bank will need solid, large
references before they purchasetechnology-based solutions.
Very cautious.

Catalogs
Home Shopping
Network
J.C. Penney
QVC

Home Shopping Network: Incredibly devoted
to technology-driven processes. In fact, their
Annual Report discusses their different
methods for 6 pages.
Phones so important, HSN built own IVR
company and later spun it off.

Potential use as a reference may bedifficult.
Would Home Shopping Network be as
good as an airline or telco?

Source: SR Corp Internal Document.

million reservation calls per year.4 This translated
into about 274,000 calls per day (or about 3 calls
per second). Similarly, large banks, on average,
processed about 65,000 calls per day.
Companies in these industries had looked tovoice response and messaging systems as a way tocreate efficiencies and automate portions of theiroperations. The total 1993 revenue for the domestic

4 ”AMR Wields SABRE, Private Net,” ComputerWorld, May 1,
1989.

voice response and voice messaging systems in the
Fortune 500 niche was $1.1 billion. Vendors of thesesystems were also highly profitable. Their average
profit before tax was approximately 23 percent.
Systems enhanced with speech recognition
capabilities were available, but accounted only for$33 million in revenues, or 3 percent of the total
voice response and voice messaging markets. This
small penetration rate was due primarily to theexisting low accuracy levels. Experts agreed thatcompanies would feel more comfortable replacing
push-button commands with voice commands

689

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SR Corp: Decisions for an Emerging Technology

CASE 11 SR Corp: Decisions for an Emerging Technology

once accuracy rates exceeded 95 percent. Experts
further predicted that sales of speech enhanced
substitutes for existing voice response and messaging systems would increase dramatically andrepresent $600 million out of the total forecasted$1.5 billion for the voice response and messaging
markets by the year 2000.5
Hastings’s visits to prospective customers had
indicated that the typical company in this market
niche might purchase SR Corp’s system to support
3,000 telephone lines. He anticipated that he could
price the system at approximately $6,000 per line.
SR Corp would also have to hire a team of three
engineers per customer for approximately one year
in order to help with the integration of its systemwith the customer’s existing equipment For planning purposes, Hastings used a fully loaded cost of$100,000 per engineer per year, a figure that had
been provided by Dr. Schall.
A customer would install SR Corp’s system for asingle, targeted speech recognition application. To
develop follow-on business and generate more revenue from each customer, Hastings planned to hire
one account manager per customer at an equivalentcost of $100,000 per person per year. Both fieldengineers and account representatives would workout of a single field office located near the customer’s central office. Hastings did not expect that
customers would necessarily agree to provide
office space for SR Corp’s field personnel. The figures he used for planning were 250 square feet of
office space per person leased on an annual basis
for $10 per square foot.
Hastings had to factor in another concern. He
expected that Fortune 500 customers would have asteeper learning curve, and hence a longer sales
and implementation cycle, than either telephonecompanies or telephone switch manufacturers. MIS
departments in typical Fortune 500 customers were
not familiar with the application of speech recognition technologies. Because of this, Hastings

5 Rettig, op. cit.

681

believed it would take approximately 10 to 12
months to achieve full implementation of SR
Corp’s system for an initial application with eachnew customer. Customers would not see that timescale as a drawback, they measured deployment ofolder technology systems in years.
At the same time, because of the compellingneed of these companies to reduce operating costs,
he believed that SR Corp could land five Fortune
500 customers during the first two years. The current voice-button systems in industry did not allow
firms to completely replace their customer service
representatives. For example, a major airline foundthat voice-buttons could only accommodate 25 percent of a standard flight reservation transaction,and in particular, only that part where the customer
needed to be directed to a particular department
for human-assisted reservation making. In fact,many Fortune 500 companies had decided not to
implement voice-button systems because of thelimitations of those systems in handling complex
transactions. Their customers were found to be
frustrated and annoyed with the inflexible, “hardwired” menus of voice-button systems. SR Corp’s
technology was sufficiently dynamic to handle
complex transactions. For example, internal tests
by SR Corp found that 100 percent of a standard
flight reservation could be done through its system.
Fortune 500 companies could eliminate major portions of their total human telephone operator orservice representative costs.
Given the complexity and newness of the technology, the best channel for reaching this market
niche was to sell directly to customers. Fortune 500
companies were more likely to buy hardware fromlarge vendors such as IBM or AT&T, but they had
shown a willingness to buy specialized softwareand turnkey systems from small vendors. SR Corp
could expect to establish long-term relationships
with Fortune 500 accounts because they would
want SR Corp’s continued assistance in developinga “family” of speech recognition applications fortheir respective businesses.
By 1994, more than half of the Fortune 500 companies had implemented interactive voice-button

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CASE 11 SR Corp: Decisions for an Emerging Technology

systems to automate customer service. SR Corp
would have to replace these systems, and therefore
faced the prospect of counterarguments from thevendors. From the customer’s perspective, buying
into a new system would specifically mean replacing systems that might only be a few years old andtherefore not fully amortized. SR Corp’s system
would have to be connected to a heterogeneous
mix of PCs, mainframes, and networks. Development and maintenance software tools would also
be critical.
Hastings summarized his thoughts on this niche:
The Fortune 500 niche holds excellent opportunities
with regard to potential sales volume and a solid reference base. I’ve already spoken to two airlines whowant to start right away evaluating our technology.
These two airlines have the second highest number ofdaily transactions after the largest telephone companies. They really want our stuff.
My concern is the level of effort we’ll need to provide in order to serve these airlines or large banks ormutual fund companies, during the first two years.
We’ll have to hire engineers and set up a field office ateach customer site. These things may all put aresource drain on the company during its initial yearsof marketing, particularly when compared to either
telephone companies or telephone switch manufacturers, who basically know what they are doing technically. The lack of knowledge in this market niche
about speech recognition deployed in a local area network environment would also lengthen our sales
cycle. Lastly, an airline reservation application is much
more complicated than directory assistance or handsfree dialing.

The Telephone Companies
Telephone company prospects included all telephone companies in the United States that owned
and maintained telephone lines. The majority ofthese lines were owned by local exchange carriers(LECS) and long distance providers. Telephonecompanies would put speech recognition systems
in their central office locations where telephonelines were connected. For example, in 1994 Bell
Atlantic had approximately 19 million phone lines

and as many as 500 central offices in its MidAtlantic region.
Voice processing technologies such as messaging,speech synthesis, and speech recognition offered
substantial opportunities in the operator services
arena. Hastings believed that implementation ofthese capabilities should be worth hundreds of millions of low-risk dollars in cost containment andnew enhanced service revenues to each of the local
exchange carriers (including Baby Bells & GTE) andinterexchange carriers (including the long distancecompanies such as AT&T, Sprint, and MCI).
Many large telephone companies had alreadymade substantial investments in new operator services platforms that integrated directory assistance,intercepts and toll assistance functions. Further,some had developed voice messaging and speech
controlled services for calling cards and 800 and
900 service.
Directory assistance was a compelling example of
how speech recognition could save a company
money. Industry experts believed that operator services enhanced with speaker-independent voicerecognition technology could save telephone companies $600 million annually in equipment andoperational costs. One Baby Bell shared the results ofa recent internal study with Hastings that showed
impressive savings through automation. The company’s average directory assistance work time was
18 seconds. Eliminating just a single second would
translate into $8 million in annual savings.
SR Corp was shooting for a high level ofautomation of directory assistance services which
would include names of cities and individuals. The
system incorporated alphabet recognition, so that auser could spell the last name and city if he or sheneeded to. The system also understood the majority of foreign accents in English. Even a speech
recognition system that automatically recognized
only city and state words (not name and address)
could save as much as 10 seconds on average.
Even with the best technology, however, telephone companies would still provide users withthe option of speaking to a human operator. With
its 99 percent accuracy, SR Corp’s system would

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CASE 11 SR Corp: Decisions for an Emerging Technology

provide an effective automation rate of 98 percent(99 percent for the city words times 99 percent forthe state words; in general, the effective accuracy
rate would decrease by 0.99 times the number ofwords in the transaction). Human operators would
be required to handle the remaining 2 percent of
the city and state part of transactions.
The combined local and long distance carrier
industry reached $150 billion in 1994. There were130 million telephone access lines controlled by
local exchange carriers in the United States. (SeeExhibits 5 and 6.) Of the 130 million lines, only
about 200,000 were trunks, where individual lines
came together and provided logical targets forembedding speech recognition.
Sales of speech recognition enhanced products
to telephone companies totaled $44 million in 1994.
However, industry experts predicted sales would
rise to $1 billion by the year 2000. Based on his own
field research in several telephone companies,
Hastings expected that most telephone companies
would be interested in speech recognition for atleast 25 percent of their trunks over the next several years and would gradually move toward 50 to
75 percent within 5 to 10 years.

683

SR Corp’s product could be configured for any
number of phone lines. Speech recognition offereda telephone company an opportunity to generate
new incremental revenues from innovative applications. One Baby Bell, for example, concluded it
could sell voice dialing services to seven million
customers by mid-1996 at a $5 monthly charge, producing approximately $400 million in additional
revenue per year. Speech recognition could also
serve as a means to overhaul and automate many
internal functions.
A growing subset of the telephone company
niche was cellular companies. By 1994, most telephone companies had an equity interest in a major
cellular company in the United States. (See Exhibit7.) Revenues for the cellular industry totaled $11 billion in 1993, and the industry served a total of sevenmillion subscribers. Cellular markets were growing
at 45 percent per year versus the 3 percent annual
growth of line-based telephony. New types of digital cellular technology, such as personal communications services and global mobile services, were
emerging on the scene. Cellular telephony provided
a strong market for speech recognition services.
Hands-free command and control for voice dialing

EXHIBIT 5
Local Exchange Carrier Access Line Information and Corporate Data
Total Access Lines Serviced

Carrier
GTE
Bell Atlantic
BellSouth
AmeritechNYNEXUS West
SNET
Pacific Bell
Southwestern Bell
Total

1992

1993

16,819,000
18,180,700
18,621,600
17,001,000
15,700,000
13,300,000
1,936,577
14,306,000
12,700,000
128,564,877

17,000,000
18,612,700
19,296,500
17,471,581
15,700,000
13,700,000
1,959,555
14,600,000
13,200,000
131,540,336

Source: Annual Review & Forecast, TE&M, Jan. 15, 1994.

%
Growth
1.08
2.38
3.62
2.77
3.01
1.19
2.06
3.94

1993
Revenue(000,000)

Estimated
Number ofCalls per Day$ 12,400$ 10,700$ 13,000$ 10,000$ 11,000$ 8,000$ 1,000$ 9,000$ 7,000$ 82,100

95,119,112
104,142,559
107,968,585
97,757,722
87,845,298
76,654,814
10,964,184
81,690,532
73,857,193
736,000,000

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CASE 11 SR Corp: Decisions for an Emerging Technology

EXHIBIT 6Long Distance Company Information
Interexchange Carriers Market Shears 1992 (percent)Toll revenues
Switched minutes
Premium minutes
Private line
PresubscribedBusiness customers

AT&T

MCI

Sprint

Other

Total

65
63
64
62
79
52

14

10

11

11
11
17

8
6
16

19
4
15

$ 52B
$324B
$318B
$ 8B
$132B

Total Market Share Long-Distance Market (percent)VendorAT&T
MCI
SprintInt'l Telecharge
Nat'l Tele Serv
OthersTotalmarket share

Hospitality
industry

Publicpayphone

Privatepayphone

71.00
9.00
6.00
2.20
1.60
10.20

74.00
7.00
5.00
2.00

76.00
6.00
8.00
4.00
3.00
3.00

51.00
4.00

12.00

Traditional
68.00
13.00
9.00

21.00
24.00

10.00

Source: 1993 Geodesic Network, Geodesic Co., Washington, D.C.

EXHIBIT 7
Cellular Market Information

Cellular subscribers
POPS (millions)
Cellular penetration
1993 growth in subscribers
Ave. monthly revenue per subscriber
Cellular’s share of total company value

Cellular subscribers
POPS (millions)
Cellular penetration
1993 growth in subscribers
Ave. monthly revenue per subscriber
Cellular’s share of total company value

Ameritech

Bell Atlantic

BellSouth

NYNEX

860,000
21
4.00%
47%
$68
13.50%

1,039,000
31
3.30%
48%
$77
11.10%

1,559,132
39
4.00%
39%
$63
25.30%

575,000
20
2.90%
47%
$82
11.40%PACTELSouthwestern BellUS WestLEC Average

1,046,000
33
3.10%
41%
$83
35.30%

2,049,000
36
5.70%
45%
$63
28.10%

601,000
18
3.30%
45%
$72
11.00%

1,104,162
28
3.76%
45%
$73
19.39%

Source: 1993 Geodesic Network, Geodesic Co., Washington, D.C.

693

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SR Corp: Decisions for an Emerging Technology

CASE 11 SR Corp: Decisions for an Emerging Technology

and messaging were two examples. These factors
made cellular companies good candidates for SR
Corp’s marketing efforts.
Judging from telephone company buying patterns and their need to reduce operational costs,
Hastings believed that a large telephone company
would want to introduce speaker-independent
speech recognition capability into 5,000 lines in thefirst year and could pay up to $10,000 per line. SR
Corp’s system could handle up to five lines per
workstation, which translated into 1,000 systems
delivered to a customer’s central offices.
Given the complexity of the technology,
Hastings thought that the best channel for reaching
this market niche was to sell directly to customers.
When compared to Fortune 500 firms, telephonecompanies were even more likely to buy hardware
from large vendors such as IBM or AT&T because atelephone company’s fault-tolerant environment
required proven hardware and strong technicalsupport. However, telephone companies had
looked to emerging telecommunications firms for
specialized solutions, particularly in software. SR
Corp could expect to establish long-term relationships with such companies because they would
want its help building new applications.
By 1994, most telephone companies had implemented interactive voice response systems as well
as voice mail systems. The switching costs facing atelephone company considering SR Corp would belarge. These voice response and mail systems weretypically large computers placed in central offices.
Not only was amortization of installed equipment
an issue, but substitution with a new speech recognition system would require simultaneous replacement of old systems in numerous geographicalsites.
Dr. Schall figured that he would need to hire ateam of about 20 engineers per telephone company
in order to help with the complex integration of the
speech recognition technology into the central
offices. To develop follow-on business, Hastings also
expected to hire one account manager per telephonecompany at a cost of $100,000 per person per year.
Both field engineers and account representatives

685

would work from a single field office located near
the customer’s central office. Once again, the figures
used for planning were 250 square feet of officespace per person leased on an annual basis for $10
per square foot.
Based on his discussions with several companies, Hastings believed that SR Corp could obtain
10 percent of the typical 5,000 line sale upon contract signing. Integration would take approximately a year. He felt confident that two telephonecompanies could be converted into customers during the first two years.
Hastings summarized the telephone company
niche for his colleagues:
Telcos offer a high-growth market and can definitely
deliver the volume for SR Corp to achieve strong profitability. Furthermore, Telcos would have the mostknowledge about speech recognition and its implementation. Their learning curve would be quick. Also,
because Telcos could use this technology, both insidetheir companies as well as outside by selling it to theirown commercial customers, the technology would
provide a quick payback.
There are a couple of catches, though. Telcos are
multibillion-dollar customers who could slow us
down and drag out the sales process. I’ve heard ofsome Telcos agreeing to a contract and then, after
wasting 12 months of a vendor’s time, canceling the
program—we cannot afford that type of a problem atthis early stage. In addition, AT&T and several Baby
Bells are experimenting with their own homegrownversions of speaker-independent speech recognition.
We would not want to alert them to what we havealready done. This would invite legal battles overintellectual property. This particular threat is a very
real—they might try to hire away our best engineers
or tie us up in court.

The Telephone Switch Manufacturers (OEMS)
This last niche in telephony was comprised of original equipment manufacturers (OEMs) making
switch equipment for telephone companies.
Telephone switches were presently digital, computer-based systems. The largest switch OEMs included Northern Telecom, AT&T, Alcatel, GTE, BritishSR Corp: Decisions for an Emerging Technology

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CASE 11 SR Corp: Decisions for an Emerging Technology

Telecom, and Ericsson. This market brought in revenues of $2.5 billion in 1993.
SR Corp’s strategy in this market niche would
be to license its speech recognition system toswitch manufacturers who would bundle the technology into their switches. SR Corp would provide the integration of its technology undercontract into an OEM’s system and then receive aroyalty on units sold. Switch manufacturers
would most likely choose to manufacture thespeech recognition boards themselves. They
would also be wholly responsible for the selling of
their switches, including that portion containing
SR Corp’s technology. They would neither
demand nor expect exclusive rights to SR Corp’s
technology or that of any other vendor of speech
recognition technology.
The average advanced switch was priced at
approximately $100,000, and 45,000 units were soldin 1993 to telephone companies. Northern Telecom
had 24 percent of the global market, AT&T had 24
percent, GTE had 18 percent, Alcatel had 11 percent, and other switch OEMs held the remaining 23
percent. The current “action” in this market was thedevelopment of a new generation of switches basedon the asynchronous transfer mode (ATM) networking protocols—a method that allowed morereliable communications for data, voice, and video.
Speech recognition had been recently integrated
into advanced switches. Switches with voicebutton speech recognition accounted for 1993 revenues of $17 million, or less than one percent of themarket. Industry experts believed that the market
for speech enhanced switches would grow as accuracy levels increased and would represent $300
million in revenues by the year 2000. Many of theOEMs, such as AT&T and Northern Telecom, were
working on their own speaker-independent speech
recognition programs.
Switch OEMs always looked for new technologies that would add value to their systems. By
adding speech recognition, OEMs could spare telephone companies the cost of adding the technology
themselves later. Additionally, OEMs were in astrong position to help SR Corp disseminate its

technology because their systems were installed intelephone companies’ central offices. In fact, if SR
Corp decided not to work through the largest
switch manufacturers, the switches provided bythose OEMs could prove tough barriers to entry to
SR Corp’s own direct sales.
Through discussions with several switch manufacturers, Hastings concluded that SR Corp could
sell its technology at approximately $5,000 per lineof recognition and could gain at least three customers during the first two years. The price per line
was lower than that for direct sales to Fortune 500
firms ($6,000 per line) or telephone companies($10,000 per line). This lower price would be
required because the switch manufacturers would
do all the selling of the final solution to the telephone companies. Also, OEMs would perform theactual manufacturing of the boards containing SR
Corp’s technology. The speech recognition portionof their equipment would only represent a small
percentage (5 to 10 percent) of the overall final sale.
Based on his study of their sales volumes, Hastings
estimated that an individual switch manufacturer
would purchase 6,000 lines of speech recognition,
for a total of 18,000 lines if three OEMs became customers in the first two years. He believed that
OEMS, like the telephone companies, would pay 10
percent of the contract amount upon signing.
Here again, the best channel for reaching thismarket niche was to sell directly to the switch manufacturers. Switch OEMs had shown a strong tendency to purchase component technologies from
whatever firm had the best technology, be it a large
firm or small one. Once an OEM had completed a
new type of switch, contacts with component vendors were minimal.
Since SR Corp was seeking to be part of thedesign of a next-generation system, there would be
no significant switching cost for the OEM. SR Corp
would become part of a “new design.” Of course,
the OEM would have to retrain its own engineers sothat they would understand how to use SR Corp’s
development environment and support the system.
SR Corp would have to put a team of six
engineers with each switch manufacturer to help

695

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SR Corp: Decisions for an Emerging Technology

CASE 11 SR Corp: Decisions for an Emerging Technology

integrate its technology into the new switch. Dr.
Schall believed that the integration effort would
take approximately 10 months. An account manager would also be assigned to each customer togenerate additional revenue. Both field engineers
and account representatives would be based in afield office near the customer. Labor of $100,000
per person per year and office space costs of 250
square feet at $10 per square foot per person wereused for planning purposes.
Hastings reflected on this niche:
OEMs would be a solid way to move SR Corp’s technology on a mass scale, while also providing a solidreference base for future customers. In addition,
OEMs are always searching for emerging technologies
to enhance their offerings, and are willing to take earlytechnological risks if the payoff is there.
However, my concern is that SR Corp runs the riskof not being able to participate in either the way or
how fast an OEM decides to market the technology. In
addition, although OEMs have a basic working understanding of speech recognition, sales cycles in thisniche have been known to approach two years due tointegration and standards issues. Furthermore, we
may risk getting too close to some of our competitors,
such as AT&T, who hold large market shares in thisindustry and no doubt will do anything to protect
their positions—including lawsuits.

THREE RECENT EVENTS
Hastings finished his presentation of the three telephony niches by describing to SR Corp’s management team three highly relevant events that had
occurred during the last 24 hours.
The first event was a new industry report on thetelephone industry, the Telco Business Report
Hastings handed out copies of the report to his colleagues.6 It stated that “more than 70 percent of the
1,200 respondents—including RBOCs (regional
Bell operating companies), independents, and long

6 “Operator Services Slated as the Next Investment Boom for
Telcos.” Telco Business Report, PC-Plus Group, Munic, Germany,
Dec. 5, 1994.

687

distance companies worldwide—said they plan torenew or update their operator services in the next
two years with automation.” This report also indicated that telephone companies in the United States
wanted more technologically sophisticated software to improve and expedite delivery of regional
directory assistance services. Speech recognition
systems were a main interest. Technological change
in this niche was moving even faster than Hastings,
Dr. York, and or Dr. Schall had expected. This carried risks as well as opportunities. Once a telephone company invested in a new speech
recognition platform (even if it was an inferior system relative to what SR Corp had to offer), the company’s doors would probably be closed to newvendors for at least two or three years because of
the need to amortize such a large investment.
Would SR Corp risk losing these customers by
pursuing Fortune 500 firms or switch manufacturers? At the same time, could SR Corp afford not topursue other customers? Hastings knew that selling to a major telephone company might take morethan a year because a single speech recognition
application would include up to a dozen different
departments and each department head would
have to agree to contribute budget resources.
The second event was a telephone call from a
Fortune 500 airline executive, who had clearly stated that he would purchase SR Corp’s systems rightaway if the accuracy claims could be proven: “Wehave to handle 200,000 phone calls a day. If thisstuff really works, we could cut our operating costs
by a substantial amount.” Reminding his listeners
that the sales cycle for a Fortune 500 customer was
typically shorter than that for a telephone company,
Hastings pointed out that this executive was someone who could make things happen fast:
Fewer departments, and hence, decision makers
would be involved. An airline deal would probably besmaller than a Telco deal. But that’s okay because it
will be more manageable in terms of scale and scope.
I bet we could land the deal in six months. Further,once we did an airline, the other big ones would probably follow soon thereafter because the industry is so
price competitive. The big catch in all this is that, fromSR Corp: Decisions for an Emerging Technology

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CASE 11 SR Corp: Decisions for an Emerging Technology

what I have seen, their MIS departments know next tonothing about speech recognition technology.
Integration would be painful.

The third event had happened the night before.
Hastings had given a guest lecture to engineering
managers for a former business school professor. In
speaking about market strategies for emerging
technologies, Hastings had used his own firm as
one of the examples. After Hastings finished speaking, one of the students in the class introduced himself and indicated that he worked for a major
telecommunications equipment manufacturer. The
student’s company was designing a new asynchronous transfer mode switch. Due to customer
demand, all the large switch manufacturers weredeveloping state-of-the-art ATM switches. Major
telephone and cable companies needed to provide
improved commercial data services for businesses
and video on demand for home markets. ATM
switches seemed the most pragmatic, workable
solution to achieve this from a network perspective. The student had said, “If you’ve got what I
think you’ve got, we need to build it into our nextgeneration switch.” He wanted Hastings to visit his
company the following week.
Hastings concluded his remarks to SR Corp’s
management team by noting the obvious: eachmarket niche exhibited tremendous opportunity,
yet each held substantial risk. After listening to
Hastings’s report and hearing about the three latebreaking developments, the lead investor turned to
Dr. Schall and said:
Engineering better be telling us the truth. If our gun
isn’t loaded, we’re the ones who will end up getting
shot!

On a positive note, the investor reiterated that
he would provide additional funding once a single major customer showed clear signs of a successful outcome. Any delays in procurement or
systems integration would mean that SR Corp
would have to wait longer, not only to be paid by
the customer but also to get the investment it
needed to build a strong sales force. The investor
also needed to see a marketing plan that showed
the prioritization of the telephony niches and of
the key accounts within those niches. Turning to
Dr. York, he remarked:
It all boils down to making sure the technology, isbullet-proof and getting the right customer. You better hurry though. I wouldn’t be surprised if there isanother ‘Hastings’ working for a company just likeours trying to make the same decision for his own
firm’s breakthrough speech technology.

697

Kortec and Wrenware
Architectural Hardware

It was the spring of 1991. Tim McDern was justgetting in from his weekly tennis match. The
match, a victory, had provided a short but muchneeded break from the problem he was facing as
Director of International Sales of Kortec and Wrenware Architectural Hardware.
Kortec and Wrenware Architectural Hardware
were two separate and distinct companies in thearchitectural hardware business operating as a single division of a Fortune 100 company (The Lock
Company) in central Connecticut. Each company
operated separately, each with its own brandnames, product lines, and distribution channels.
Due to changes in the architectural hardware
industry, it was no longer a perceived benefit, nor
was it cost-effective, to support two separate brandnames.
Reorganizations of sorts had already takenplace to combine the separate support areas for thetwo brand names. Consideration was now focusedon creating a new brand name for the two companies. McDern’s assignment was to determine thealternate approaches The Lock Company could
follow in trying to come up with a new brand
name, with the positive and negative factors thatshould be considered with each approach (specifically, as they related to their international markets)
when it came time to actually decide on a new
brand name.
COMPANY BACKGROUND
Kortec and Wrenware Architectural Hardware bothmanufactured commercial locksets, exit devices,closers, and key systems. Each company wasstarted independently in the mid-1800s as a diver-30
CA S E 12

sified manufacturer of products that ranged fromlocks to furniture hardware to mailboxes. They
were strong competitors with each other in the areaof locks. Over time, both of their product lines
phased out the furniture hardware and mailboxes
and concentrated on commercial locks. The companies went on to expand their product lines toinclude exit devices and door closers.
As the companies continued to evolve separately, they developed their own unique productlines, distribution channels, and markets.
In the early 1900s, these two staunch competitors took a step that shocked the hardware industry. They decided to merge at the corporate level,
but they continued to run their operations separately, with separate product lines, distribution
channels, and markets.
In the 1930s and 1940s, the companies experienced some economic gains by using the samescrews in the manufacture of the two separate anddistinct locks sold by each of the divisions. This
marked the first significant step to further economies of scale by the two companies.
In the 1950s and 1960s, the synergy continued.
The companies began using the same components
in the manufacture of their locksets, with the
exception of the key systems. By this time, eachcompany was producing very similar lockset
designs, with the primary differences in the key
systems used. They also continued to maintainseparate brand names, distribution channels, geographic markets (international only), sales forces,
and management.
In the late 1960s, a Fortune 500 company acquired
both companies and began to operate them as a single division. At this time, the companies wereThis case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

689

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Kortec and Wrenware Architectural Hardware

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CASE 12 Kortec and Wrenware Architectural Hardware

brought under a single roof for the first time—an
800,000 square-foot facility. Because they now
shared the same physical location, the companies
were able to combine their manufacturing processes, engineering support, and new productdevelopment. However, they continued to maintain different brand names, sales organizations, distribution channels, and geographic markets.
In the late 1980s, the Fortune 500 corporation
was acquired by a Fortune 100 corporation (TheLock Company). It was at this time that senior
management decided to merge its sales and marketing organizations to support the two different
brand names. Due to various considerations, which
will be discussed in the next several sections, it was
felt to be no longer cost-effective, nor were there
any perceived benefits, to maintain separate sales
and marketing organizations.
Product Description
The product lines of Kortec and Wrenware had
evolved so that they were built with identical components except for the key system. The key systemis the part of the lockset that is referred to as thecylinder. The key system is the major element of the
product that keeps the two brands different. Once
set up, the key system controls who has accessthrough any particular lock in the system. This is
an important concept for two reasons:
1. When an order is received, it is very important to get
the precise specifications about the key systems
needed (how many and on which doors each system
will be installed). An example would be the security
needs of a hospital. Each key system in the hospitalmust be individually set up to provide or restrict
access to the locks in the system. In setting up a hospital’s key system, the purchaser (installer) of thesystem needs to know who should have access towhat rooms. The hospital would not want the janitor’s key to fit the narcotics room lock, yet the janitor
must have access to a number of other rooms formaintenance. Thus, it is very important to identify
up front precisely who needs access to what areas to
avoid future re-works for the installer and unforseen
breaches in security for the customer.

2. Because the key systems of Kortec and Wrenware aredesigned differently, purchasers must consider thesedifferences carefully before choosing the company
from which to purchase key systems. It is probable
that, in the lifetime of a key system, additions orchanges will be made to the system. Purchasers needassurances that they will be able to acquire locksets
compatible with their existing key systems when
they are needed.

MarketKortec and Wrenware’s products were primarily
sold for new commercial construction and for theaftermarket (i.e., for replacement on buildings suchas offices, schools, hospitals, and hotels). Both companies had sales in the U.S., Canada, and 65 countries overseas. Both companies had been sellingoverseas since the late 1800s and exerting a strongemphasis on international sales over the last 15–20
years. Each brand name had its regional strength.
Kortec’s strength was largely in North America andAsia while Wrenware’s strength was in Europe andthe Middle East.
Distribution Channels(Manufacturer
Distributor
End User). Distribution of the products for both Kortec and
Wrenware was primarily through small, privatelyowned family businesses, which would frequently
act as subcontractors on new and after-market projects. Distribution through this channel wasreferred to as one-step distribution because the product went to one middleman before going to the end
user. For the most part, these distributors supported either the Kortec or Wrenware name. Withina given city, there were as few as one or as many as
three distributors.
(Manufacturer Wholesaler Distributor
End User). Wholesalers were also used to someextent. This was referred to as two-step distribution.
The wholesalers in the architectural hardware
industry actually helped bring the two brand names
closer together. The distributors and end users

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Kortec and Wrenware Architectural Hardware

CASE 12 Kortec and Wrenware Architectural Hardware

gradually become aware that the Kortec and
Wrenware products were essentially the same. As aresult, the end user would frequently go to a distributor and ask for either brand. For example, if an
end user went to a Kortec distributor and asked fora Wrenware product, the distributor was forced toseek out a wholesaler to obtain the product because
the distributor was forbidden by agreement with
Kortec from going to Wrenware directly.
Distributors had historically been brand loyal,
but this had been changing over time. New competition was offering new alternatives. In addition,
senior management at The Lock Company nolonger saw any “perceived benefit” to having two
unique brand names in the marketplace because
the end users and people in the architectural hardware industry were aware of the product similarities and differences in the key systems. Experience
was showing that distributors were able to get bothproducts from wholesalers. It made sense to reduce
the total number of distributors. Therefore, senior
management reduced the number of distributors
from approximately 900 in the 1970s to approximately 400 in the late 1980s (200 for Kortec and 200
for Wrenware).
Support for Distribution
Operating two separate sales and marketingorganizations required The Lock Company tomaintain two separate channels of support for
their salespeople, literature (catalogues, pricebooks, and technical manuals), promotions (theyneeded two separate booths at trade shows andany promotional items ordered had to be brandspecific), and advertisements (the ads had to bebrand specific). Maintaining two separate channels had become very expensive, especially inlight of increased competition and the fact thatthe industry was becoming more and more awareof how similar Kortec and Wrenware products
were to each other. The economic benefits ofoperating these areas separately no longer
exceeded the economic costs. Senior managers at
The Lock Company decided that the company

691

would be in a better position by combining themonies spent on sales and marketing—they’d get
more bang for their buck.
PERCEIVED STRENGTHS AND
WEAKNESSES IN THE MARKETThe Lock Company perceived various strengths
and weaknesses in Kortec’s and Wrenware’s positions in the architectural hardware market. This
information would be relevant to any decision
made regarding changing the individual brandnames.
Strengths in the Market
Brand Awareness. Both Kortec’s and Wrenware’s
names were easily recognized by the domestic commercial hardware industry, which consisted of thearchitects who drew the building designs as well as
the end users. This was not the case in the international markets, where each company had a regionalpresence. In international markets, either the Kortec
or Wrenware name was known, but not both.
Market Coverage. Both Kortec and Wrenware
had domestic and international sales (North
America, Canada, and 65 countries overseas).
Full Line Product Strength. Both companies
carried a full assortment of products for commercial
doors consisting of locksets, key systems, closers,and exit devices. Because of this, buyers were able
to obtain everything they needed from either company (some competitors carried less than a fullproduct line).
Breadth of Product Line. Both Kortec’s andWrenware’s product lines consisted of locksets, key
systems, closers, and exit devices in a broad rangeof price and grade levels.
Regional Sales Office Presence in International
Markets. Between the two companies, the major
markets of the world were covered. The international offices were responsible for their own sales
and marketing efforts (i.e., they prepared their own

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CASE 12 Kortec and Wrenware Architectural Hardware

brochures). Thus, they were able to “think globally,
yet act locally.” The international offices were also
free to take what they could use from the homeoffice and either use it “as is” or enhance the design
to meet their own local needs. In addition, thebrochures were designed with an international flavor (e.g., they were written in the local language
and included such things as metric conversions).
Weaknesses
Reduction in Distribution Loyalty. Kortec and
Wrenware faced reduction in distributor loyalty
due to increased competition. Hardware products
were becoming more and more generic.
Reduced Visibility of Brand Names. Economic
constraints, combined with the need to split theadvertising and promotion dollars to cover two
separate brand names, tended to reduce the overall
visibility of each brand.
Delivery and Quality of Products. Delivery
and quality of products, especially in the international markets, had taken a downturn within thepast five years. As a result, competitors had picked
up some of their markets. Kortec and Wrenware
were in the process of addressing these issues
through new manufacturing processes; however,the benefits would not be felt immediately.
Promotional and Technical Support Materials
in Disrepair. Both Kortec and Wrenware were inneed of new promotional and technical support literature. However, due to the pending brand namedecision, managers did not want to develop newmaterials. A complete product catalogue alone
would cost each company $200,000 to develop,
design, print, and deliver for worldwide distribution. Managers decided to live with the existingmaterials for the time being.
New ‘92 Sales Brochures Needed. New brochures were needed for the upcoming year at a costof approximately $80,000 for each company.
Management was uncertain about whether or not
to combine them.

Expertise in Distribution. As stated earlier, it
is very important for vendors selling key systems
to get accurate key-system specifications with eachorder. In addition, there must be a thorough understanding of the application of the products. The
purchasers/architects must be careful to comply
with various fire codes, handicap codes, UL (Underwriters Laboratory) codes, as well as other laws.
Kortec’s and Wrenware’s distribution networks, now seen as a strength, could become aweakness due to the recent reduction in distributors around the world.
DECISIONS . . . DECISIONS. . .
Tim McDern settled back in his favorite recliner toponder his assignment. He needed to develop thealternative approaches The Lock Company should
consider when determining a new brand name. In
addition, he needed to determine the various positive and negative factors that should be considered(specifically, those related to their international
markets) when it came time to determine a new
brand name.
McDern took a sip of his Gatorade and thought
to himself: “In coming up with the various alternative approaches, there will be certain factors thatmay pertain to more than one alternative.” Hedecided to call these “generic factors.” He would
list other factors under each alternative approachseparately.
So, relying on his knowledge of Kortec’s andWrenware’s backgrounds and their perceived
strengths and weaknesses, McDern pulled out anotebook and began to write.
GENERIC FACTORSMcDern considered generic factors to be such basic
factors as language differences, possibility of brandpiracy, and local laws in the markets served by bothcompanies that would affect the new brand name,no matter what approach was followed.

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CASE 12 Kortec and Wrenware Architectural Hardware

693

Language

Brand Piracy

Because Kortec and Wrenware had sales in 65 foreign countries, marketing would take place in avariety of foreign languages. A number of questions had to be answered before a brand namecould be chosen. Would the brand name be easilytranslatable to the various languages? Could thebrand name be easily pronounced in all of the languages? (For example, if Wrenware were chosen as
the brand name, Asian customers would have difficulty pronouncing the name because of their trouble in pronouncing the ‘R’ and ‘W’ sounds of the
English language. Could or would this have aneffect on sales?) Would the brand name inadvertently insult a particular culture because of whatthat name might mean when translated to the language of that culture (or even standing on its own
untranslated)? McDern realized the need to be sensitive to the various cultures in which Kortec and
Wrenware operated.
In addition, two other factors that needed to beconsidered were the length of the name and theimage that the name would project. The Lock
Company would not want a name that was toolong to print when preparing written materials inmany different languages. The length might also
affect customers’ ability to remember the name,especially if a totally new brand name were chosen.
Additionally, depending upon the name chosen,certain negative images might be implied in one ormore of the various cultures in which the companies did business. An example would be a namethat might imply a weak company or a shoddy
product in any of the markets, depending upon
how the brand name was translated or interpreted.
Another example might be that the name chosen is
acceptable, but very similar to the name of anothercompany, in any of the markets that has a shoddy
reputation; The Lock Company would not want its
name inadvertently confused with or associatedwith the shoddy company or product.
Any one or more of these factors could adversely
affect The Lock Company’s market in the foreigncountries.

In selecting a brand name, laws of the various
countries regarding brand name piracy must be
considered. There are three general forms of piracy:
1. Imitation—A company may copy your establishedbrand name or logo.
2. Faking—A company may identify its product with asymbol or logo very similar to your establishedbrand/logo.
3. Pre-emption—A company may register your brandname in its country before you and then possibly try
to sell it back to you to make money.

Between them, Kortec and Wrenware were alreadyestablished in 65 foreign countries and did not haveany piracy problems with their current names.
Local Laws
The names currently used in foreign countries complied with the laws of those countries, but The Lock
Company needed to consider the various laws andprocedures to register its new brand name when
the time came. In addition, The Lock Company
needed to be cognizant of the fact that, if it were tochoose a new brand name, it would need to ensurethat the new name did not infringe upon any othercompanies already doing business in any of the foreign markets under that name.
Once McDern had finished listing his genericfactors, he turned his attention to some alternatives
The Lock Company should consider before determining a new brand name. He listed these, withvarious international factors, both positive andnegative, that should also be considered before
choosing the brand name.
ALTERNATIVE 1—LITERALLYDO NOTHING
The Lock Company could literally do nothing andcontinue to do business under the two separate
company names. McDern listed this alternative,
although he knew it would not be considered. The
Lock Company had already made the decision to704

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CASE 12 Kortec and Wrenware Architectural Hardware

combine the various parts of the company operations and look for a new brand name. As stated
before, there were no more economies of scale operating under separate names.
Still, it was an alternative in the event that no
new brand name could be agreed upon. A positive
factor in this case was the fact that the Kortec and
Wrenware names were already established overseas; on the negative side, The Lock Company
would need to maintain two separate sets of support materials (determined as not cost-effective).
ALTERNATIVE 2—KEEP SAME NAMESBUT DIFFERENTIATE THE PRODUCTS
McDern felt that under this alternative The Lock
Company could continue to operate the companies
under the same two separate names but somehow
differentiate the products. By differentiating the
products, The Lock Company might substantiate
the costs that would be necessary to support twobrand names.
The differentiation between the names could
come by way of product quality. For example, Kortec
might be marketed as a high quality, high costproduct while Wrenware could be the lesser quality, lower cost product.
An alternative differentiation could come by
way of product market. For example, Kortec might
be targeted toward the hotel and hospital market
while Wrenware would be targeted toward theschool and prison market.
A third alternative differentiation could be bygeographic market. For example, Kortec might be targeted at North America and Asia while Wrenware
might be targeted at Europe and the Middle East.
Their current regional strengths were alreadylocated in these markets.
Several positive and negative factors must be
considered in differentiating the products.
Product Quality
Negative. The two companies were in predominantly separate market concentrations overseas.

For example, it could potentially cost The Lock
Company a great deal of money to introduce the
Wrenware name to the Asian market, where it iscurrently not readily recognized.
Negative. The existing distributors of the
Wrenware product might become upset if theirproduct began to be marketed as one of lesser quality. This could affect future sales, as well as relationships with existing customers, to whom
distributors had previously marketed Wrenware asa high quality product. Thus, relationships with
distributors, as well as existing and future customers, could be affected.
Negative. The overlap in the markets might create confusion, both on the part of purchasers andthose providing the support and necessary technical expertise.
Positive. Differentiating by product quality, if
successful, would substantiate the need to continue
to support two brand names. It might also help
expand the market share of both lines. The Lock
Company may be able to pick up some of theircompetitors’ market share by marketing both ahigh quality product and one of lesser quality.
Product Market
Positive. Again, if successful, keeping the samenames but differentiating the products might cause
The Lock Company to focus on more specific typesof markets.
Negative. Again, this might have a negative
impact on distributors and existing customers.
Distributors with contacts in a particular industry(e.g., schools) might suddenly find their producttargeted toward hotels, which could affect theirsales. Existing customers might also be confused.
For example, if school customers needed additional locks that had originally been bought from
Kortec, they would be confused to find that
Wrenware was now being targeted toward theirschool—especially since the key systems from the705

Kortec and Wrenware Architectural Hardware

CASE 12 Kortec and Wrenware Architectural Hardware

two companies originally were not compatible.
McDern made a note that, if this option were to be
pursued, The Lock Company would need to becareful how it introduced and promoted the change.
Geographic Market
Positive. The products were already primarily
established and concentrated in different geographic markets. The Lock Company would notneed to worry about introducing a new brand
name. In a sense, the brand name may already be
widely recognized in the geographic markets, or it
may be the leading seller—no need, then, to interrupt this process.
Negative. This, in a sense, was The Lock
Company’s current situation, which it hoped tochange.
Product Quality and Market
Negative. The architects in the foreign countries
were not as familiar with the similarities between
the existing brands. This could have an adverse
effect on their recommendations if the companies
suddenly began to be targeted toward different
markets. The architects might be confused or unfamiliar with the specifications of the alternative
brand name.
ALTERNATIVE 3—COMBINETHE EXISTING NAMES
Under this alternative, the two company names
could be combined in a form such as “Kortec &Wrenware Architectural Hardware.”
Positive. This would enable The Lock Company to keep both names. Architects and end users
would then not be totally confused by the change.
They would still see a name they recognized.
Positive. It would result in fewer costs thanhaving to introduce a “new” or “different” brandname to the markets served.

695

Negative. The name of the company would
become very long. This is important when preparing written literature (catalogues, brochures, advertising—too long is not good). For example, the nameis put in every “environment” possible, such as letterheads, business cards, trade show booths, etc. A
longer name would make it more costly and difficult to prepare these materials. A longer namewould also be harder for customers to remember.
Negative. Confusion might be created in existing markets. For example, in Hong Kong the nameWrenware means nothing because the product iscurrently not distributed there.
Major Negative. In those countries where
both products were offered, and given the fact that(a) the distribution channels were recently
reduced to approximately 200 for each brandname and (b) most distributors were selling either
one or the other brand name, The Lock Company
is now conceivably going to ask distributors to sella product that they had considered to be a competitive brand name. These distributors, for example, may have promoted Kortec while criticizing
Wrenware because they carried only the Kortec
product. The previous separate sales forces sellingto the distributors had also promoted in this manner. Now they will be asked to sell a product that
includes a name they may have previously “badmouthed.” This could have an adverse effect on
the distributors’ existing relationships with theircustomers.
Negative. The existing names may have meant
something special to the architects. The Lock
Company wouldn’t want to lose their association
with the existing brand name.
ALTERNATIVE 4—USE EITHERONE NAME OR THE OTHER
Positive. Consideration should be given to language, culture, and local brand name laws, as previously discussed. In light of these considerations,
The Lock Company would want to choose the706

Kortec and Wrenware Architectural Hardware

696

CASE 12 Kortec and Wrenware Architectural Hardware

name that gave off the stronger image (e.g., Kortec
sounds like a stronger company) or be more easily
pronounced, (e.g., Kortec may be more easily pronounced, depending on the culture).
Positive. A distribution system is alreadyestablished in those countries served by the company that would lose its name. Additional work in
the form of well-prepared advertising, support,
and promotional materials could help overcome
the recognition problem faster than if The Lock
Company attempted to go in without an established distribution channel and support materials.
Negative. Using one name only, The Lock
Company runs the risk of loss of name recognitionin the countries served by the company that would
lose its name. Additional costs of introduction andpromotion would also result. There is a risk of losing sales in these areas, at least until name recognition for the new name is established.
ALTERNATIVE 5—NEW NAME
Alternative 5 would involve coming out with anentirely new brand name.
Positive. The opportunity would exist here fora clever, descriptive brand name and/or trademark
or logo. The name chosen might enable The Lock
Company to tie the brand name more closely to the
product it is offering.
Positive. A new name would enable The Lock
Company to update its technical manuals, etc., thatwere in a state of disrepair. In addition, it would
offer The Lock Company the opportunity todevelop new and better materials.
Positive. The Lock Company could also continue to sub-label whatever brand name was chosen with “A Fortune 100 Company: The Lock
Company,” to help maintain the customers’ identification with its products. This might help alleviate
some anxieties arising from a brand name change.
Positive. Given that various cultural factors
are taken into consideration in arriving at a newname, it will be very important how The Lock
Company then uses and effectively markets thatname in the future. For example, “Coke” doesn’tmean anything by itself as a word, but it has beenso effectively marketed that it has become synonymous with the soft drink.
Negative. A new name would require The
Lock Company to scrap its existing support materials that contained the old name and develop newmaterials. This would be more expensive up front.
Using any one of the other alternatives would haveenabled the company to use its existing materials
for a while longer.
Negative. Finding a new name would most
likely require hiring an expert consultant. The consultant would be responsible for determining if thename was already being used, whether it infringed
upon existing trademarks or logos, and the impact
the new name would have in existing foreign markets with respect to language, culture, and existing
local laws, etc.
McDern looked up at the clock as it struck 1 A.M.
Before he retired for the night, he reflected on what
he had been doing.
In preparing the alternative courses of actionthat The Lock Company would consider when
determining a new brand name for its international markets, he found there was much more torenaming a company than simply coming up witha new name and figuring the associated costs. For
instance, the language, culture, and laws of each
foreign market had to be considered. Nor could
established relationships with distributors andcustomers be neglected. All in all, there weremany associated issues to consider, not just aname change. Arriving at a new brand namewould require expert consultants, brand awareness studies (both nationally and internationally),
studies on the distribution networks used by both
Kortec and Wrenware, and a significant amountof related analysis. The Lock Company would
need hard facts to back up any decision it would
make.

707

Kortec and Wrenware Architectural Hardware

CASE 12 Kortec and Wrenware Architectural Hardware

This was not a short-term but a long-term decision that would affect the long-term positioning of
the company. Key strategic decisions would need
to be made in order to position The Lock Company

697

to capture a worldwide market share. These decisions should only be made after considering thevarious international implications and factors.

C A S E 1 3 Sony Corporation:
Car Navigation Systems

In April 1996, Masao Morita, president of theSony Personal and Mobile Communication
Company, a division of the Sony Corporation, pondered how to recover Sony’s initial leadership in
car navigation systems in Japan. As the first company to launch a reasonably priced (around $2,000)
after-market model in 1993, Sony could claim tohave created the world’s largest car navigation systems market in Japan. Since the late 1980s, Sony led
a group of 40 companies in establishing an industry standard (called NaviKen) which enabled consumers to benefit from mutually compatible digital
map software while manufacturers reduced theirrisk by sharing development costs. Sony’s efforts
grew the Japanese market from 58,000 units in 1992
to 160,000 in 1993. Sony held a 60 percent market
share in 1993. Exhibit 1 reports unit sales of car
navigation systems in Japan through 1995 and forecasts from 1996 through 2005.
Market growth fueled intense competition in
Japan, leading to many new product launches andlower prices. The average retail price per unit
decreased from $4,000 in 1990 to $2,500 in 1995.1
Ironically, competitors not in the NaviKen groupwere able to introduce new and improved products
more often and more rapidly by developing or
acquiring proprietary digital map technologies.
Increasingly sophisticated consumers sought out
differentiated products with the latest features. In
contrast, NaviKen member companies, including

1 $2,500 was the retail price with a monitor. A system retailed
at around $1,500 in 1995 if a monitor was sold separately as
shown in Exhibit 1.

31Sony, lost time while trying to agree on standard
software upgrades. Sony’s unit sales increased, but
at a slower growth rate than the market; Sony’s
market share fell from 60 percent in 1993 to 23 percent in 1994 and 17 percent in 1995, and was estimated to drop to 15 percent in 1996. Exhibit 2
summarized the major competitors’ market shares.
Exhibit 3 compares sales performance of NaviKenand non-NaviKen companies.
In Europe and the United States, Sony was also
the first to launch car navigation systems in theautomobile after-market. Fewer than 1,000 units
sold in test markets to gather information in eachregion by the summer of 1996. In Europe, local
manufacturers, such as Philips and Bosch, started
to market competing products aggressively. OtherJapanese competitors, such as Alpine, Matsushita,
and Pioneer were expected to enter Europe and theUnited States by 1997. Exhibit 4 summarizes market forecasts for car navigation systems by geographic region.
SONY CORPORATION:
COMPANY BACKGROUNDThe Sony Corporation was founded in 1946 in theremains of a bombed department store as theTokyo Tsushin Kogyo (Tokyo Telecommunications
Engineering) by Akio Morita (Masao’s father), andMasaru lbuka. As a young company, Sony did nothave a keiretsu of affiliated companies and lacked
the strong domestic sales base and the distribution
networks that supported the other companies.
With only $500 in capital, the founders realized
they would have to differentiate themselves from

Copyright ©1996 by the President and Fellows of Harvard College Harvard Business School Case 9-597-022, Rev. 4/14/98.
Doctoral Candidate Yoshinori Fujikawa prepared this case under the supervision of Professor John A. Quelch as the basis for classdiscussion rather than to illustrate either effective or ineffective handling of an administrative situation. Reprinted by permissionof the Harvard Business School.

698

709

710

ActualEntire Market<1> Unit Sales
Growth Rate Year-on-Year (%)<2> Retail Sales (¥ millions)
Growth Rate Year-on-Year (%)

Estimate

Forecast

1990

1991

1992

1993

1994

1995

1996E

1997E

1998E

1999E

2000E

2005E

16,40027,600168%

57,800209%

160,400
278%

343,500
214%

578,500
168%

850,000 1,200,000 1,500,000 1,800,000 2,000,000 2,800,000
147%
141%
125%
120%
111%
107%

6,430

10,290160%

15,470150%

25,020162%

51,530206%

83,880163%

114,080136%

150,000
131%

170,000
113%

190,000
112%

200,000
105%

230,000
103%<3> Retail Price/Unit (¥)

392,073

372,826 267,647

155,985

150,015

144,996

134,212125,000

113,333

105,556

100,000

82,143<4> % Penetrationof New Cars

0.27%

0.46%

0.96%

2.67%

5.73%

9.64%

14.17%

20.00%

25.00%

30.00%

33.33%

46.67%<5> Cumulative Numberof Car Navigation System
Installed

16,40044,000 101,800

262,200

605,700 1,167,800 1,990,200 3,132,400 4,472,000 5,928,500 7,350,000 2,385,000<6> % Penetration of
All Cars

0.03%

0.07%

0.17%

0.44%

1.01%

1.95%

3.32%

5.22%

7.45%

9.88%

12.25%

39,000139,016

297,900

462,500

550,000

700,000

800,000

850,000

900,000 1,100,000

356%

214%

155%

119%

127%

114%

106%

106%

104%

67%

87%

87%

80%

65%

58%

53%

47%

45%

39%

18,80021,35045,600116,000

300,000

500,000

700,000

114%

214%

254%

259%

167%

140%

136%

116%

109%

13%

13%

20%

35%

42%

47%

53%

55%

61%

Growth Rate Year-on-Year (%)% of Entire Market (%)
OEM MARKET<8> Unit Sales
Growth Rate Year-on-Year (%)% of Entire Market (%)
Notes:

Source:33%

20.64%

950,000 1,100,000 1,700,000<1> Manufacturer unit sales.
<2> Retail sales level does not include monitors, adapters, software, sold separately from the navigation systems.
<3> = <2>/<1><4> Assuming that annual new car sales in Japan were approximately 6 million (i.e., <4>=<1>/6 million).
<5> Assuming that the car navigation system will be renewed every five years (i.e., 1992 figure=90-92 total, 1997 figure = 93.97 total, etc.).
<6> Assuming that there were approximately 60 million cars in Japan (i.e., <6>=<5>/60 million).
1990–1995 figures are actuals drawn from Yano Keizai Kenyusho, 1996 Car Navigation Systems: Market Forecast and Corporate Strategy(Tokyo, Japan).
1996–2005 figures are forecasts of the case writers, based on research interviews.

CASE 13 Sony Corporation: Car Navigation Systems

AFTER MARKET<7> Unit Sales

Sony Corporation: Car Navigation System

EXHIBIT 1
Market Development and Forecasts in Japan

699

700

EXHIBIT 2
Major Competitor’s Unit Sales and Market Shares in Japan: 1994–1996E
Unit Sales, Total Market (% market shares)
1996E

Three Years

1996E Unit Sales(% sales composition)

After-Market OEM

After-Market

OEM

(24%)
(23%)
(15%)
(10%)
(1%)
(6%)
(0%)
(5%)
(5%)
(2%)
(2%)
(1%)
(3%)
(1%)
(0%)
(0%)
(0%)
(0%)
(0%)
(0%)
(0%)

#####
98,00090,00087,00030,00027,00024,00024,00020,00015,00011,00010,500
7,800
6,000
6,000
2,800
2,000
2,000
1,500
1,200
700

(19%)
(17%)
(15%)
(15%)
(5%)
(5%)
(4%)
(4%)
(3%)
(3%)
(2%)
(2%)
(1%)
(1%)
(1%)
(0%)
(0%)
(0%)
(0%)
(0%)
(0%)

157,000
124,000
149,000
127,000
41,00038,00045,00039,00037,00026,00013,00011,00010,000
8,000
8,000
4,000
3,000
2,000
1,000
2,000
—

(19%)
(15%)
(18%)
(15%)
(5%)
(4%)
(5%)
(5%)
(4%)
(3%)
(2%)
(1%)
(1%)
(1%)
(1%)
(0%)
(0%)
(0%)
(0%)
(0%)
(0%)

351,000
302,000
289,000
250,000
74,60084,00069,00080,00075,00047,50031,00026,50029,70017,50014,000
7,300
6,500
4,000
3,200
3,500
700

(20%)
(17%)
(16%)
(14%)
(4%)
(5%)
(4%)
(5%)
(4%)
(3%)
(2%)
(1%)
(2%)
(1%)
(1%)
(0%)
(0%)
(0%)
(0%)
(0%)
(0%)

(21%)
(19%)
(18%)
(11%)
(4%)
(6%)
(1%)
(5%)
(6%)
(1%)
(2%)
(2%)
(1%)
(1%)
(1%)
(1%)
(0%)
(0%)
(0%)
(0%)
(0%)

17,0003,000
30,00057,00016,000—36,0007,000—
22,000
—
—
3,000
—
—
—
—
—
—
—
—

(9%)
(2%)
(16%)
(30%)
(8%)
(0%)
(19%)
(4%)
(0%)
(12%)
(0%)
(0%)
(2%)
(0%)
(0%)
(0%)
(0%)
(0%)
(0%)
(0%)
(0%)

89%
98%
80%
55%
61%
100%
20%
82%
100%
15%
100%
100%
70%
100%
100%
100%
100%
100%
100%
100%
—

11%
2%
20%
45%
39%
0%
80%
18%
0%
85%
0%
0%
30%
0%
0%
0%
0%
0%
0%
0%
—

Total

(100%)#####(100%)#####(100%)#####(100%)(155%)#####(100%)

77%

23%

Source: Adapted from Yano Keizai Kanigusho, op. Cl.

Sony Corporation: Car Navigation System

PioneerSony
Matsushita
AlpineMitsubishi
Kenwood
ZanaviClarionFujitsus Ten
Nippon Denso
Sharp
Casio
Sumitomo Denko
ToshibaCitizen
Caisonic
NEC
Chuo Jidosha
MasproSanyo
Nakamichi

CASE 13 Sony Corporation: Car Navigation Systems

1995

1996E Unit Sales(% market shares)

711

712

Sony Corporation: Car Navigation System

CASE 13 Sony Corporation: Car Navigation Systems

701

EXHIBIT 3
Sales Comparison: NaviKen Group vs. Non-NaviKen Groups: 1994–1996E
Companies

NaviKen Format
Group

Proprietary Format(Can Read NaviKen)a

Proprietary Format(Cannot Read NaviKen)aSony
Mitshubishi
Zanavi
Sharp
Casio
ToshibaCitizenCalsonic
NEC
Chuo Jidosha
MasproSanyo

Matsushita
AlpineKenwood
Fujitsu

Pioneer
ClarionNippon Denso
Sumitomo Danko
Nakamichi

Proprietary Format(Can Read NaviKen)a

Proprietary Format(Cannot Read NaviKen)a123,000
216,000
361,000

117,400
162,500
222,000Group
NaviKen Format
Unit Sales (% share) Group
1994
1995
1996E

103,100
200,000
262,000

1996E Group
Unit Sales(% Composition)

NaviKen Format
Group

After-market
OEM

246,000
70,000

(30%)
(35%)
(31%)

(78%)
(22%)

(36%)
(37%)
(43%)

(34%)
(28%)
(26%)

Proprietary Format(Can Read NaviKen)a

Proprietary Format(Cannot Read NaviKen)a225,000
82,000173,000
49,000

(73%)
(27%)

(78%)
(22%)

Note:

The second group’s car navigation systems can read both proprietary and NaviKen software, while the first group’s systems can only read NaviKen CD-ROMS. The third group’s systems can only read their respective original software.
Source: Calculation of the case writers, based on the figures in Exhibit 2.

their larger competitors by developing more innovative products. From the failure of their first new
product—a tape recorder that customers deemed
expensive and flimsy—they learned the importanceof paying close attention to consumer needs.
Throughout its history, Sony pursued the innovationof commercially appealing products, maintaining alarge research organization and vesting unusual
decision-making authority in its engineers. The company’s first breakthrough occurred after lbuka
acquired a patent license for transistors. Morita andlbuka began mass production of transistor radios in

1954, and dubbed their new product Sony, after
sonus, the Latin word for sound. Soon thereafter, thepair renamed the company.
Internationally, as well as in Japan, Sony wasoften first to market with technological innovations that set industry standards. In 1968, Sony’s
sophisticated Trinitron technology expanded thecolor television market. In 1979, it launched thelegendary Walkman, a lightweight portable tapeplayer with headphones. In the mid 1980s, Sonydeveloped a compact size camcorder video camera. Such innovations turned Sony into a leader in

702

EXHIBIT 4
1998E

Forecast
1999E

2000E

2005E

Japan
<1>After Market (Unit)<2>OEM Market (Unit)<3>Entire Market (Unit)<4>Entire Market (Retail % mil)
<5>Entire Market (Retail $ mil)
<6>Retail Price / Unit ($)<7>% Penetration of New Cars
<8>Cumulative Number of Installed Units<9>% Penetration of All Cars

550,000
300,000
850,000¥114,080$1,141$1,342
14.17%
1,990,200
3.32%

700,000
500,000
1,200,000¥150,000$1,500$1,25020.00%
3,132,400
5.22%

800,000
700,000
1.500,000¥170,000$1,700$1,13325.00%
4,472,000
7.45%

850,000
950,000
1,800,000¥190,000$1,900$1,05830.00%
5,928,500
9.88%

900,000
1,100,000
2,000,000¥200,000$2,000$1,00033.33%
7,350,000
12.25%

1,100,000
1,700,000
2,800,000¥230,000$2,300$821
48.67%
12,385,000
20.64%

Europea<1>After Market (Unit)<2>OEM Market (Unit)<3>Entire Market (Unit)<4>Entire Market (Retail % mil)
<5>Entire Market (Retail $ mil)
<6>Retail Price/Unit ($)<7>% Penetration of New Cars
<8>Cumulative Number of Installed Units<9>% Penetration of All Cars

10,00020,00030,000—$60$2,0000.33%
30,0000.02%

50,00050,000100,000—$170$1,7001.11%
130,000
0.10%

100,000
100,000
200,000—$300$1,5002.22%
330,000
0.25%

200,000
150,000
350,000—$455$1,3003.89%
680,000
0.52%

400,000
200,000
600,000—$600$1,0006.67%
1,280,000
0.98%

900,000
900,000
1,800,000—$1,440$800
20,00%
3,752,000
2.89%

US<1>After Market (Unit)<2>OEM Market (Unit)<3>Entire Market (Unit)<4>Entire Market (Retail % mil)
<5>Entire Market (Retail $ mil)
<6>Retail Price / Unit ($)<7>% Penetration of New Cars
<8>Cumulative Number of Installed Units<9>% Penetration of All Cars

10,00010,00020,000—$34$1,7000.13%
20,0000.01%

50,00050,000100,000—$150$1,5000.67%
120,000
0.06%

100,000
100,000
200,000—$260$1,3001.33%
320,000
0.16%

250,000
300,000
550,000—$550$1,0003.67%
870,000
0.44%

400,000
500,000
900000
—
$720
$800
6.00%
1,770,000
0.89%

1,000,000
1,400,000
2,400,000—$1,200$500
16.00%
4,720,000
2.36%

TOTAL (Japan, Europe, US)<1>After Market (Unit)<2>OEM Market (Unit)<3>Entire Market (Unit)<4>Entire Market (Retail % mil)
<5>Entire Market (Retail $ mil)
<6>Retail Price / Unit ($)

570,000
330,000
900,00—$1,235$1,372800,000
600,000
1,400,000—$1,820$1,3001,000,000
900,000
1,900,000—$2,260$1,1891,300,000
1,400,000
2,700,000—$2,905$1,0761,700,000
1,800,000
3,500,000—$3,320$949

3,000,000
4,000,000
7,000,000—$4,940$706Sony Corporation: Car Navigation System

1997E

CASE 13 Sony Corporation: Car Navigation Systems

Estimate
1996E

713

714

Forecast Global Car Navigation
Navigation Systems Market (Units)

7,000,000

Sony Corporation: Car Navigation System

EXHIBIT 4(continued)

Forecast Global Car Navigation
Navigation Systems Market (Retail $MM)

$5,000$4,5006,000,000$4,0005,000,000

US4,000,000

Europe3,000,000

Japan

US

$3,500$3,000Europe$2,500Japan$2,000$1,5002,000,000$1,0001,000,000

$500

2005

2000

1999

1998

1997

1996

1995

2005

2000

1999

1998

1997

1996

1995

1994

a Europe figures include France, Germany, Italy, and United Kingdom.
<1>, <2>, <3> Manufacturer unit sales.
<3> = <1> + <2>.
<4> The figures are for the value of retail sales.
<5> Assuming an exchange rate = ¥100/$1 from 1996 throughout the year 2005.
<6> = <5>/<3>.
<7> Assuming that annual new car sales in Japan, Europe and the United States were approximately 6 million, 9 million, and 15 million,
respectively (i.e., <7> = <3>/6 million.
<8> Assuming that the car navigation system will be renewed every five years (i.e., 1992 figure = 1990 – 1992 total, 200 figures = 1996 – 2000
total etc.)<9> Assuming that there were approximately 60 million cars in Japan, 130 million in Europe, and 200 million in the United States (i.e., <9> =<8>/60 million.
Source: Forecasts of the case writers, based on research interviews.

CASE 13 Sony Corporation: Car Navigation Systems

Notes:

1994

$0

0

703

Sony Corporation: Car Navigation System

704

CASE 13 Sony Corporation: Car Navigation Systems

consumer electronics with FY 1995 worldwide
sales over $43 billion.
Sony’s only significant failure came in the early
1980s, when its Betamax format VCR lost out toVHS. Sony developed the video cassette recorder as
early as 1975, but motion picture studios protested
that the new machine would encourage widespread copyright infringement of movies and television programs. Discussions of this matter gaveSony’s competitors such as Matsushita and JVCtime to develop a different VCR format, VHS,which permitted an additional three hours of playing time and was incompatible with Sony’s
Betamax. Although Betamax was generally considered technically superior, VHS soon became theindustry standard, and Sony lost its early lead in
the lucrative VCR market.
The Betamax VCR experience in the early 1980s
convinced Sony that technological innovation alone
could not insure market dominance, and that thematch between hardware and software was critical.
Subsequently, Sony began to cooperate more withcompetitors to develop industry standards. In the
1980s, for example, Sony joined the Dutch electronic
firm Philips to pioneer compact disc (CD) technology.
In the mid 1990s, Sony Corporation reorganized
to keep the company market-driven and increaseautonomy. Sony organized its businesses into 10
divisions, including Display, Home AV, Information
Technology, Personal AV, Personal & Mobile
Communications, Broadcast Products, Image &Sound Communication, Semiconductors, Components & Computer Peripherals, and Recording
Media & Energy. To develop future top managers,
Sony appointed promising young executives aspresidents of each company with substantial autonomy. Masao Morita was appointed president of the
Personal & Mobile Communication Company.
CAR NAVIGATION SYSTEMS
Evolving Products
A car navigation system plotted a driver’s current
location on a dashboard-mounted LCD monitor by

calculating signals received from satellites and/or
utilizing a dead reckoning system fed by speed
and gyro sensors. The system also told the driverthe best way to his or her destination by employing a digital map database stored on either a CDROM, a computer hard disk, or an IC-card. Unlike
VCRs and personal computers, car navigation systems hardware and software were not standardized as of 1995, but a typical model consisted of
hardware such as a satellite signal receiver, a CDROM player, an LCD monitor mounted on/in a car
dashboard, and digital map software in the form ofa CD-ROM. Exhibit 5 summarizes the cost andmargin structure of the system.
In the late 1980s, the earliest car navigation systems could only report where a driver was, his/her
desired destination, and whether or not the car washeaded in the right direction. By the mid 1990s,
however, the systems had become more intelligent.
Recent models could inform a driver of his/hercurrent location at all times and deduce the bestroute to a destination automatically by taking into
account current traffic conditions. Some systems
could even communicate verbally with the driverand provide turn-by-turn instructions on the LCD
map or through voice.
Enabling Hardware
Car navigation systems were facilitated by the
Global Positioning Satellite (GPS) system, a constellation of 24 satellites operated by the U.S.
Department of Defense. CPS was originally developed at a cost of $10 billion for military applications during the Cold War, but became available forcivilian use at no charge in the late 1980s.
The central concept behind GPS was triangulation. If a car’s exact distance from a satellite was
known, the car’s location had to lie somewhere on
the sphere defined by that radius. If the driver’s
distance from a second satellite was also known,
the car’s position had to be along the circumference of the circle where the two spheres intersected. Knowing the distance from a third satellite
would result in two points where all three spheres

715

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Sony Corporation: Car Navigation System

CASE 13 Sony Corporation: Car Navigation Systems

EXHIBIT 5
Typical Cost and Margin Structure of
Car Navigation Systems
a. Typical Cost and Margin Structure for Car
Navigation Systems:
Retail Price
Less Dealer Margin
Manufacturer selling priceLess Manufacturer Margin
Manufacturer Total Cost
Indirect Cost (SGA)
Direct Cost
(LCD Monitor(CD-ROM Player(CPU(GPS Receiver(Other Components

100%
35%
65%
5%
60%
10%
50%
30%)
8%)
7%)
3%)
2%)

b. Japanese Model (e.g., Sony NVX-F16):
Retail selling priceLess Dealer margina
Manufacturer selling priceLess Manufacturer total costs
Manufacturer margin$2,000$700$1,300$1,200$100

c. Overseas Model (e.g., Sony NVX-F-160):
Overseas retail selling priceLess Overseas dealer margina
Manufacturer selling priceLess Manufacturer total costsb
Manufacturer margin$3,000$1,000$2,000$1,800$200

Notes:a Dealer charged separate fee for product installation.
Japanese dealers charged around $200. US andEuropean dealers charged around $30
b Manufacturer total costs of overseas model included
applicable transportation costs and import duties.
Source: Estimation of the case writers, based on researchinterviews.

intersected. GPS in fact used four signals from four
different satellites to locate the position of theantenna.
Triangulation on GPS could result in accuracy as
close as thirty meters. Worrying that GPS could be
used by an enemy to guide missiles or smart bombs,
Department of Defense engineers intentionally built

705

errors into the system for civilian use. The civilian
signal could deliver 95 percent accuracy within 100
meters of the actual location. The GPS signal could
also be blocked by tall buildings, trees, or overpasses, a common problem in large cities.
In order to improve the precision in identifying
the car’s location on the earth, the car navigation
systems were equipped with a few supporting
technologies. When GPS did not function accurately, a back-up dead-reckoning system of speed
and gyro sensors typically installed in the car trunk
could take over seamlessly and relay the car’s
speed and direction to the navigation system.
Aided by the dead-reckoning system, map matching technologies enabled the car navigation system
to pinpoint the car’s position on the digital map.
In car navigation hardware, there was no dominant product standard. Some products utilized
both GPS signals and dead-reckoning systems, butothers employed only one of the two. Productinterfaces were also diverse. Some displayed a colorful digital map on an LCD monitor. On a typical
LCD screen, a small red circle sign, representing thecar, moved along a highlighted street leading thedriver to his/her desired destination. Some othermodels’ monitors showed only right or left arrowsigns and the street name to signal the next appropriate turn. Others did not have display devices but
provided directions verbally.
Diverse Software Formats
The software database technology used in car navigation systems was the offspring of GIS, or
Geographic Information Systems. GIS was originally developed by the U.S. Department of Defense for
guiding missiles. In essence, GIS software turned aconventional map into a digital database.
For accurate navigation, a digital map had tocontain correct details of every street. Every sign,
every painted line, every relevant piece of information along the road had to be included. For example, the database had to note whether there was aconcrete divider along a highway, whether two
streets intersect or one was on an overpass, and soSony Corporation: Car Navigation System

706

CASE 13 Sony Corporation: Car Navigation Systems

forth. Consequently, each street corner required
three to four dozen items of data.
As many data layers as desired could be added
to the digitized map. Postal zip codes and phone
numbers could be stored in the database so that adriver could find a destination by entering an
address and/or phone number. Information on“points of interest,” such as banks, restaurants andgas stations, could also be digitized on the map.
One could analyze these data in hundreds of different ways and, in conjunction with a GPS receiver, could interact with the data on a real time basis.
In real life, for instance, a stranger was not likely toknow the ATM closest to any given spot. However,with a points of interest database, a car navigation
system could sort through ATMs by distance, findthe nearest one operated by the driver’s preferredbank, and provide route guidance to this ATM.
Collecting and digitizing all the road-related
information and the point of interest data werelabor intensive. Government geological surveys
and commercially published maps were often old
and inaccurate. Hence, digital map companies had
to send out research teams to take aerial andground photos to fill in gaps and update the oldinformation. Collecting, and digitizing the necessary information on the city of Boston, for example,
required 20 engineers to work for one year. Given
continuous change due to road construction andstore openings and closings, digital map companies
had to retain local staff to update the data.
The cost of digitizing the cartography of theUnited States was estimated at $1 billion with anadditional $100 million a year for updating. A single company starting this task in 1995 could notachieve payback before 2005. There were two
major digital map companies in the U.S. competing independently. As of early 1996, Etak, a Silicon
Valley division of Rupert Murdoch’s News
Corporation, had covered cities representing 80
percent of the U.S. population. NavTech, another
Silicon Valley startup, had covered 90 percent of
the U.S. population.
There were three digital map companies working in Europe. Etak focused its European operationon the United Kingdom and had so far covered
cities accounting for 80 percent of the population.
EGT, NavTech’s European subsidiary, covered 80
percent of Germany and 70 percent of France. A
third company, TeleAtlas, was digitizing Italianmaps. These companies had developed independently non-compatible digital map software.
In Japan, 40 companies, including car companies, electronic firms, and digital map developers,
formed the Japan Navigation Research Association,
known as NaviKen, in the early 1980s, and completed 100 percent digitization of the entire country
by 1988. The NaviKen format was consistently
applied in the navigation systems produced by the
NaviKen member companies such as Sony and
Mitsubishi. However, other incompatible formats
had been developed independently by Pioneer andMatsushita respectively, which did not join
NaviKen. Exhibit 6 compares the number of CDROMs available for different competitors’ car navigation systems.
The data storage media also varied. Some
devices used the digital map stored on a CDROM, while others used maps stored on computer
hard disk or IC card. CD-ROM based navigation
systems were popular in Japan and Europe, but
hard disk and IC card were believed equallyacceptable in the United States, especially for
low-end products.
Distribution Channels
Car navigation systems could be sold either on an
OEM basis or through after-market retail channels. Exhibit 7 summarizes the distribution alternatives.
In the OEM channel, car navigation system producers contracted with car assemblers to supply
car navigation systems to the automaker’s specifications. The systems were either pre-installed by
the car manufacturers or installed later by dealers
as a purchase option on new cars.
After-market models were usually designed
and marketed by car navigation system makers
and distributed through wholesalers to auto parts

717

718

Company
Software Format

Sony

AlpineMalsushita

Pioneer

NaviKen

Proprietary & NaviKena

Proprietary & NaviKena

Proprietary

General Road Maps
Sports (golf, ski, camping, etc.)
Travel (hotels, parks, etc.)
Shops/Restaurants
Radar Detection
Games/Quizzes
Karaoke

5
6
4
1
0
4
0

7
6
4
1
0
4
0

(2)
(0)
(0)
(0)
(0)
(0)
(0)

6
6
4
1
0
4
0

(1)
(0)
(0)
(0)
(0)
(0)
(0)

2
3
1
1
1
6
56

TOTAL

20

22

(2)

21

(1)

70

Note:

a

Sony Corporation: Car Navigation System

EXHIBIT 6
Number of CD-ROMs by Car Navigation System Producer: 1995

Numbers include both original and NaviKen CD-ROMs since Alphine and Matsushita’s systems can read NaviKen software.

Numbers in parentheses are proprietary CD-ROMs developed by Alpine and Matsushita.
Source: Adapted from various product catalogues.

Car
Manufacturers

Installed in car
as original equipment

Car
Dealers

OEM
ChannelInstalled in car
as purchase option

Car Navigation
Systems
Manufacturers

Parts and Accessories
Wholesalers

Auto
Shops

Installed in car
as “add on”

Consumers
Large
Electronic Sold to consumers
Retailers with or without installation

Electronic
Wholesalers

Small
Sold to consumers
Electronic
with or without installation
Retailers

After
MarketChannelCASE 13 Sony Corporation: Car Navigation Systems

EXHIBIT 7
Channels for Car Navigation System

707

Sony Corporation: Car Navigation System

708

CASE 13 Sony Corporation: Car Navigation Systems

retailers and electronics outlets. Sales to end consumers were either made on a cash and carry basis
or involved dealer installation and other after sales
services.
All components of OEM models, including LCD
monitors, were neatly installed together withaudio equipment such as radio, cassette, and CD
players in the car dashboard. In contrast, aftermarket systems usually had to be installed as “addons” to the dashboard. Volume contracts with the
car manufacturers meant that Japanese OEM products were technically one to two years behind andmore expensive than after-market models.
In the Japanese market, 80 percent of the systems were sold through after-market channels
while 20 percent were sold on an OEM basis.
However, as the technological innovation diffused
and products became more standardized, the percentages were forecast to be even by 2000 and to
be reversed by 2005. The fledgling European markets mainly involved OEM sales in 1995, but the
proportion of after-market sales was expected toincrease. The U.S. market was still undeveloped,
but OEM models were expected to exceed aftermarket sales, especially if the price decreased substantially.
In Japan, major auto parts chains, such as
AUTOBACS and Yellow Hat, accounted for 60 percent of after-market unit sales. Hybrid models
based on both GPS and dead-reckoning sensor
were distributed through these auto parts retailers
since they required professional installation andmaintenance. These auto parts retailers carried, at
most, five brands on their shelves. GPS-based systems which did not require complicated installation were channeled mainly through large
electronics discount chains and were more subject
to price competition.
MULTINATIONAL MARKETSAdvanced Japanese Market
The Japanese market for car navigation systems
was the world’s largest in 1995 with sales of 580,000

units and $840 million.2 Car navigation systems
were installed in 10 percent of new Japanese cars in
1995. The penetration rate for all cars registered inJapan was 2 percent. With competition among 30
companies, the average retail price per unit
decreased dramatically from $4,000 in 1990 to$2,500 in 1995. As competitors vied to introduce
new models with the latest technological features,
market shares fluctuated wildly.
The popularity of car navigation systems reflected the uniqueness of the Japanese car driving environment. First, the Japanese road system was more
complicated than its European and U.S. counterparts. Since not all the streets had names and roadsigns were few and far between, people reliedheavily on maps and landmarks for finding theirway. Caught on narrow roads without the benefitof a highly developed highway system, drivers
were always looking for a way to bypass heavily
congested arteries, especially in major metropolitan
areas.
Given serious traffic jams and well-developed
train systems, most Japanese used their cars forweekend joy-riding rather than daily commuting.3
Many, therefore, welcomed car navigation systems
as a means of finding their way around in unfamiliar cities and towns.

2 The concept of the car navigation system had been aroundin Japan since the early 1980s. Honda claimed to be the firstcompany to put a navigation system on the road. However, thedead-reckoning system, which required a driver to replace aslide-like map at each town boundary, did not attract consumers. The Japanese market remained small during the 1980s
although electronic car component producers such as Alpine
and Nippon Denso did supply car navigation systems on an
OEM basis to the automobile assemblers. They offered the navigation systems as optional accessories on a limited number of
their luxury models, such as the Honda Legend and the Toyota
Crown. The navigation systems at that time were priced ataround $6,000.
3 If all the cars registered in Japan were to be on the road at
the same time, the distance between each would be only four
feet.

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Sony Corporation: Car Navigation System

CASE 13 Sony Corporation: Car Navigation Systems

Japanese car drivers, especially young people,
were willing, to spend heavily on cars and electronic accessories. Many drivers would readily
invest over $2,000; few U.S. drivers would invest
more than $1,000. Outside Japan, higher auto theftrates discouraged heavy investment in expensive

709

electronic options. Exhibit 8 summarizes results ofJapanese consumer and dealer research.
The Japanese car navigation market was boosted
further by Japanese government investment in
improving the efficiency of the Japanese road system. A real-time traffic information system called

EXHIBIT 8
Results of Japanese Consumer and Dealer Surveys: 1992–1995•••

1992 Consumer Surveya
•

•

•

•

Forty-five percent expressed their interest in buying
a car navigation system in one or two years; two percent had already purchased one.
Those who would buy a system were willing tospend $500–$1,000 (50 percent), $1,000–$2,000 (40percent) and $2,000+ (10 percent).
Seventy-five percent of those who would buy a system rated “accuracy of road map” as an importantfactor for their purchase decision, followed by“detailed traffic information” (56 percent), “numberof CD-ROMs” (52 percent) and “up-to-date point-ofinterest information” (43 percent):
Benefits mentioned in order of frequency: can enjoy
weekend drive better (90 percent), can drive in unfamiliar area (80 percent), can use landmarks for finding a route (75 percent).

1994 Dealer Surveyb•••

Eighty percent of respondents stated that the price ofcar navigation systems was too high. Among these,
80 percent believed $1,500 was appropriate and 20
percent said $1,000.
The most frequently asked question by customers toretailers was: “Can I use NaviKen format CD-ROMs?”
Ninety-two percent of dealer salespeople preferred
selling systems with NaviKen compatible software.

1995 Customer Surveyc•

Customer demographics were as follows:• 20–24 years (15 percent), 25–29 years (30 percent)
30–39 years (40 percent), and 40 years and older(15 percent)

•

•

•

•

married (44 percent) and not married (56 percent)male (95 percent) and female (5 percent)
75 percent owned new cars and 25 percent usedcars
• Average price of their cars was $33,000
Respondents used car navigation systems: when driving in unfamiliar areas (95 percent); when enjoying
weekend drives (85 percent); not during regular commute (70 percent); all the time (15 percent).
Ninety percent stated that a map display was essential for route guidance while 10 percent said arrowsigns and voice guidance were sufficient.
Important factors influencing the purchase decisionin order of frequency of mention: accuracy of map
and map-matching; automatic route calculation; easyto-set-up destination; speed of route calculation.
Respondents wished to have the following information: “real time traffic jam” (100 percent), “one-ways”(85 percent), “real-time parking space” (80 percent),“alternative bypass route” (80 percent), and “expected arrival time to the destination” (75 percent).

Source: Compiled from the following surveys conducted by
one of the car navigation systems producers:a
Survey of 550 high potential purchasers, sampled fromcar audio magazine readers in October 1992.
b
Survey of dealer salespeople in 20 largest auto parts
chain stores, conducted in May 1994.
cSurvey of 600 owners of car navigation systems, sampled from car audio magazine readers in October 1995.

Sony Corporation: Car Navigation System

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CASE 13 Sony Corporation: Car Navigation Systems

VICS (Vehicle Information and Communication
System), would be launched in Tokyo and Osaka in
1996.4 With VICS information, the next generationof navigation systems would be able to incorporate
real-time traffic and weather alerts so that drivers
could avoid gridlock, accidents, or washed out
roads.
Emerging European Market
The European market lagged behind Japan bysome five years. However, once major electronics
manufacturers such as Bosch and Philips introduced products in Germany, the market began todevelop. The market was expected to grow fromannual sales of 30,000 units and $60 million in 1995
to 600,000 units and $600 million by 2000. (SeeExhibit 4.)
European road systems were complex, especially in historic inner cities. However, most streets
had names and road signage was good. As a result,opinions differed on whether a car navigation system needed to show a digital map on an LCD monitor or if right/left arrow signs and voice guidancewere sufficient.
European drivers frequently drove across borders. Car navigation systems, therefore, needed toprovide multi-lingual guidance. Digital map software also had to correspond to different traffic
rules and road regulations from country to country.
European governments collaborated on efforts
to improve the highway system. For example, theEuropean Union’s DRIVE program analyzed how
the car should relate to the road infrastructure,
while the PROMETHEUS project involving all
major European manufacturers examined how
cars could communicate with each other. The technologies developed through these projects con-

4 The ATIS (Advanced Traffic Information System) was
launched earlier in 1995. The system allowed a driver toretrieve real-time traffic information by using a car cellular
phone.

tributed to Philips’ and Bosch’s development of
navigation technologies such as route calculationand guidance.5
Untapped U.S. Market
The U.S. market lagged both Europe and Japan. Car
navigation systems were not widely known.
However, one forecast expects the U.S. market
would surpass the European market by 2000, withannual sales of 900,000 units and $720 million, andapproach the size of the Japanese market by 2005,
with sales of 2.4 million units valued at $1.2 billion
a year. (See Exhibit 4.)
The United States was well-organized withstreet names, traffic signs, and highly developed
highway systems. The value of car navigation systems which pinpointed a car’s current location was
not so obvious to the U.S. driver. For car navigation
systems to be attractive, they had to provide turnby-turn route guidance and other more sophisticated functions.
As of 1995, few U.S. consumers were familiar
with car navigation systems. A manager at one digital map maker explained:
If it were described to you before you experienced it,
you might not understand. But after testing the system, most drivers come around. All it takes, after all, isthe admission that a map database knows more about
the road than you do.6

Consumer research studies indicated risinginterest among U.S. consumers. One study reported that 58 percent of car owners had heard about
vehicle navigation systems, primarily through television (37 percent) or published material (36 percent). Among those aware, most could recall thesystem’s purpose and basic features, but relatively
few understood what “GPS” meant, knew about
voice prompts, or about systems being available inrental cars.

5 “Smart Cars,” TelecomWorld, Aug. 1992, pp. 44–45
6 Wired, Winter 1995.

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Sony Corporation: Car Navigation System

CASE 13 Sony Corporation: Car Navigation Systems

The same research reported that 70 percent ofrespondents were interested in purchasing a car
navigation system. Among those, 26 percent wereinterested in buying an OEM, pre-installed, in-dashmodel with display, 57 percent voted for an aftermarket, on-dash model with a monitor, while 17
percent, indicated preference for a lower-end,voice-navigation model with no display.
Respondents were, willing to pay $700 to $1,000 for
a pre-installed OEM model, $600 to $700 for thesecond type, and $500 to $600 for the third type.
Exhibit 9 summarizes the detailed research results.
Another survey conducted by J.D. Power andAssociates focused on potential purchasers. The
study involved 170 consumers taking two-day test
drives of navigation system-equipped automobiles,
and completing three questionnaires: prior to driving the system-equipped cars (to assess awarenessand image of the navigation systems); following a
10-minute test drive (to simulate consumer impressions after a dealership test drive); and after driving the car for two days (to simulate impressions

711

following an experience driving a system-equipped
rental car). Exhibit 10 summarizes the research
results.
The survey revealed that both the 10-minute andthe two-day test drives enhanced respondents’
understanding of the system’s features, benefits,
and ease of use. After the initial test drive, participants noted several key advantages, including convenience, the ability to save time and money, theability to replace maps, and less of a need to ask fordirections. The extended two-day test led to lower
stress and improved driving confidence. The
longer test drive increased the likelihood of respondents recommending the system to family andfriends.
In 1992, five years after Japan, the federal U.S.
government began a six year program of investingin smart highway technologies, including sensors,
television cameras, and radars to monitor city traffic and relay traffic conditions to central computers.
From workstations at command headquarters,
technicians would be able to alter freeway signals

EXHIBIT 9Survey of California Car Renters: January 1996
•
•

•

•
•
•

Drivers were willing to pay, on average, $5 more per
day to rent a car with a navigation system.
Drivers who would purchase or lease a car with anavigation system (70 percent of the sample) werewilling to spend, on average, an extra $550. Eleven
drivers were willing to spend over $1,000.
Drivers who would buy navigation systems andinstall them in their current cars (35 percent of thesample) were willing to spend, on average, $1,100.
Twenty percent said they would buy the navigation
system if it cost $1,200.
Twenty percent stated they used the system “all thetime.” Another 30 percent used it “a lot.”
Benefits mentioned in order of frequency: prevents
you from getting lost in a new city; helps you findyour destination; eliminates the need for maps;
increases driving safety; you don’t have to stop andask directions; takes you via best route; and gives
feeling of confidence when driving.

•

•
•

•

Problems mentioned in order of frequency: took time
to figure out how to use it; destination not in computer; not able to calibrate alternate route; out ofrange error; directions unclear and/or hard to hear;and monitor hard to read.
Sixty percent found the navigation system worked
better than they expected.
Sixty percent used the system for guidance in getting
to a destination. Twenty percent used it for finding
points of interest, for experimenting with different
routes, and for determining current location.
Two-thirds of respondents stated the device was easier to use when the car was parked. Forty percent
believed it was distracting to use while driving.

Source: Compiled from survey of 53 frequent Avis car renters in
California, conducted by Center for Strategy Research, January
1996.

Sony Corporation: Car Navigation System

712

CASE 13 Sony Corporation: Car Navigation Systems

EXHIBIT 10
Results of J.D. Power Consumer Survey: August 1995
•

•

•

•

•

•

•

Using a 10-point scale for satisfaction, where 10 is“extremely satisfied,” eighty percent of respondents
rated their overall satisfaction as a “nine” or “10,”resulting in a mean of 8.43.
Sixty percent were “very likely” to recommend thesystem to family and friends after the 10-minute test
drive. The percentage increased to 70 percent after
the two-day test drive.
Respondents preferred an in-dash OEM system to an
on-dash after-market model by a margin of four toone, due to perceived better quality and system reliability resulting from more professional installation
and better integration with the vehicle’s electricalsystem.
Those who would buy an after-market system mentioned perceived transferability/portability andlower price as reasons for their preference. The average expected price for an after-market model was$900, versus $1,000 for an OEM system.
Those preferring an after-market model expected topurchase it at “specialty store” (41 percent), “electronic store” (17 percent), “discount store” (13 percent)and “department store” (6 percent). “Specialty store”
included outlets specializing in selling and installing
alarms, audio systems, and vehicle cellular phones.
Over eighty percent said that availability of a car
navigation system would be an important factor in
deciding which vehicle to purchase next time.
Regarding the value of different point-of-interest
information, “emergency assistance/hospital/and stoplights to reroute traffic, and relay advisories to cars equipped with more sophisticatednavigation systems. On the other hand, safety regulations in 13 major states, including California and
New York, prohibited any in-car visual devices,
except for security purposes.
SONY IN INTERNATIONAL COMPETITION•

police” was rated highest (9.03), followed by “autocare/gas” (8.23), “travel points” (8.13), “entertainment/tourist attractions” (8.04), “business facilities”(7.50) and “ATMs/banks” (7.39).
Focus group discussions revealed high interest in
point-of-interest listings of new and different entertainment and dining options, particularly in unfamiliar areas. Said one New York participant:“We went to Connecticut to visit relatives andarrived early and decided to get something to eat.
We just looked through point-of-interest listingsand selected a restaurant.”
A participant from Los Angeles noted:“The system opens up your world; it lists theaters
and restaurants and places you haven’t heard of.”Notes: Survey of 170 high potential purchasers by J.D. Power
and Associates, July and August 1995.
Respondents participated in a two-day test drive of avehicle equipped with an Avis car navigation system.
They were screened for the following criteria:• Household income of at least $50,000• Cellular phone ownership and monthly cellular
phone bill of $50 or more
• Average of 2 or more hours per day in vehicle on
business travel (excluding normal commute)• Ages 25 to 59
Source: Adapted from J.D. Power and Associates, The Power
Report, November 1995.

Electronic Corporation, a Japanese leader in carstereo and laser disc players. Since the GPS signal
was not yet available around the clock and was easily interrupted by high-rise buildings in Tokyo,
Pioneer defined the product as a “Satellite Cruising
System,” emphasizing the innovative and entertainment aspects of the product rather than its practicalcapabilities as a navigation device.7 Pioneer had

Competition in JapanIn November 1990, the first GPS-based after-market
car navigation system was introduced by Pioneer

7 With only 12 satellites until 1992, GPS did not provide thesignals necessary for 24 hour coverage. The system became
complete with 24 satellites in 1993.

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Sony Corporation: Car Navigation System

CASE 13 Sony Corporation: Car Navigation Systems

developed its own digital map software andstressed the variety of point-of-interest information
its system could provide, ranging from hotels torestaurants. In addition, to distract drivers fromJapan’s endless traffic jams, Pioneer included entertainment software containing games, quizzes, horoscopes, and karaoke. Pioneer distributed the
products through the same channels used for conventional car stereos, principally auto parts shops,
since the product required professional installation.
Despite a high retail price over $5,000, Pioneer sold
20,000 units annually in the early 1990s.
The market changed dramatically in June 1993,
when Sony entered the after-market segment with
the NVX-F1O, including a 4-inch LCD monitor at a
low-price of $2,000. Six months later, Sony introduced NVX-15 with a larger 5-inch display at$2,500. Unlike Pioneer, Sony emphasized the product’s practical benefits and named it “Digital Map
Car Navigation System.” Sony advertised the product as a problem-solving device for drivers, who
did not want to face traffic jams, get lost in unfamiliar towns, or be late for appointments. These
GPS-based products showed only the driver’s current position on the digital map screen, but did notprovide route guidance toward the destination.
However, sharply lower prices attracted many consumers. Aiming at rapid market expansion, Sony
distributed almost 50 percent of its units throughconsumer electronics channels. Sony sold some
10,000 units monthly through 1993, achieving a 60
percent market share.
To develop the market further, Sony set out toestablish an industry standard for digital map software. Sony was the most active member of theNavigation Research Association to set theNaviKen format for CD-ROM based digital maps.
The standard setting effort lowered entry barriers,
resulting in 10 new entrants in 1994 and anotherfive in 1995. Competition fueled market growthfrom 160,000 units in 1993, to 340,000 units in 1994,
and to 580,000 units in 1995.
Market growth encouraged intense competition
and faster new product development. Exhibit 11
reports the timing of product introductions by713

different competitors. Once every six months during 1994 and 1995, competitors introduced progressively more advanced products. In April 1994,
Matsushita, which had not joined NaviKen, was thefirst to develop a hybrid system employing both
GPS and dead-reckoning sensor. The Matsushita
model was also the first to be able to calculate andcommunicate the best route to a destination. In
October 1994, Alpine, which was originally a
NaviKen member but later became an independent
developer, introduced the first hybrid model that
could provide turn-by-turn route guidance. In early
1995, Pioneer introduced a new hybrid model witha flash memory chip in its CPU; this enabled theentire system to be upgraded by just installing a
new CD-ROM. As shown in Exhibit 12, these moresophisticated hybrid models began to outsell thesimpler GPS-based products by 1995.
NaviKen member companies, including Sony,
did not respond quickly enough. It took the 40
NaviKen members more than a year to agree on astandardized software upgrade. In addition,
NaviKen members saw little room to differentiate
their products from each other. As shown in
Exhibit 13, Sony introduced new products almost
every six months, but all were modified versions of
the original GPS-based products, which did notprovide automatic route calculation or turn-byturn route guidance. In May 1994, Sony introduced
NVX-F16, an extended version of the NVX-F15, butsold only 15,000 units by April 1996. In October
1994, Sony introduced NVX-B50, which employeda CD-ROM changer in which a driver could placesix different CD-ROMS. The product sold only
9,000 units by April 1996. Sony had perhaps introduced the product too early because the averagenavigation system owner had only 1.5 CD-ROMs
as of 1995.
In July 1995, Sony finally introduced NVX-S1, ahybrid system with a route guidance function.
However, the market did not respond well to thislate entry. According to a trade magazine, NVXS1, which still employed the NaviKen standard inits digital map database, calculated a route too
slowly and provided turn-by-turn guidance tooSony Corporation: Car Navigation System

714

CASE 13 Sony Corporation: Car Navigation Systems

EXHIBIT 11
Number and Timing of New Product Introductions in Japan: After-Market Models
Company/Brand

1990

1991

1992

1993

1994

1995

TOTAL

1995 Product
Linea

PioneerSony
Matsushita
AlpineMitsubishi
Kenwood
ZanaviClarionFujitsu Ten
Nippon Denso
Sharp
Casio
Sumitomo Denko
ToshibaCitizen
Caisonic
NEC
Chuo Jidosha
MasproSanyo
Nakamichi

2
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0

0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0

1
1
0
0
1
1
0
0
0
0
0
0
0
0
0
0
0
0
1
0
0

4
3
1
3
1
0
0
2
0
0
0
0
1
2
0
0
0
0
0
1
0

4
5
3
2
3
3
0
1
1
0
3
1
3
2
0
2
1
1
1
0
1

3
5
3
2
4
2
4
2
3
2
0
1
1
3
3
3
1
1
1
3
0

14
14
7
7
9
6
4
5
4
2
3
2
5
7
3
5
2
2
3
4
1

7
8
4
2
6
3
4
3
3
2
2
2
3
5
3
4
1
1
2
3
1

TOTAL

2

0

5

18

37

47

109

69

Note: a After adjusting for discontinued products.
Source: Analysis of the case writers, based on research interviews.

infrequently, compared to competitive products.
See Exhibit 14 for a summary of the magazine’s
product comparison.
By 1995, competition focused on the richness ofthe digital map databases. In October 1995, Alpine
introduced another new product with a database of
11 million phone numbers built into its digital map
software which a driver could use to identify
his/her destination. The product sold well, giving
Alpine the market share leadership, as shown in
Exhibit 15. Other competitors followed suit, building more advanced databases filled with large
numbers of phone numbers, landmarks, and otherpoint-of-interest information.

Fighting against heavy odds in the main models, Sony turned its product strategy back to theGPS-based model, by introducing portable navigation systems. In December 1995, Sony introduced Handy Navigation System GPX-5, theworld’s first detachable model. It could be usedboth inside and outside an automobile, targetingcustomers who wanted to use the system for outdoor camping, bike touring, and marine sports.
The GPS-based device alone retailed for $2,000,
with an option to purchase a gyroscopic sensor toconvert the system into a hybrid for an additional$300. A customer could also add a home station kit
for $200; this could connect a navigation system to

725

726

Turn-by-Turn Route Guidance

1993
1994
1995

No (GPS)Yes (Hybrid)

98%
56%
20%

2%
44%
80%

Sony Corporation: Car Navigation System

EXHIBIT 12
Unit Market Shares of Advanced Models in Japan: 1993–1995

Automatic Route Calculation

1993
1994
1995

No (Manual)Yes (Automatic)

97%
50%
30%

3%
50%
70%

CASE 13 Sony Corporation: Car Navigation Systems

715

General Information

NVX-1
NVX-F10
NVX-F15
NVX-F1
NVX-2
NVX-F16
NVX-9
NVX-B50
NVX-4
NVX-F18MK2
NVX-A1
NVX-S1
NVX-F30
GPX-5

Cumulative

1995

HardwareRetailPrice

LaunchDate

Unit
SalesaUnit
SalesaGPS orHybrid$4,700$2,100$2,800$1,600open price$2,500$1,400$1,800$1,500$2,500

92/06
93/06
93/10
93/10
94/02
94/06
94/06
94/10
94/10
95/02

7,000 (3%)
100,000 (41%)
15,000 (6%)
4,000 (2%)
3,000 (1%)
15,000 (6%)
4,000 (2%)
9,000 (4%)
9,000 (4%)
10,000 (4%)- (0%)- (0%)- (0%)- (0%)- (0%)
7,000 (7%)- (0)%
4,000 (4%)
4,000 (4%)
10,000 (10%)$1,300$1,500$2,300$2,100

95/04
95/07
95/07
95/12

4,000 (2%)
40,000 (16%)
20,000 (8%)
3,000 (1%)

10,000 (10%)
40,000 (41%)
20,000 (20%)
3,000 (3%)

TOTAL

243,000 (100%)

98,000 (100%)

(%)

(%)

Functionsw/ or w/o Route
RouteMonitorb Guidance Cal.

GPS
w/
GPS
w/
GPS
w/
GPS
w/
GPS
w/o
GPS
w/
GPS
w/o
Hybridw/oHybridw/oGPS (w/w/
Hybrid Option)GPS
w/oHybridw/oGPSw/
GPS (w/w/
Hybrid Option)

Auto Route Voice
Re-Cal. Recognition

No
No
No
No
No
No
No
No
No
No

No
No
No
No
No
No
No
No
No
No

No
No
No
No
No
No
No
No
No
No

No
No
No
No
No
No
No
No
No
No

No
Yes
Yes
Yes

Yes
Yes
Yes
Yes

No
No
No
No

No
Optional
Optional
OptionalSony Corporation: Car Navigation System

Notes: a All sales were made in Japan in the after-market. All products used the NaviKen format.
b “w/o monitor” means that the product was sold without a monitor. A customer needed to buy a monitor (which cost $500–$1,000) tocomplete the system.
Source: Analysis of the case writers, based on research.

CASE 13 Sony Corporation: Car Navigation Systems

Product

716

EXHIBIT 13
Sony Product Introduction Chronology: 1992–1995

727

728

Company

Product

Pioneer
AVIC-XA1
Sony
NVX-S1
Matsushita
CN-V700
AlpineNTV-W055V
Mitsubishi
CU-9510
Kenwood
GPR-03EX
ZanavlXA-N1
Clarion
NAX9100
Fujitsu Ten
E500NCU
Nippon Denso MV-1000S

1995

HardwareRetailPrice

Launch
Date

Unit
Sales

GPS orHybridw/ or w/o
Monitor$2,630$1,500$1,570$2,480$1,490$1,450$1,480$1,470$1,650$2,580

95/11
95/07
95/07
95/11
95/05
95/10
95/06
95/11
95/11
95/01

30,00040,00050,00040,00015,00015,0005,000
10,00010,0003,000

HybridHybridHybridHybridHybridHybridHybridHybridHybridHybrid

w/
w/o
w/o
w/
w/o
w/o
w/o
w/o
w/o
w/

SoftwareFunctions

Digital Map
FormatRoute
Route Auto Route Voice
Guidance Cal.
Re-Cal. Recognition

Original Only
NaviKen Only
Both
Both
NaviKen Only
Both
NaviKen Only
Original Only
Both
Original Only

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

No
No
Yes
Yes
No
No
No
No
Yes
No

Sony Corporation: Car Navigation System

EXHIBIT 14
Top 10 Brand Product Comparisons: 1995

No
Optional
No
No
No
Yes
No
No
No
No

User Test Result (5=excellent, 1=poor)
Product

Pioneer
AVIC-XA1
Sony
NVX-S1
Matsushita
CN-V700
AlpineNTV-W055V
Mitsubishi
CU-9510
Kenwood
GPR-03EX
Zanavi
XA-N1
Clarion
NAX9100
Fujitsu Ten
E500NCU
Nippon Denso NV-1000S
Average

Easy To Use
Command

Easy To Read
MonitorEasy To Find
Destination

Speed of RouteCalculation (Seconds)

Accuracy ofRoute Guidance

Total Score

2
2
5
4
3
3
4
3
3
5

3
3
5
4
3
3
3
5
4
4

3
3
4
5
2
2
4
3
2
5

2 (141)2 (121)
3 (58)
5 (16)
2 (110)3 (57)
4 (43)
4 (46)
2 (110)4 (42)

3
2
5
5
4
2
3
4
3
4

13
12
22
23
14
13
18
19
14
22

3.4

3.7

3.3

3.1 (74)

3.5

17Notes: For each brand, this exhibit reports sales of the best selling after-market in 1995.
“w/o monitor” means that the product sold without a monitor. A customer needed to buy a monitor (which cost $500–$1,000) to complete the system.
Source: Adapted from 1996 New and Improved Car Navigation Systems, Naigal Shuppan Publishing, 1995.

CASE 13 Sony Corporation: Car Navigation Systems

Company717

PioneerSony
Matsushita
Kenwood
Fujitsu
Clarion
AlpineSumitomo Denko
Others

24%
24%
15%
9%
7%
6%
5%
4%
4%

1994 July–December
Pioneer
AlpineSony
Matsushita
FujitsuKenwood
Clarion
Sumitomo Denko
Others

29%
16%
13%
11%
8%
7%
6%
6%
4%

1995 January–June
AlpinePioneer
Matsushita
Sony
ClarionKenwood
Fujitsu
Sumitomo Denko
Others

24%
21%
14%
8%
7%
6%
6%
3%
10%

1995 July–December
AlpinePioneer
Matsushita
ClarionKenwoodSony
Fujitsu
Sumitomo Denko
Others

29%
20%
15%
10%
9%
7%
4%
3%
3%

CASE 13 Sony Corporation: Car Navigation Systems

1994 January–June

718

EXHIBIT 15
Unit Market Share Changes in After-Market/Auto Parts Store Channel in Japan: 1994–1995

Sony Corporation: Car Navigation System

729

730

Sony Corporation: Car Navigation System

CASE 13 Sony Corporation: Car Navigation Systems

a home television and enable a consumer to plan aroute before going out to drive.
European Competition
In Europe, car navigation systems were first
installed on an OEM basis in luxury automobiles inlate 1994. Philips developed its first system as an
optional accessory to BMW’s 7- and 5- Series models in October 1994. Philips’ model employed ahybrid system with GPS and dead-reckoning sensors, provided route guidance by either map,arrows, or voice, and used the CD-ROM based digital map software developed by EGT, a subsidiaryof NavTech of the United States. Retailing for
DM6,900 ($4,600), the first model sold 10,000 units
in 1995. In September 1995, Philips started marketing the same product at the same price throughafter-market channels in Germany and France, butsold only 400 units in the last three months of 1995.
In October 1994, Bosch began supplying car navigation systems for Mercedes S-Class models.
Bosch’s product was similar to Philips’ except that itprovided route guidance only with arrow signs and,voice direction, with no map on the display. Boschemployed the CD-ROM based map database developed by Etak. Retailing for DM 4,000 ($2,700), theproduct sold 8,000 units in 1995. Bosch also developed a model with a map on the monitor for theafter-market segment in Germany and France, introducing it in June 1995, three months earlier thanPhilips. Retailing for DM6,500 ($4,300), the aftermarket model sold 1,800 units by December 1995.
Besides the two European companies, only Sony
competed in the after-market segment. Sony started test marketing its GPS-based model in France inlate 1995, but sold only 300 units by April 1996. The
product specification was similar to Sony’s NVXFl6 and used Etak software. The GPS system pinpointed the car’s current position on an LCD
monitor, but did not give route guidance to the destination. It showed a driver where the destination
was located, but the driver had to plan the route. It
was unclear whether Sony would continue marketing the tested model in Europe.

719

Some other companies including Alpine,
Matsushita, and Pioneer, were said to be planningto enter the European market in 1997–98. Luxury
car manufacturers, such as Jaguar and Volvo, werereportedly considering OEM installation of car navigation systems. Volkswagen, Audi, and Opel wererumored to be seeking OEM suppliers of low-end
models offering voice navigation with no monitor
for around DM600 ($400). Exhibit 16 summarizes
current and prospective competitors in Europe andthe characteristics of their products.
U.S. Competition
As shown in Exhibit 4, sales of one million units per
year were expected in the United States by 2000. On
the other hand, none of the models introduced todate had sold more than a few thousand units as of1995. Car navigation systems were not yet widely
known among U.S. consumers.
Industry observers believed price reductions
would be critical before demand for car navigation
systems would take off in the United States. Market
research revealed that few U.S. consumers would
pay over $1,000 for car navigation systems. Automanufacturers had told the car navigation makers
that they needed prices to drop as low as $500,
which was not expected until 2005 after further
investments in mapping, data storage, and route
guidance were completed.
Zexel, a Japanese auto parts supplier, was thefirst to bring car navigation systems to the UnitedStates.8 As an OEM, Zexel began supplying systems for GM’s Oldsmobile Eighty Eight in summer
1994. Zexel’s navigation products employed hybrid
systems with GPS and dead reckoning sensors andprovided route guidance by either map, arrows, orvoice. The digital map database was stored in a
170MB hard disk drive located in a car trunk. With
the price tag of $1,995, however, the product was

8 Zexel did not sell car navigation systems either on an OEM
basis or through after-market channels in Japan as of 1996.

720

EXHIBIT 16
Current and Prospective Competitors in Europe
Current Competitors

Company

Auto Maker

RetailPrice

BoschPhilips

MercedesBMW

DM 4,025
DM 6,900

Cumulative

HardwareLaunch
Date

Unit
Sales

GPS orHybridInterface:map, arrow, voice

Digital Map
FormatSoftware
Media

10/94
10/94

8,000
10,000HybridHybridarrow, voice
map, arrow, voice

Etak
NavTech

CD-ROM
CD-ROM

Cumulative

HardwareGeneral Information
AfterMarket

Company

Product

Bosch
PhilipsSony

Travel Pilot
Carin
NVX-160

Software

SoftwareRetailPrice

Launch
Date

Unit
Sales

GPS orHybridInterface:map, arrow, voice

Digital Map
FormatSoftwareMedia

DM 6,500
DM 6,900
DM 5,500

06/95
09/95
10/95

1,800
400
300

HybridHybridGPSmap, arrow, voice
map, arrow, voice
map

Etak
NavTechEtak

CD-ROM
CD-ROM
CD-ROM

Expected

HardwareProspective Competitors
General Information
RetailPrice

Launch
Date

Unit
Sales

GPS orHybridInterface:map, arrow, voice

Digital Map
FormatSoftwareMedia

Mitsubishi
Bosch
Bosch

Volvo
VW
Audi

—
DM 600DM 600

Early 97
Early 97
Early 97———

HybridGPSGPSmap, arrow, voice
voice
voice

TeleAtlas
Etak
Etak

CD-ROM
CD-ROM
CD-ROM

Expected

HardwareCompany

Product

RetailPrice

Launch
Date

Unit
Sales

GPS orHybridInterface:map, arrow, voice

Digital Map
FormatSoftwareMedia

AlpineMatsushita
Pioneer

NTV-W055V DM 6,000————

Mid 96
Early 97
Early 97———

HybridHybridHybridmap, arrow, voice
map, arrow, voice
map, arrow, voice

NavTech——

CD-ROM——

Source: Analysis of the case writers, based on research interviews.

SoftwareSony Corporation: Car Navigation System

Auto Maker

General Information
AfterMarket

SoftwareCompanyOEM

CASE 13 Sony Corporation: Car Navigation Systems

General Information
OEM

731

732

Sony Corporation: Car Navigation System

CASE 13 Sony Corporation: Car Navigation Systems

expensive. In 1994, the most expensive car accessory in the United States was a European branded
premium hi-fi speaker system for $1,200. Due toa lack of marketing expertise at Zexel andOldsmobile and due to the fact that digital maps
were only available for a few major cities, only
2,500 units were sold by the end of 1995.
Zexel licensed its product technology to
Rockwell for after-market sales. Rockwell sold the
product to rental car companies such as Avis andHertz. The rental car companies purchased a few
thousand units in total and rented the systems for a$5 to $7 daily upcharge. However, neither Rockwell
nor the rental car companies had aggressively marketed the product.
Sony began marketing the NVX-F160, the U.S.
version of the Japanese model NVX-F16, in
California and Florida in late 1994. Despite its lackof route guidance capability, Sony launched the
NVX-160, the most advanced model in Sony’s
product line as of 1994, in order to be the first to
market an after-market model. At a price of $2,995,
only 800 units were sold by the end of 1995.
A low-end product priced under $1,000 was introduced in December 1995 by Amerigon, a Silicon
Valley startup known for its voice recognition technology. The system was bundled with car stereos
and sold under car audio brand names by manufacturers such as Alpine, Clarion, and Kenwood. The
price was about $600, although when the stereo andinstallation were included, the price was more like
$1,000 to $1,500. This CD-ROM based system,
named AudioNav, did not employ GPS, relying
instead on a dead-reckoning sensor alone. There wasno monitor; only a voice system that used a microphone similar to one used in a cellular phone. The
driver had to spell out the destination for route calculation. It was hands free, but the driver had to finda street sign or local landmark if he/she became lost.
Unit sales to date were unknown.
Within a year or two, Alpine and Nippon Denso
were expected to supply OEM models to Honda
and Toyota factories in the United States. Pioneer,
Alpine, and Matsushita were expected to enter the
U.S. after-market segment, introducing modified

721

versions of their latest domestic market models.
Exhibit 17 lists current and prospective competitors in the United States and characteristics of theirproducts.
SUMMER 1996: RECONSTRUCT THE
GLOBAL STRATEGY
Masao Morita, the son of the legendary founder
Akio Morita, contemplated how to formulate his
multinational marketing strategy for the fastchanging car navigation systems market for the
next five years. Given the different market conditions from one region to another and Sony’s unsatisfactory position in each market, Morita resolved
to reevaluate the company’s marketing strategy for
car navigation systems and the benefits Sony could
and should provide drivers around the world.
Morita needed to resolve the conflicting views
within his company regarding several key issues.
Geographical Focus Issue
Some managers believed it was time to focus much
more effort on markets outside Japan. One international marketing manager said:
Both the European and United States markets are
expected to grow as large as the Japanese market within 10 years. We should preempt competitors with ourown after-market models. We will be too late if we
wait until these overseas markets take off. We shouldbe the company that creates these markets as we did athome.

In contrast, a marketing manager in Tokyo
insisted that Sony should focus on reestablishing its
competitive position in Japan:
Our share is down because we have lagged behind
our competitors in developing more accurate hybrid
models and more sophisticated route guidance technology. The fact is, in 1996, 98 percent of our car navigation sales come from Japan. The, growth forecasts
for markets overseas are totally speculative.

The allocation of R&D resources depended inpart on Sony’s geographical priorities. In 1996,

722

EXHIBIT 17
Current and Prospective Competitors in Europe
Current Competitors

Company

Auto Maker

Zexel

GM/
Oldsmobile

HardwareLaunch
Date

Unit
Sales

GPS orHybridInterface:map, arrow, voice

Digital Map Software
FormatMedia$1,995

08/94

2,500

Hybridmap, arrow, voice

NavTechCumulative

HardwareLaunch
Date

Unit
Sales

GPS orHybridInterface:map, arrow, voice

Digital Map Software
Format
Media

10/94
01/95
12/95

800
7,000
—

GPS
map
Hybridmap, arrow, voice
Dead Reck voice
No GPS

Etak
NavTechNavTech

Expected

Hardware

SoftwareLaunch
Date

Unit
Sales

GPS orHybridInterface:map, arrow, voice

Digital Map Software
FormatMedia$2,000——

Mid 96Late 96
Early 99———

HybridHybridHybridmap, arrow, voice
map, arrow, voice
map, arrow, voice

NavTechNavTech
Etak

Expected

HardwareLaunch
Date

Unit
Sales

GPS orHybridInterface:map, arrow, voice

Digital Map Software
FormatMedia

Dead Reck
No GPS
HybridHybridHybridHybridvoice

NavTech

CD-ROMmap, arrow, voice
map, arrow, voice
map, arrow, voice
map, arrow, voice

NavTech—NavTechNavTech

CD-ROM
CD-ROM
CD-ROM
CD-ROM

General Information
AfterMarket

Company

Product

RetailPrice

Sony
RockwellAmerigon

NVX-160
GuideStar
AudioNav

$2,995$1,995$600

Software

Hard Disk(170MB)

Software

CD-ROMHD (170MB)
CD-ROM

Prospective Competitors
General Information
OEM
Company

Auto Maker

AlpineHonda
Nippon Denso Toyota
Bosch
MercedesRetailPrice

General Information
AfterMarket

Company

Product

RetailPrice

Delco (US)Telepath 100$500

Mid 96—

Pioneer
Matsushita
ClarionKenwood

—
—
—
—

—
—
—
—

Early 97
Early 97
Early 97
Early 97————

Source: Analysis of the case writers, based on research interviews.

HD(170MB)
HD (170MB)
CD-ROM

SoftwareSony Corporation: Car Navigation System

Cumulative
RetailPrice

CASE 13 Sony Corporation: Car Navigation Systems

General Information
OEM

733

734

Sony Corporation: Car Navigation System

CASE 13 Sony Corporation: Car Navigation Systems

Sony employed 200 highly skilled engineers dedicated to car navigation systems development, all ofwhom were stationed in Japan, except for only one
each in Europe and the United States.
Product Choice
Given the poor performance of the current overseas
model NVX-F160, it seemed that a simple GFSbased model at a price of $3,000 was unlikely toappeal to drivers in Europe and the United States.
There were at least three product options for Sony:(1) launch the Handy Navigation System GPX-5,
the portable GPS model most recently introduced
in Japan, as a global product; (2) modify the hybrid
NVX-S1 for Europe and/or the United States; and(3) develop a new low-priced model for overseas
markets.
A marketing manager in Tokyo emphasized theadvantage of the GPX-5 as a global product:
The portable nature of the GPX-5 should appeal to amuch broader population, including consumers interested in outdoor camping, bike touring and marine
sports. Users can also use it to enjoy regular TV channels while traveling. Since the product is detachable, it
is not strictly an automobile device, so auto safety regulation and product liability issues may not apply.
Portability also reduces the risk of theft.

The U.S. country manager, however, questioned
the product’s potential:
For the product to succeed in the United States, weneed software with geocoded information specifically for camping sites, fishing locations, mountainskiing routes, and the like, all of which currently do
not exist. It will cost at least $1 million and take ninemonths to develop software for each recreation
activity. By the time we have a variety of CD-ROMS,
competition could be on different basis. In addition,
if the product is priced around $3,000 again, it will
flop. Finally, modifying the GPX-5 for the UnitedStates would require five engineers working for six
months.

Another manager in Tokyo proposed to modify
the NVX-S1, the hybrid model with turn-by-turnroute guidance capability, for overseas markets:

723

In the countries where street names are clearly signed
and road systems are straightforward, the current
GPS-based model, which only shows the driver’s
position on the map, adds little value to drivers. We
need a more sophisticated hybrid model, which can be
upgraded to accommodate future advances such as areal-time traffic information service and a traffic emergency warning system.

However, there were also pessimistic views
regarding this product modification:
In turn-by-turn route guidance technology, Sony lags
far behind its competitors overseas. The product modification option requires Sony to reinvent its digital
map software for the U.S. and European markets.
When competitors launch more sophisticated route
guidance systems, the present system will quickly
become obsolete. Moreover, this option will incur substantial time and cost. It will take two years for oursoftware vendor Etak to digitize U.S. and European
maps for turn-by-turn route guidance. This will cost$100 million in initial development costs and $30 million for annual maintenance and content upgrades.
This option will require 50 engineers to work with
Etak in the United States and Europe. NavTech, Etak’s
competitor, will have soon digitized 100 percent of the
U.S. and European maps for turn-by-turn guidance.
We can switch from Etak to NavTech, but we are notsure how much competitive advantage we will lose byusing the same database as our main competitors.

Rejecting the above product modification
options, some sales managers in the United Statesargued for developing low-end models fromscratch, solely for the overseas market:
As consumer research has shown, it is obvious
nobody here will buy a $3,000 gadget for his/her car.
If we want to create a market here, we need a productdesigned to meet local needs. European and U.S. drivers don’t need a fancy digital map nor an expensive
LCD monitor and will be happy with some simple
arrow and voice guidance at a price of $1,000 or less.

The international marketing manager in Tokyo,
however, strongly opposed this low-end productstrategy:
Even if a low-end stripped-down product stimulates
the market in the short run, Sony will gain little in theSony Corporation: Car Navigation System

724

CASE 13 Sony Corporation: Car Navigation Systems

long run. It will precipitate price competition andmay shrink the market, at least in value terms. The
product will not be adaptable to future developments
in road infrastructure. It will diminish Sony’s leadership image in car navigation systems. Furthermore,this option will need 60 of our engineers to work fora year on developing this new product. Given thecompetition we face at home, we can not afford todivert them.

Standard Setting Issue
There was wide debate over continuation of theNaviKen consortium. Some managers contended
that Sony should leave NaviKen or at least develop
proprietary digital map technology in parallel inorder to compete head-to-head with other companies. A young manager in charge of product development stated:
The NaviKen format was helpful early on. However,product introductions are now so frequent that weneed our own digital map technology to respondquickly to the market’s evolving needs. Customers
appreciate a differentiated database to standardized
ones. As one survey says, an average consumer
owns only 1.5 CD-ROMS, and most do not use CDROM maps across different hardware anyway. Car
navigation systems are not the same as personal
computers.

In contrast, several of the digital map engineers
who were heavily involved in establishing
NaviKen format in the 1980s opposed such a radical move. As one senior engineer stated:
Such a myopic and opportunistic action may bringsome market share in the short run, but hinder market
development for the future. Standardized software
will always benefit the consumer as well as the industry, as has been shown in the cases of CD players and
VCRs. Our market research shows 80 percent of ourcustomers care about software compatibility. As amarket leader, Sony always tries to grow the market
pie. Sony does not pursue a larger share of a shrinking
market. After all we’ve put into establishing the
NaviKen standard, why should we quit now? Now it
is time for us to extend our effort overseas and to stimulate consumer demand as we have done in Japan.

Other managers took a compromise view. While
supporting NaviKen in Japan, they proposed toestablish different digital map formats for Europe
and the United States. One manager explained:
To boost the market overseas, especially early on, we
need a variety of compatible software. However, theNaviKen standard was developed for the unique
Japanese road system, and is not extendible to othermarkets. Since the traffic infrastructures are very different from country to country, we should try to establish new product standards region by region.

735

Procter & Gamble:Bringing theCompany into the 21st Century

I

n January 1999, Durk Jager took over as the new
CEO of P&G. His predecessor, John Pepper,
stepped down after only three years on the job. His
early departure was attributed to the fact that P&G
at that time needed a CEO who could change its
culture, protect its market share, and find successful new products. Mr. Pepper, known around P&G
as a “nice guy” and a consensus builder, simply
was not what the company needed. Mr. Jager wasconsidered to be the type of person who could
revive the company as it entered the twenty-first
century.

32
CASE 14each with its own marketing, product supply, product development, finance, sales, human resources,
and management systems. These groups reported
to a category general manager (vice president) who
in turn reported to a group vice president at thesector level. In addition, these groups (other thanmarketing) also reported to senior levels of management within their own functions. Thus, P&G
was organized as a matrix of category and functional hierarchies. Exhibit 3 shows the organizational arrangement at P&G.
P&G’S PROBLEM

COMPANY BACKGROUND
In 1837, William Procter, a candle maker, and James
Gamble, a soap maker, merged their companies toform Procter & Gamble. Today, P&G is a great
American company with $37 billion in revenues in
1998. It had four times the sales of ColgatePalmolive, and three times of those of KimberlyClark. The company is well-known for its flagshipbrands such as Crisco®, Tide®, and Crest®, andother leading brands such as Duncan Hines®,
Charmin®, and Folgers®, that P&G acquired fromother companies and built into major businesses
over the years. It sold more than 300 brands in 140
countries. There was at least one P&G producttucked into nearly every kitchen cabinet or under
every bathroom sink in the United States. Exhibit 1
shows the company’s financial results for 1998.
Exhibit 2 lists the company’s major brands.
P&G was organized into four major divisions or“sectors:” laundry and cleaning products, food andbeverage, health and beauty care, and paper products. Each sector comprised several categories,

P&G is a great American company with a big problem: It has stopped growing. Revenues have flattened out. Some of its most famous brands have been
losing market share for years (see Exhibit 4). Former
number one Pampers—once 70 percent of the disposable-diaper market—has lost nearly half its market share over the past 20 years. Former number one
Ivory now makes up barely 5 percent of the market,
while Unilever’s Dove leads with 20 percent. The
last time P&G hit a home run, a billion-dollar product that invented a new category, was in 1961, theyear Pampers introduced the disposable diaper. Tide
was rolled out in 1946. Crisco in 1911. Ivory in 1879.
You get the idea. The problem, it seems, is that as theworld has changed, P&G has not.
In some ways P&G’s success has been its undoing. Because its brands have been so dominant forso long, the company’s culture acquired a pervasive, slavish adherence to precedent. P&G has kept
going by simply repeating the same formula over
and over, coming up with newer, improved versions of the same old products. Tide, for example,

This case was prepared as a basis for classroom discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

725

737

738

Procter & Gamble: Bringing the Company into the 21st Century

726

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

EXHIBIT 1
Financial Results Procter & Gamble Company
Consolidated Statement of Earnings
Years Ended June 30
Amounts in Millions Except Per Share Amounts

1998

1997

1996

Net Sales
Cost of products soleMarketing, research, and administrative expenses$37,154
21,064
10,035$35,764
20,5109,766$35,284
20,938
9,531

Operating Income
Interest expense
Other income, net

6,055
548
201

5,488
457
218

4,815
484
338

Earnings Before Income Taxes
Income taxes

5,708
1,928

5,249
1,834

4,669
1,623

Net Earnings$ 3,780$ 3,415$ 3,046

Basic Net Earnings Per Common Share
Diluted Net Earnings Per Common ShareDividends Per Common Share

$
$
$

$
$
$

$
$
$

2.74
2.56
1.01

2.43
2.28
.90

2.14
2.01
.80

See accompanying Notes to Consolidated Financial Statements.

has gone through more than 60 product upgrades
since its launch. But repeating the same formula
works for only so long. The corporate landscape islittered with fallen giants of the ‘60s and ‘70s suchas Kellogg, Sears, or Kodak, that failed to change,or adapt. They slowly eroded until they got to thepoint where they were just not great anymore.
In May, 1997, P&G promised Wall Street that by2006 it would double sales to $70 billion. Thatshould have been easy: For the past 20 years P&G’s
average annual growth rate has been 8 percent.
Now that goal seems unreachable. In 1997, P&G’s
sales were up just 1 percent. In 1998, they grew 4
percent, to $37 billion. In 1999, things were not looking any better: Sales growth continued to inch alongat 2.5 percent; volume was flat. At this rate, it would
take a quarter-century to hit $70 billion. To do it insix years as promised, the company would need tostart growing again at 8 percent per year. And that,most Street analysts agreed, was impossible.

DURK JAGER’S SOLUTION
Durk Jager intended to make it happen. According
to him, the core business was innovation. “If weinnovate well, we will ultimately win. If we innovate poorly, we won’t win.” The point was clear.
Procter needed a recharge, a big jolt. As Jager
remarked, “To innovate, you have to go away fromthe norm. You have to be rebellious or nonconventional. You have to do things differently.”
CREST FIASCO
What happens when you do things the old way is
the kind of catastrophe that befell Crest in 1998.
Crest is P&G’s flagship, a brand everyone in the
country knows instantly—knows what it looks like,knows what it tastes like. And that’s because for 30
years more Americans have been brushing theirteeth with Crest than with any other toothpaste.

739

Procter & Gamble: Bringing the Company into the 21st Century

727

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

EXHIBIT 1
Financial Results Procter & Gamble Company (continued)
Consolidated Balance Sheets
June 30
Amounts in Millions Except Per Share Amounts

1998

1997

$ 1,549857
2,781$ 2,350
760
2,738

1,225
343
1,716
595
1,511

1,131
228
1,728
661
1,190

Total Current Assets

10,577

10,786

Property Plant, and Equipment
Buildings
Machinery and equipment
Land

3,660
15,953539

3,409
14,646570

Accumulated depreciation

20,152(7,972)

18,625(7249)

Total Property, Plant and Equipment

12,18011,376

Goodwill and Other Intangible Assets
Goodwill
Trademarks and other intangible assets

7,023
1,157

3,915
1,085

Accumulated amortization

8,180(1,169)5,000(1,051)

Total Goodwill and Other Intangible Assets

7,011

3,949

Other Non-Current Assets

1,198

1,433

$30,966$27,544ASSETS
Current Assets
Cash and cash equivalents
Investment securities
Accounts receivable
Inventories
Materials and supplies
Work in process
Finished goods
Deferred income taxes
Prepaid expenses and other current assets

Total Assets

Not many brands, other than Coke or McDonald’s,
have been on top for so long. But last year—for the
first time—P&G lost its No. 1 spot to Colgate. It
was an epic, once unthinkable moment in consumer marketing, like Coke losing the cola war to
Pepsi, or the Whopper outselling the Big Mac.

When Crest first came out in 1955, it was revolutionary because it was the first cavity fighter. The
trouble is that since then, it has been stuck withpretty much the same sales pitch; the same red,white, and blue box; and the same basic “Look, Ma. . . no cavities” tag line. Meanwhile, the rest of the740

Procter & Gamble: Bringing the Company into the 21st Century

728

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

EXHIBIT 1
Financial Results Procter & Gamble Company (continued)
June 30
Amounts in Millions Except Per Share Amounts

1998

1997

LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent Liabilities
Accounts payable
Accrued and other liabilities
Taxes payable
Debt due within one year

$ 2,051
3,942
976
2,281

$ 2,203
3,802
944
849

Total Current Liabilities

9,250

7,798

Long-Term Debt

5,765

4,143

428

559

Other Non-Current Liabilities

3,287

2,998

Total Liabilities

18,73015,498

1,821

1,859

—

—

Deferred Income Taxes

Shareholders’ Equity
Convertible Class A preferred stock,stated value $1 per share (600 shares authorized)
Non-Voting Class B preferred stock, stated value $1 per share(200 shares authorized; none issued)
Common stock, stated value $1 per share (5,000 shares authorized;
shares outstanding: 1998—1,337.4 and 1997—1.350.8)
Additional paid-in capital
Reserve for employee stock ownership plan debt retirement
Accumulated other comprehensive income
Retained earnings

1,337
907
(1,616)(1,357)
11,144

1,351
559(1,634)(819)
10,730Total Shareholders’ Equity

12,236

12,046

Total Liabilities and Shareholders’ Equity$30,966$27,544world has moved on. Consumers have developed
concerns beyond cavities, yellowing teeth, sensitivegums, bad breath. While other toothpaste makers
moved in to cater to those concerns, Crest just kept
fighting cavities. Arm & Hammer launched bakingsoda toothpaste; Rembrandt introduced “anti-aging”
and whitening formulas; Tom’s of Maine rolled out“natural” toothpaste. Mentadent promised to freshen
the breath. Between 1987 and 1997, Crest’s market
share slipped from 39 percent to 25 percent.

But the final stroke came in late 1997, when
Colgate came out with a toothpaste that fought
everything; cavities, tarter, plaque, bad breath, and,most importantly, gingivitis, that nasty gum disease
every dentist in the country harps on. Some 100 million Americans suffer from gum disease, andColgate’s Total was the only toothpaste with FDA
approval to claim it fights it. By the end of 1998,
thanks to Total, Colgate had grabbed 30 percent of the
toothpaste market, leaving P&G behind at 26 percent.

741

Procter & Gamble: Bringing the Company into the 21st Century

729

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

EXHIBIT 1
Financial Results Procter & Gamble Company (continued)
Consolidated Statement of Earnings
Years Ended June 30
Amounts in Millions Except Per Share Amounts

1998

1997

1996

Cash and Cash Equivalents, Beginning of Year$ 2,350$ 2,074$ 2,028

Operating Activities
Net earnings
Depreciation and amortization
Deferred income taxes
Change in accounts receivable
Change in inventories
Change in accounts payable, accrued, and other liabilities
Change in other operating assets and liabilities
Other

3,780
1,598
(101)
42
(229)
(3)
(65)
(137)

3,415
1,487
(26)
8
(71)
561
503
5

3,046
1,358
328
7
202
(948)
(134)
289

Total Operating Activities

4,885

5,882

4,158

Investing Activities
Capital expenditures
Proceeds from asset sales
Acquisitions
Change in investment securities(2,559)555(3,269)63(2,129)
520
(150)
(309)

(2,179)
402
(358)
(331)

Total Investing Activities(5,210)(2,068)(2,466)

Financing Activities
Dividends to shareholders
Change in short-term debt
Additions to long-term debt
Reductions of long-term debt
Proceeds from stock options
Treasury purchases(1,462)
1,315
1,970
(432)
158
(1,929)(1,329)
(160)
224
(724)
134
(1,652)(1,202)
242
339
(619)
89
(432)

Total Financing Activities(380)(3,507)(1,583)

Effect of Exchange Rate Changes
On Cash and Cash Equivalents

(96)

(31)

(63)

Change in Cash and Cash Equivalents

(801)

276

46

Cash and Cash Equivalents, End of Year$ 1,549$ 2,350$ 2,074

Supplemental Disclosure
Cash payments for:
Interest, net of amount capitalized
Income taxes
Liabilities assumed in acquisitions

$

$

$

Source: P&G.

536
2,056
808

449
1,380
42

459
1,339
56

742

Procter & Gamble: Bringing the Company into the 21st Century

730

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

EXHIBIT 2
Selected P&G Brand Names
Laundry and Cleaning

Personal Care

Food and Beverage

Paper

Ariel
Bold
BounceCascade
Cheer
Comet
Dash
Dawn
Dreft
Era
Mr. Clean
Spic and Span
Tide

AlwaysAttends
Bain de Soleil
Camay
Clearasil
Cover Girl
Crest
Fixodent
Giorgio
Head & Shoulders
Ivory
Max Factor
Metamucil
Oil of Olay
Old Spice
Pantene
Pepto-Bismol
Pet
Scope
SecretSure
Vicks
Vidal Sassoon
Zest

CriscoDuncan Hines
Fisher Nut
Folgers
Hawaiian Punch
Jif
PringlesSunny Delight

BountyCharmin
Downy
Luvs
Pampers
Puffs

Source: P&G.

Procter publicly insisted that Total’s victory was
only a minor setback, what with all the new,improved toothpastes it had out there or was about
to deploy. There is Crest Extra Whitening,
Multicare, and a slew of other variants. And yes,
sales of Crest were still gigantic ($400 million in the
United States), but P&G was obviously spooked byits loss of first place. Among rank-and-file P&Gers,
Crest was very much a touchy subject. Gordon
Brunner, the head of R&D at P&G, became visibly
uncomfortable when asked about it. His face reddened, and he stared stonily across his desk. Clearly
he did not want a discussion. Finally, he said tightly,“I credit Colgate in being very creative in theirapproach to get approval. Have they produced

major benefits to the American population? I don’t
think so.” P&G went so far as to send out thousandsof telegrams to dentists trashing Colgate’s clinical
trials just as Total was launching. Colgate says it did
everything by the book. P&G has since backed off.
Squabbles aside, the real issue was how Procter
got left behind. According to a former P&G
employee, “They were too focused on what they
had always been and never really saw the trends
emerging.” Procter even has had its own gingivitisfighting toothpaste for at least six years. But insteadof being in supermarkets, it was still in testing. In
this case Procter, which spent $1.5 billion on
research—nearly 4 percent of sales—was beaten tomarket by Colgate, which spent 2 percent.

EXHIBIT 3
Procter & Gamble Organizational Structure

Procter & Gamble: Bringing the Company into the 21st Century

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

731

743

744

Procter & Gamble: Bringing the Company into the 21st Century

732

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

EXHIBIT 4
P&G: Decline of Market Dominance

P&G’S CULTURE
Procter is nothing if not meticulous. It is also
achingly slow. Olestra, its fat substitute, took 30
years to get to market. The company blames this on
the glacial FDA approval process. Still, on average,
the company estimates that it takes five years to geta new product out. Typically it takes six months
just to put through a request to start manufacturing
a product. Creating a prototype takes five months.
Scrappier competitors do it in half the time or less.
In 1998, Arm & Hammer took nine months frominception to market to launch its first kitty litter
product. According to a packager who suppliedboth Procter and Colgate, Colgate’ll give you a project—in a week it’s out the door. By contrast, a P&G
project can take years.
Almost anyone who has worked at Procter will
rant about the “P&G way” of doing things. There’sa P&G way for using the bathroom. There’s actually a set of guidelines, called “Current BestApproaches,” directing employees on everythingfrom how to run market tests to how to approachretailers. People often don’t use their heads; they
just look up what they’re supposed to do. Even
P&G ads have a formula: problem, solution, andproduct demonstration. Think: Bounty is thequicker picker upper; Tide gets out the stains other
detergents cannot. One could probably recognize a
P&G ad anywhere; they must be written in a specific format; otherwise they get sent back over andover until it is right. Typically, an ad went through15 changes before it could be given to the brandmanager.
Breaking the mold can mean big trouble.
According to a former employee, he was hauledinto his department head’s office and chewed out
for being a “troublemaker” when he tried to createan ad outside the P&G formula. He left in 1993 tostart his own business. Former and current P&G
employees talk about the firm’s obsession withsecurity as though it has an internal secret-police
force. If a manager is at a cocktail party, talking too
loudly about something he was working on hewould get called in by security the next day. The

745

Procter & Gamble: Bringing the Company into the 21st Century

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

company says its security policies are no different
from any other large companies.
After so many decades of rigid conformity, P&G
has become known as the land of the Proctoids, aplace that squelches entrepreneurs, creative types,
and free thinkers, where “troublemakers” don’t
belong.
Over the years, P&G has lost some of the best
business minds around. AOL’s Steve Case,
Microsoft’s Bob Herbold, and Intuit’s Scott Cook all
got their start at P&G. Cook, who left in 1976, says
he felt stifled by Procter.
CAN JAGER STRAIGHTEN THINGS OUT?
Jager claims he is changing all that. He is looking
for rebels, for people who are willing to stick theirneck out and go with their guts rather than withsome rule book. Above all, he was looking for people who could come up with big, bold, new ideas,
the kind that gave birth to billion-dollar brands.
Jager is convinced that these people exist somewhere within P&G’s pool of 110,000 employees
and that his job is to emancipate them. Now
underlings, however lowly, can go straight to the
top with an idea and they might even be rewarded
with some of the stock options P&G has beenhanding out for the best ideas employees come up
with. On the company’s intranet there is a “MyIdea” site, where employees could post their zaniest ideas; in the three months it has been up, there
have been more than 3,000 postings. As for the rulebooks, Jager is openly trashing them. On one
employee video, Jager told employees to scrap
their “Current Best Approaches” manuals andthink for themselves.
But for all the rebellious rhetoric, Jager is a P&G
guy through and through. He had, after all, spent
the past 29 years at the company. On weekends hespent hours prowling drugstores and supermarkets
to check up on P&G products. Can an old-timer likehim really change the place? From the looks of it, healready has. Wall Street seems to think so: Since
Jager took over in January, P&G’s stock price hasgone up 11 percent, to $100.

733

Wandering through P&G’s Cincinnati headquarters these days, it feels like a city just liberated froman occupying army. Suddenly everybody is a rebel,
jumping at the chance to bash the old system.
EMPHASIS ON EMERGING MARKETSOut of all this, Jager is hoping to make P&G growagain. After all, the only true measure of the company’s transformation is growth. Jager wants P&G
to start catching up in emerging markets, where he
expects to tack on an extra 3 percent—or $1 billion
a year—to revenues. Here, too, the company has
fallen behind competitors: Unilever is entrenchedin Africa and India; in parts of South America,“Col-gah-tay” (Colgate) is a common word for
toothpaste. To coordinate P&G internationally,
Jager is reshuffling the company into seven global
business divisions; each would be run essentially as
an independent multinational corporation.
REAL SOLUTION: NEW PRODUCTS
But what P&G needs more than anything is great
new products. The company has pinned its future
on a small group of items consumers could neverthink they would need: Fit, an antibacterial fruitand-vegetable cleanser; Thermacare, a portable
heat wrap; Swiffer, a dry mop; Febreeze, a spray-on
odor eliminator; and Dryel, the home dry-cleaningproduct. These are P&G’s new inventions, thefuture Pampers and Tides of the world—it hopes.
From now on, Jager says, Procter will launch
approximately five new products a year. It has justspent millions building a new prototype lab to help
get them out to market. At least $200 million a year,or 15 percent of the R&D budget, is now devoted tomajor new business projects. Over the next five
years Jager expects new products to generate
another $1 billion in sales a year.
Can he deliver? Think about Dryel. For the firsttime in a long while, Procter is operating inuncharted territory (See Exhibit 5). Jager expects
Dryel’s sales to reach $500 million, making it as big
as Downy or Bounce. But selling a new kind of

746

Procter & Gamble: Bringing the Company into the 21st Century

734

CASE 14 Procter & Gamble: Bringing the Company into the 21st Century

EXHIBIT 5
The Next Tide: Dryel
P&G is on a mission to create the next Tide. At groundzero in this mission is Kathy Walkenhorst, a petite
brunette homemaker in the suburbs of Cincinnati. Twoyears ago P&G handed Walkenhorst a sea-foam-green
box containing a bottle of liquid, four towelettes, and awhite plastic bag. Her instructions: Use the mysterious
product, called Dryel, on her soiled silks and linens.
Every few months since then, Carol Berning, a Procter &Gamble psychologist, has traveled to Walkenhorst’s
house to watch and take notes. One Wednesday in early
March, 1999—with Berning peering over her shoulder—
Walkenhorst opens the green box, pulls out the plastic
bag, and stuffs it with a black sweater and a wool jacket.
Adding one of the moist towelettes, she tosses the bag

into her dryer. Now Berning questions: How does thismake you feel? Does Dryel make you happy? Are you
comfortable with it?
Thirty minutes later Walkenhorst’s clothes come out
dry-cleaned. Yes, dry-cleaned. Dryel, coming soon to asupermarket near you, is a bold move by P&G to dominate what it hopes will be a new consumer category—home dry cleaning. If P&G pulls it off, Dryel may soon
become as familiar as the company’s other big-nameproducts, old brands like Clearasil, Old Spice, Head &Shoulders, Ivory, and Pepto-Bismol.

home dry-cleaning product is not like selling thenewest version of Tide; it is much harder. Procter
has to convince consumers that they need a kind of
product they have never heard of. P&G reasonsthat Dryel will sell because it is cheaper ($9.99 for abox that cleans 16 articles of clothing) and moreconvenient than professional dry cleaning. And,
most important because it works.
But will consumers buy it? Dryel, and Fit andThermacare and other as-yet unconcocted innovations, may be the future of Procter, but none comeswith a guarantee. Which is exactly the point. Jager

believes P&G has no choice but to leap into theabyss, to invent new categories like home drycleaning.
Ironically, even here P&G is being outinnovated. As it happens, in the great, untappedmarket for home dry-cleaning, a New Jersey
startup, Creative Products Resource, is years aheadof P&G, it started selling a home dry-cleaning kit
called the Custom Cleaner on QVC in 1994. Custom
Cleaner is now available in stores for $6.99. Clearly,
the P&G rebellion has a long way to go.

Source: P&G.

33
C A S E 15

SpainSkoIn December 1994, Gonzalo and Pilar Goyes wereasking themselves what the future of SpainSko,
S.L. might be. They started this small family concern about eight months earlier, and had alreadyinvested some seven million pesetas (1), which was
about 70 percent of the 10 million total investment
they had originally forecasted as funds necessary
for their new business venture to reach break-even.
SpainSko imported Dansko shoes and then distributed them within Spain using direct marketing
methods. (See SpainSko’s initial advertising leaflet
in Exhibit 1, pages 746–748.)
Dansko shoes followed the new European concept of “comfort shoes:” they were not orthopedic,
but simply aimed to allow the feet to work properly. They fitted any shape of healthy foot perfectly
and the design sacrificed aesthetic appearance in
the interests of greater comfort.
The figures that Gonzalo and Pilar obtained fromthe calculations they did to work out the cost of identifying new customers seemed excessively high tothem. They were still a long way from making eachpurchase of Dansko shoes a profitable transaction.
In the past, they carried out various promotional
activities to reach different potential customer segments, some of which produced results far
removed from those obtained in similar exercises inother parts of Europe. They made inserts for magazines, and mailings to various consumer groups(priests and nuns, pharmacists, chiropodists, members of associations of diabetics, etc.).
Gonzalo knew that the key to reaching profitability and self-financing the growth of the business lay in building up a database of existingcustomers of Dansko shoes, who would be sent a
mailing every six months, each of which was
expected to yield an 8 percent response.

In December 1994, however, the most important
objective was to lower the cost of gaining new customers. If they failed to do so, they would have togive up their attempt to carry out direct sales in
Spain, because even greater resources would beneeded in order to overcome the lack of response to
the advertising campaigns.
Faced with this situation there were several
options:
1. Persevere with the system they had been using(inserts and mailings). This was the method
used in Germany, the country with the highest
sales figures.
2. Set up a retail store.
3. Look for a new distribution channel, such as
selling through pharmacists, teachers of physical education, physiotherapists, etc.
4. Publish advertisements like those that
Birkenstock (their rival) had been using.
5. Attend trade fairs (as was done in Germany).
BACKGROUND
History
Pilar Cerezo left the labour market at the age of 25
in order to devote herself full-time to looking after
her husband and four children. As they got older,
the children took up less and less of her time andPilar decided to talk to her husband Gonzalo about
her wish to make some contribution to the family
income, given that she had a few hours a day inwhich to do so.
Gonzalo Goyes had several years of experience
as a manager, consultant, and expert in setting up
new business ventures. He had great initiative andimagination. He was the general manager of aThis case was prepared by Clara Parés, under the supervision of Professor Lluís G. Renart and Francisco Parés, lecturer at IESE,
Barcelona, Spain. Copyright © 1995, IESE. Reprinted by permission.

735

747

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SpainSko

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CASE 15 SpainSko

company called Interstrategies, S.A., which had anumber of shareholders and was a business strategy consultancy and promoter of small companies
that were just starting up. In view of Pilar’s situation, he realized that he had to come up with an
idea for a small business venture that was personal, had flexible working hours, was close tohome, did not require regular travel, and called fora maximum investment of 10 million pesetas.
Some 20 years before, Gonzalo had to spend
two weeks in Denmark during the month ofFebruary. The bad weather, the cold, and the damp
ruined his footwear (traditional moccasins) and hefound it necessary to buy another pair of shoes thatwere both hard-wearing and as comfortable aspossible. It was his first purchase of Dansko shoes(which in Denmark sold under the brand name of
Jacoform). For the next 20 years he remained aloyal consumer of the brand, mainly on account of
their comfort and durability. He bought themwhenever he went to Denmark or ordered them
via any friend or colleague who happened to be
going there. Later, he discovered that he couldorder them by telephone.
Importing Dansko shoes and distributing themin Spain was, on the face of it, the sort of, venturethat would suit Pilar. For this reason, on May 25,
1993 Gonzalo got in touch with the manufacturerof Dansko, a Danish company by the name of A/S
Jac. Engelbredt which was owned by the family of
the same name. Jacob Engelbredt recommended
that Gonzalo contact Alfred Frank in Switzerland.
He was the person responsible for sales of Dansko
worldwide (except in Scandinavian countries),and acted as an independent distributor for
Switzerland.

A/S Jac. Engelbredt was a family company with
about 60 workers in its factory near Copenhagen
and another 20 or so in a second factory in Poland.
The shoes they manufactured were sold in the
Scandinavian countries under the name of Jacoform
and in the rest of Europe under that of Dansko.
The company started in the 1960s as a designer
and manufacturer of children’s shoes, prompted bya Danish physiotherapist who was looking for apair of shoes with the right anatomical shape thatwould allow his children’s feet to develop correctly.
From their studies of footwear for children, theyrealized that it would be possible to apply the same
concept to fully developed feet. They started manufacturing shoes for adults: basic, functional,
anatomical shoes, with enough room for the toes tospread at each step. In 1994, the leather for the
shoes was selected and imported from countries
such as Spain, cured in Denmark, then sent to
Poland to be hand-sewn, and returned to Denmark,where the soles were stuck on and the shoes wereprepared for sale (the laces were fitted, etc.).
At first, A/S Jac. Engelbredt sold in Denmarkand exported to Germany using the brand name
Jacoform. The shoes were a success, but the distributor registered the Danish brand in his own nameand started to manufacture locally. After the subsequent lawsuit, Jacob Engelbredt was allowed to use
the Jacoform brand only in the Scandinavian countries. In addition to this, a change in fashion in the
Scandinavian countries (one that favoured the saleof Italian-designed shoes) brought serious problems for the manufacturer. It was then that, withthe help of Alfred Frank (an expert in consumer
marketing who was interested in setting up a small
business in Switzerland), the following decisions
were made:INFORMATION RECEIVED
FROM ALFRED FRANK

1. Change to a new brand name that would be registered internationally: Dansko.
2. Maintain the traditional shape of Jacoform
shoes, giving priority to the functionality of thefoot over aesthetics, fashion, and price.
3. Dansko would be positioned as a “special” shoein terms of comfort and functionality.

Jacoform and Dansko Distribution in Europe
A telephone conversation with Alfred Frank helped
Gonzalo Goyes begin to understand how the worldof Dansko shoes worked.

749

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CASE 15 SpainSko

4. Outside of Scandinavia, the shoes would be distributed by means of direct marketing, since thecosts of producing in Denmark and of the raw
materials used were incompatible with thedemands of traditional shoe retailers.
Product Features
Dansko shoes were authentic moccasins: theleather covering the sides and the sole of the footwas all one piece, thereby guaranteeing that there
would be no stitching on the soles. They wereshaped anatomically, which made them lookstrange, but it was this shape which allowed thetoes to spread freely when the foot was bent forwalking. They were scientifically designed to beadaptable and appropriate to maintaining correct
posture. The sole was made of special rubber, theflexibility of which was graduated so that it wassofter under the toes than under the heel, which iswhere practically the whole weight of the body isborne. The high quality leather and the fact that theshoes were hand-sewn ensured their great durability and comfort.
The range of Dansko products was quite wide.
There were about 40 different models of shoes andsandals in a variety of basic shoe colours (black,brown, navy blue, beige, etc.).
Sales experience in other European countries
showed that one third of the retail price of each pairof shoes went to paying the manufacturer’s costs,
one third was spent on advertising, and the rest
covered the distributor’s overhead expenses andprofits. (Exhibit 2, on pages 750–752, has a technical description of the product.)
Distribution of Dansko in Central Europe
The key differentiating features of Dansko’s distribution system were that they did not compete on
price and they were not sold in traditional shoe
shops. Dansko shoes were sold directly to the public using direct marketing methods. They were
offered to groups of potential customers, such as
religious orders, pharmacists, diabetics, naturist

737

associations, etc., through direct mailings or via
inserts in magazines. The mailings included anadvertising leaflet about Dansko shoes and anorder form (which was printed on thicker card andrequired no return postage). The customer did nothave to pay for the shoes on receipt. The shoes weresent by mail and the customer had a few days to try
them out. If the customer finally decided to buy
them, he/she went ahead with the payment. If not,the customer was expected to return the shoes, also
by mail.
Under this system, 50 percent were returned,
half because the customer wanted a different sizeor style, and the rest because the customer decided
not to buy after all, having once seen and tested the
product.
The distributor had to bear the risk of dispatching the shoes. Given the particular characteristics of
Dansko’s customers, there were very few nonpayments. The “Group” of importers of Dansko
shoes into different countries was very satisfied
with this system.
All the importers of Dansko shoes in different
countries were considered to form a “group.”
They shared the design of advertising leaflets,
mailings, and other promotional activities in orderto reduce costs. Every new distributor had to be
accepted by all the members of the group, each ofwhich had exclusive rights in its own country. The
group shared their experience and know-how
with new members, while new members had tobear in mind that they too would one day bemembers of “the group” and that they shouldmake financial contributions toward promotion.
“The group” met twice a year and participated in
product development with Jacob Engelbredt. It
also took part in the joint planning of production
requirements and would assume the moral obligation of finding a way to get rid of obsolete stock,should it be necessary.
In 1993, “the group” was made up of the exclusive importers of Dansko shoes located inGermany, Switzerland, Holland, and Austria.
Alfred Frank started his importing business in
Switzerland very successfully in the same way as

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SpainSko

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CASE 15 SpainSko

Pilar would be doing. He had been a manager at
Procter & Gamble and then decided to retire to his
farm, at some distance from the centre of Basel, inorder to set up his own business. His fine results
had led J. Engelbredt to appoint him as “thegroup’s” coordinator.
In 1994, “the group” would sell some 35,000
pairs of shoes and 45,000 were forecast for 1995.
Forecasts for the year 2000 were for 120,000 pairs
between the whole group.
In the first letter that Alfred Frank wrote to
Gonzalo, he talked about various aspects of the distribution and sale of Dansko shoes, and advised theGoyes family:“Sales prices in the whole of Europe are quite high,higher than Clarks, Ganter, or other brands of comfort shoes that are on sale in shoe shops and otherretail stores. This is normal and Dansko customers
are not particularly price sensitive.
“The initial problem I had in Switzerland was
how to explain to my target audience why Dansko
shoes have this peculiar shape, and how to convince
women that they could wear these shoes too. It was
not an easy task, but the result was brilliant. In 1994,
60–65 percent of Dansko customers in Switzerland
were women, whereas in Germany they represented
only 40 percent.
“I think that anyone wanting to set up a business
importing and distributing Dansko shoes in Spainmust do so with a view to reaching reasonable sales
levels after three to five years. I ought also to say that
I would rather start exporting to France than toSpain.
“Prospective distributors in Spain must believethat the product can be sold directly. In the future,
the distributor will be expected to contribute funds
to the group of Dansko distributors for the design ofadvertising leaflets and mailing costs.
“In Switzerland, Germany, and Denmark manydifferent models and colours are currently sold. I
would recommend that you start with a limited
range of models.
“We are only prepared to collaborate with distributors who we believe really understand the product,
have mastered direct sales techniques, able to contribute enough funds to “the group,” and can reachadequate sales figures in three years.”

FIRST STEPS FOR THE GOYES FAMILY
Market Study
During, the summer of 1993, using the sparse information derived from Alfred Frank’s letters,
Gonzalo asked his daughter Yolanda, who had adiploma in business studies and was about to start
the fourth year of her economics degree, to carryout a small market study of the shoe sector in Spainin order to start to get to know their future distribution area. They had to find out if Spain was as difficult a market as Alfred Frank had said.
In broad terms, this was how the Spanish
footwear market stood in 1992.
Spain was one of the largest manufacturers offootwear in the EEC, although the average qualityof the products was nowhere near as high as
Dansko. For this reason, shoes manufactured in
Spain were not expensive on average. In spite ofthis, the figure for the purchase of shoes per capita
in Spain (3.2 pairs a year) was one of the lowest in
Europe (average of 4.2 pairs a year). This was dueto the mild climate in the country (which meansthat shoes do not have to be replaced so often) andto the lower level of income.
In 1989, 186.3 million pairs had been manufactured in Spain. Shoe manufacturers were small
companies and formed a very fragmented sector,
with 4 percent of the manufacturers having someinternational presence. Spain was one of the main
footwear exporting countries, particularly in thehigher price points. The trade balance in 1989 hadbeen the following:
Exports from Spain
Imports into Spain
Balance

128,738,000,000 ptas.
15,001,000,000 ptas.
113,737,000,000 ptas.

The sector was in difficulty and many manufacturers were going under.
With regard to distribution systems, there wereno large chains of shops specialized in shoe retail,and the value chain was basically as follows:• Retailers usually had a gross margin of 50 percent of the retail price.

751

SpainSko

CASE 15 SpainSko

739• Wholesalers and sales representatives had agross margin of around 13 percent of the retailprice.
• Manufacturers got about 37 percent of the retailprice.

Clarks and Scholl: a little cheaper than Mephisto,
but more difficult to find. The design was very
classic and not as sporty as Mephisto. The range
was wider as it included styles for around thehouse as well as sandals.

For example, if the recommended retail price ofa pair of shoes in a retail store was 15,000 ptas.,7,500 ptas. was the retailer’s gross margin; 1,950
went to the wholesaler or representative; and 5,550
ptas. was the price paid to the manufacturer.
On the other hand, the fashion factor was more
important than in other countries that had morefunctional tendencies. Sports shoes were gaining
ground over dress shoes, and the changing seasons
were well reflected in sales. Women bought morepairs of shoes per year than men, although at lower
unitary values.
Demand in the Spanish market was very seasonal, and was becoming more focused on themedium-high range, with more importance given to
comfort and durability. The demand for shoes did
not increase with the level of income, and brands
were becoming more important (sales through retailstores with exclusive brands were going up).
In Yolanda’s opinion, there seemed to have been
only one brand of comfort shoe in the Spanish market for two years: Birkenstock, whose head office
was in Germany. It was advertised through small
advertisements in the magazine Integral; anyone
interested was invited to send off for further information and a catalogue, prior to placing an order.
In addition to Birkenstock, there were otherbrands in the Spanish market that, although they
were not exactly “comfort shoes,” were shoes thatwere more comfortable than most and were aesthetically more “normal” (such as Mephisto or Clarks).
They were sold in retail outlets (pharmacists andshoe shops) at higher than average prices (around
20,000 ptas.). The competition in this category wasbroadly made up of three groups of brands:

Bally: only sold in top-class shoe shops and at
higher prices than Dansko. They were very classical dress shoes.

Mephisto: easy to find and similarly priced to
Dansko. Their sporty design made them moresuitable for use in the mountains, at weekends,
etc.

Selling shoes through distributors and retailers
was an option that the Goyes family had not yet
rejected until they analyzed the prices and margins:
50 percent of the retail price of each pair of shoes
sold was the retailer’s margin, which was justified
by the high level of stock required because of fluctuations caused by the fashion factor. This margin
was too high for a shoe like Dansko, where the costfor the importer-distributor was already higher
than the retail price of the majority of shoes sold in
Spain.
The immediate conclusion reached by Pilar and
Gonzalo Goyes was that they would need to sell
the shoes via direct marketing, although it would
be difficult to find people interested in the productsince this type of shoe was a totally new concept for
Spanish consumers. For the time being, they knewthat the shoe market had great potential because of
its size, and they had the feeling that there was asignificant number of people who had problems
with their feet.
One of the main problems encountered by theGoyes family was that of introducing the concept ofa “comfort shoe.” The customers had to be prepared to sacrifice the aesthetic appearance of their
shoes and accept comfort as the fundamental feature of Dansko shoes. They would have to get used
to the idea of accepting the natural shape of the footas an aesthetic shape, and likewise the design of
Dansko shoes. This seemed to be the most difficult
part.
TravelBefore they started buying any shoes fromEngelbredt, Gonzalo thought it would be sensible

752

SpainSko

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CASE 15 SpainSko

to visit Alfred Frank and the shoe factory inDenmark, thereby making their first serious investment in the potential business.
In October 1993, the Goyes couple traveled firstto Switzerland, where their immediate impression
was that the business was organized in basicallythe way that they were looking for: a business run
by Frank and his wife, with the help of two girls.
They sold enough pairs of shoes to keep the family
and cover the cost of two extra salaries.
They went to Denmark a couple of days later,where they familiarized themselves with the manufacturing process of the Dansko shoes and gradually expanded their knowledge of the world of
shoes, about which they had never previously
known anything in particular (nor had they ever
dreamt they would end up knowing it in such great
detail!).
Start of Operations
There were a number of factors that pushed theGoyes family into starting the new business. For
example, SpainSko (the name and brand they had
chosen for the importing and distribution company
in Spain) was able to start operations and share certain costs with other newly created companies thatwere also supported by Interstrategies (the consulting company of which Gonzalo was a director). In
addition to this significant help, they calculated
that with a maximum of 10 million pesetas they
could set up the business and reach the break-evenpoint.
The business suited Pilar perfectly in terms of
day-to-day requirements. She knew that one of thechildren would be able to answer the telephone
and process orders on any occasion when she
could not get to the office. For the time being, thecosts had been calculated without including any
labour costs (Pilar would be paid no salary at the
beginning), but Pilar was happy to accept this sacrifice since she knew that “the early bird catches
the worm,” and being the one to introduce theseshoes onto the market could be an important
advantage.

Initially, the main aim of the business was to get a
database of people who had already bought Dansko
shoes, since the chances of them doing so again werevery good. Customer loyalty was very high throughout Europe and was the key to success in marketingthe product. This was reflected in the fact that they
got an 8 percent response to every mailing to pastcustomers, which was done twice a year, whereas
mailings to the general public only got a response of
two or three per thousand impacts.
In February 1994, once they made the decision toattempt to import and distribute Dansko shoes
through Spain by direct marketing, there were twoareas where Pilar set to work immediately: theadvertising leaflet and the lists of names andaddresses to reach the prospective target audience.
The offer from “the group” (the usual way ofreferring to the group of distributors in Central
Europe) regarding the brochures was generous,
although it turned out to be unsuitable for the
Spanish market. Like the Goyes family, Alfred
Frank always tried to save as much as possible on
his costs, spending only where absolutely necessary. Therefore, he offered SpainSko the possibilityof using the same brochures used in the rest ofEurope, which could be obtained at very low cost
given the large print runs. This offer was immediately rejected once the samples reached Gonzalo.
They were six pages of pale, sad colours, very unMediterranean, with a medical air about the recommendations, and graphic explanations of the
product. Gonzalo had imagined a much more modern advertising leaflet for the shoes and decided tocommission a new design from a small company inBarcelona that specialized in advertising andgraphic design and whose work was always very
successful. The design and subsequent printing
made the leaflet more expensive. In the first print
run of 100,000 copies, each leaflet cost 21 pesetas,
including the reply coupon that was stuck to it.
The leaflet included explanations about the
product and instructions on how the sales system
worked. Once it was finished, all they had to do
was to send it to people who were particularly sensitive about their footwear.

753

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CASE 15 SpainSko

As for the initial range of products, there wereabout 40 different possibilities within Dansko(combining the different styles and colours).
However, they decided to start in Spain with amuch smaller range that would combine the moreclassic styles with the two-tone styles (consideredmore sporty). All the styles would be sold at an
average price of 18,000 ptas. (VAT and handlingand shipping costs included), bearing in mind that
the German Mark (the currency used by Engelbredt
for invoicing) had an exchange rate of 80 ptas./
Deutsche Mark (see Exhibit 1).
The prices were fixed at this level because,
according to the information supplied by Alfred
Frank, the cost structure for each pair of shoes was
as follows: 1/3 of the retail price covered the cost of
buying the shoe from the manufacturer, anotherthird was spent on advertising and sales promotions, and the rest was the contribution margin for
the importer/distributor.
Pilar thought it would be useful to have one
model with a lower retail price (16,100 ptas., model
5049, Latin brown) in order to find out how sensitive the public was to price. Also, Gonzalo managed to obtain a significant discount on one of themodels of which Denmark had a high level ofstock. The reason for this excess stock was that thecolour of this style was poorly reproduced in thebrochure used in Europe (it looked a lot worse in
the brochure than in reality), and so it had not soldas well as the rest. Controlling the exact colours
was a serious problem when it came to producing
advertising material.
Furthermore, in addition to importing shoes
with laces or velcro, they also decided to import themodel “Clou,” which came in a clog design but
with the same properties as the other Dansko
shoes. Its retail price would be 15,100 ptas. Pilar
thought that if Dansko’s customers really found theshoes comfortable, they might be interested in having a pair in the same shape as those for outdoors,
but for indoor use.
After a few months of operating in Spain, theyfound that their cost structure would be different:
almost 50 percent of the retail price went on import741

costs (largely owing to the depreciation of thepeseta, which in December 1994 reached 88 ptas./
DM), while the other 50 percent did not even cover
the advertising expenses. The contribution margin
was insufficient. At bottom, this was what mostworried and frustrated Pilar. “The shoes may be
marvelous, perfect, oh so comfortable . . . but we’re
never going to make a living from them!”
Features of the Sales System Set Up in Spain
The sales process began by mailing the advertisingleaflets to selected names and addresses or byinserting the same leaflets in selected publications.
Anybody interested in the product was invited toplace his/her order by returning the reply coupon
duly completed with their personal details and thesize and style required. They also had to send acheque, VISA number, or proof of a bank transfer.
Therefore, payment had to be made in advance,
when the order was placed.
The Goyes knew that in Germany the customer
paid for the shoes once he/she had tried them on athome and was sure that they fitted. The big disadvantage of this system was that 50 percent of theshoes sent out were returned, although a lot of people tried them on, and this was the main aim: seeing the shoes in a photograph in a brochure was nota great sales tool. In spite of everything, Pilar did
not dare to send out hundreds of pairs of shoes in
Spain without having any guarantee that theywould be either returned or paid for. She had the
feeling that the Spanish market was different fromthe German market in this respect.
Each customer had to choose the style and size.
The leaflet included a scale of shoe sizes and footmeasurements. There had never been problems
with this system in the whole of Europe. The number of changes due to wrong sizes was very low.
SpainSko agreed to change the style, colour, orsize as many times as necessary until the customer
was satisfied. In some cases, the product could be
returned. Payment in advance avoided the problem
of non-payment for SpainSko, and was necessary
for the dispatch system they were using. The shoes

754

SpainSko

742

CASE 15 SpainSko

would be sent out to the customer using a courier
service and would take less than 24 hours to reach
their destination. Dispatch by mail was rejected asthey believed the Spanish system was not reliable
enough.
Given how difficult it was to try the shoes on, as
they were not available in any shops, the option oftrying the product at home was offered and could
be requested on the order form. The price of thisservice was the same as the cost of sending theshoes by courier (1,250 ptas. including waiting time
for the messenger) and the extra amount wasadded to the sales price.
Start of the advertising campaign
First shots. In March 1994, SpainSko carried out its
first promotional activity by inserting advertisingleaflets (printed in Spain but translated into
German) into a German-language magazine,
Kontakt, that was published in Spain. The magazine
had 10,000 subscribers, who were basically immigrants from Central and Northern Europe resident
in Spain. The idea came about because of the wide
acceptance of Dansko shoes in Germany. The insert
cost 120,000 ptas. (all the prices of the campaigns
are given without the 16 percent VAT), plus the costof the leaflets that SpainSko gave to the magazine.
Only three sales were achieved.
At the same time, an agreement was made withthe company, Arex, to do a number of inserts of thesame leaflet in Spanish during the months March toJune. Arex binds copies of various Spanish magazines into more hardwearing versions for use in
waiting-rooms (magazines such as Hola, Lecturas,
Woman, Interviu, Actualidad Económica, etc., in otherwords, women’s magazines, current affairs, andother non-specialized themes). This cost 102,800
ptas. plus the cost of the leaflets; 8,677 inserts were
done. Only one sale was made.
To finish off the promotional effort in this firstmonth, a mailing was done to 500 members of theGoyes family and friends, 550 chiropodists, and
500 religious institutions. A letter presenting
SpainSko was sent (see Exhibit 3, on pages
753–758), with an advertising leaflet and a reply

coupon. The cost of each mailing was 64 ptas.,
which broke down as follows: 21 ptas. for theleaflet and reply coupon; 8 ptas. for the envelope;
28 ptas. for postage; and 7 ptas. for the presentation
letter. The results were slightly better: 5 sales to chiropodists, 13 to religious centres and, fortunately,
44 sales to family and friends of the Goyes family.
Sales to family and friends were a great success,which was very comforting for Pilar and Gonzalo,
but unfortunately this was not representative of themarket. They had not achieved enough sales fromthe rest, but had gained a lot of experience (bearing
in mind that they were starting from scratch).
1st campaign. April/September 1994. Pilar was
not expecting any more replies to the previous
inserts, despite the anticipation with which she
answered the office telephone, and was looking at
alternative means of advertising within the samecontext. This time, she turned toward inserts in more
specialized magazines on nature, health and dietary
matters. She ordered another insert, this time in themagazines Integral and Cuerpomente (owned by thesame publisher), but only in the copies sent out to
subscribers (16,900 in Integral and 9,000 in
Cuerpomente). The total cost of the two inserts was
290,000 ptas. plus the cost of the leaflets. This time,
Pilar Goyes seemed to be going in the right direction: 7 sales in Cuerpomente and 44 in Integral.
Because it usually obtained good results in othercountries in Europe, leaflets were sent to the members of the Association of Diabetics of Catalonia(ADC). In total, 1,550 leaflets were sent out, withmailing costs of 115,000 ptas. including the postage,
the envelopes, and the rental of the address list. The
addresses were rented as the company did not havea right to the membership list, since it was the ADC
that actually did the mailing. They only achieved
nine sales, which earned a commission of 2,000
ptas. per pair for the ADC. Also, about 20 leaflets
were left in the lobby of the ADC and theInternational Association of Diabetic Sportsmen(IADS): three sales were made through the IADS.
The idea of trying to make contact with members ofthese associations was that people with diabetes
often have problems with their toenails: their toes
become painful if their shoes are too tight.

755

SpainSko

CASE 15 SpainSko

In view of the low response rate achieved inthese two activities, the Goyes family reached theconclusion that there were still some illnesses thatwere socially unacceptable. It was known that in1994 12 percent of the Spanish population had anexcess of sugar in their blood but that only 7 percent were being treated for diabetes.
During the month of May, another sale was madefrom the Arex campaign, but the arrival of orders
came to a complete standstill during the summer.
The low level of diversification and the high seasonality of the product range were reflected in
SpainSko’s income statement.
By September, Pilar was anxious for winter toarrive to get things going in the company again.
She thought that the middle of that month would
be a good time to restart advertising the shoes. The
family wondered whether they ought to go back to
one of the target groups to which they had alreadydone mailings and inserts, or whether they should
try to get a better response by using different
advertising media to target different groups ofpotential customers.
They opted for the latter course and did a mailing to 3,700 pharmacists all over Spain, addressing
the pharmacists as consumers and not as prescribers or retailers of the product, since SpainSko
could not yet allow itself the luxury of paying thehigh margin on each sale that professionals would
demand for recommending a product. The cost of
buying the list of pharmacists’ addresses came to47,200 ptas. (to which had to be added the cost of
the leaflets, the envelopes, the presentation letter,and the postage). The result was four sales.
Conclusion of the first campaign. Evaluating
this first campaign was difficult because sales had
been really low (leaving aside the friends) andbecause cash problems were almost upon them. In
spite of this, Gonzalo was aware of the knowledge
and experience they had gained, and so did notconsider it a failure. They had tried a good number of different means of communication that wereappropriate for their budget and product, and only
one, the magazine Integral, had brought a slightly
hopeful result. The average response rate was
decidedly low.

743

Another important aspect at the end of this firstcampaign was that of the 134 orders received since
the start of operations, 113 were first orders and 21
were repeat orders, or orders of two pairs of shoes.
Just two people sent a cheque with their orderform and without calling by phone first, while four
telephoned before doing so. The rest placed theirorders by telephone. If people were calling by telephone it was because at heart they needed some
sort of moral reassurance. “Are they really as comfortable as the ad says? Are they really as well finished as they look?” Being able to speak directly to
Pilar gave them a sense of security. Therefore,
almost 100 percent of telephone calls were converted into sales.
It was also evident that only 5 percent of customers read the information and instructions in thebrochure properly.
2nd campaign. Once again, the Goyes family
wondered whether to repeat any of the advertising
they had already done, on the assumption that asecond impact could increase the response, orwhether they should change the focus of the previous campaign. Pilar reluctantly agreed to repeat
some mailings while also carrying out some new
actions.
Given that the consumer did not seem to be too
price sensitive, an increase in price was considered,given how much the peseta had depreciated (it was
now standing at 88 ptas./DM). In the end, however, there was no price increase because it would
have meant changing all the leaflets and reprintingthem.
In September, a second mailing was sent to pharmacists and religious orders, which was where thelargest response had been. In total, some 2,500 letters were sent out at a total cost of 160,000 ptas.
(including leaflets, envelopes, postage and letters).
The result was 17 sales (8 to religious bodies and 9
to pharmacists).
In accordance with the responses, a geographic
selection of the provinces with the best response
rates were made and an insert was placed in
October in copies of Integral and Cuerpomente forsubscribers and copies sold at kiosks in those areas

756

SpainSko744

CASE 15 SpainSko(in total, 39,000 copies). The cost was 450,000 ptas.
Plus the 21 ptas./unit for the leaflet and reply
coupon.
Between October and December, 52 pairs weresold through Integral and 14 through Cuerpomente.
Situation in December 1994. The Goyes family
had invested 7,250,000 ptas. In the business andthey were therefore getting close to the limit they
had originally set themselves of 10,000,000 ptas. In
fact, the most significant investments in stock andadvertising had already taken place. A year after
the company had been set up and after eightmonths of activity, break-even was still a dream inspite of not including any salaries or labour costs inthe profit and loss statement. (See Exhibit 4 onpage 759).
Furthermore, the comments reaching Gonzalo
about the business were pretty depressing. “Are
you telling me you’re trying to sell shoes as ugly as
this by direct marketing? You must be mad!” The
income statement showed significant losses.
In spite of everything, the owners of SpainSko
knew that in Europe an 8 percent response rate wasobtained from mailings to customers if they werecarried out twice a year (16 percent annually).
Bearing in mind the significance of friends spreading the word and the fact that many potential customers kept the brochures for a long time before
deciding to place an order, an annual response of 25
percent might optimistically be reached. If so, theperiod of amortization of the cost of obtaining
clients decreased considerably. Each sale brought
the company 7,200 ptas. of gross margin, and it wasestimated that each client would buy a further four
pairs of shoes in his/her lifetime (on average), in
addition to the initial order.
Since each pair of shoes sold generated a grossmargin of 7,200 ptas., Gonzalo calculated that theinvestment made so far in advertising was not
greater than the value of the client base they had
achieved (187 clients). The gross margin was calculated by subtracting the cost of the imported shoe,
the cost of shipping via courier, the cost of collecting
the money, and VAT from the price paid by the final
consumer. The latter did not affect the company’s

results for 1994 because during that year theamount of VAT incurred had been much greaterthan that paid by the customers.
The next problem that SpainSko would
encounter was the selection of new promotion
media: where to advertise and the best time toadvertise.
There were ultimately several options for continuing the business other than letting it die (an option
which the Goyes family did consider at times of crisis, but which Gonzalo and Pilar were fairly reluctant to accept):
a. Keep selling their shoes by using essentiallythe same direct marketing media and systems
they had used so far.
b. Set up their own exclusive retail shoe store.
This was an option that would give the potential customer a chance to try out the product in
comfort, although it would require a reallyhigh investment, and it would take time to set
up. Rent of at least 200,000 ptas. a monthwould have to be paid, the premises would
have to be fitted out and an employee taken on
with a minimum salary of 1,200,000 ptas. ayear. The high volume of stock needed would
make the cost of financing much higher. The
Goyes could obtain a bank loan at an annual
rate of about 13 percent.
c. Look for new distribution channels.
They had thought about selling through pharmacies, although the same stock problem
occurred as with shops, and they did not want
the product to be associated with the idea oftreatment or illness. There was yet another significant disadvantage: the margin.
d. Run advertisements in general interest magazines and newspapers.
This method did not work in Europe andcould be too risky to try out in Spain.
However, Birkenstock did it.
The cost of an 8 x llcm ad in the weekly“Life and Science” supplement of La
Vanguardia, the most prestigious daily newspaper published in Barcelona with a circulation

757

SpainSko

CASE 15 SpainSko

of 220,000 copies, was 256,000 ptas.; the same
size ad in Cuerpomente was 60,000 ptas. for acirculation of 40,000 copies, and 60,000 ptas. in
Integral for some 60,000 copies.
e. Attend large trade shows on different topics.
The aim was to deal directly with people who
had tired feet at that precise moment, and ask
them to try the shoes. “Who would not enjoy
the chance to sit down and try on some new,very comfortable shoes in the middle of a tiring trade fair?” thought Gonzalo.
The cost of exhibiting and selling at a
trade fair in Spain was high (500,000 ptas. as a745

minimum for a small stand, including rentalof the space, the decoration, travel and theaccommodation costs of the two people toattend the public), and they would not be able
to carry enough stock to sell anything. In spiteof these disadvantages, the public would be
able to get to know the brand better and see
and try the product. Birkenstock attended
some fairs but with a lot of stock for sale.
Would one of these options be equivalent tothrowing themselves off a cliff? Did they haveenough capital available?

758

SpainSko746
EXHIBIT 1
SpainSko

CASE 15 SpainSko

Front cover of the first advertising leaflet (original size: 20 x 27 cm.)

EXHIBIT 1
SpainSko (continued)
Spread inside the first advertising leaflet (original size: 40 x 27 cm.)...wer...w
eree walking
walking on air

SPORT
SPOR
T

This is the sensation that best describes
describes using
DanskoDansk
o shoes because their shape is a true
true
reflection of your
your footfoot’’s natural
natural shape.
shape.
For the first
first time in Spain, we can offer
offer youyouauthentic moccasins,moccasins, made in Denmark,Denmark, where asingle piece of leather cov
covers the whole foot,foot,including the sole fitting it like
like a glov
glove.

CLOU

The classic
classic Dansko
Dansko shoe.
shoe.
The most traditional
traditional stylein the brand.
brand. Hardw
Hardwearearinging
and breathable
breathable.. The mostauthentic supercomfor
comf
ortab
table
le moccasin.

The perfectperfect slipper:
slipper : for
comforcomf
ortt at home.
home. All the
anatomical advantages
advantages of
Dansko.
Dansk
o. Soft as a glov
glove inNubuk.
Nub
uk. Authentic moccasin.

VARIO(Interior in allov(Interior
allover leather).
FlexibFle
xible
le quiet sole.
sole. With a strap
strap
for possible
possible heel wear
wear or use asa clog. For the real connoisseur.
connoisseur.

Ref. 5830
Ref.
Brown
Bro
wn and blue/g
blue/grereyy.
18,600 ptas.

Authentic moccasins can only be made using toughleather which is at the same time soft and flexib
flexiblele..
Top quality.
quality. Each of our shoes has been made using
a careful selection of top class leather,leather, considered thebest in the wor
world.
ld. Painstakingly hand sewn,
sewn, thedesign of our shoes combines the most advanced
advanced
technology (robotics) with the most traditional
traditional
shoemaker
shoemak
er’’s craftsmanshipcraftsmanship..
The natural shape of the foot.
foot. DonDon’t
’t taketake chances
when dealing with the health of your
your feet.
feet.
Dansko shoes are adapted perfectly
Danskoperfectly to your
your feet
feetallowing
allo
wing you
you to walk
walk naturally
naturally,, with the optimum
optimum
space forfor your
your toes,
toes, and at a height that lets your
your
spine stand correctly,
correctly, reliev
relieves your
your knees and your
yourwhole body.
body.

Ref. 5319
Ref.
Black.
Black.
Ref. 4932
Ref.
Blue.. Nub
Blue
Nubuk.
uk.

19,100 ptas.

15,100 ptas.
Ref. 5825
Ref.
Navy
Na
vy blueblue..

CITY
With the charactercharacteristic
istic shapeand comfor
comfortt of Dansk
Dansko,o, thismodel has flat stitching,
cov
co
ver
ering
ing the moccasin in an
elegant sophisticated wa
way.

Perf
erfectect forforthe city andthe office.
office.

Ref. 5219
Ref.
Black.
Blac
k.

19,870 ptas.

18,200 ptas.
LATINO
LA
TINO

MAD

E

The softest shoe forfor themost delicate feet.
feet. With
just two
two eyeyelets, this shoe
has a high instep making
it ideal forfor the mostdemanding of feet.
feet.

IN
DENM
AR

GUARANTEEGU
ARANTEE

K

Super-comfor
Super-comf
ortt. The ergonomic design based on
the natural
natural shape of the foot,foot, gives
gives your
your toes total
freedom thereby
thereby attaining an ov
over
erall
all feelingfeeling of
wellbeing.
Natural. The biodynamic structure
structure with no heel
allowsallo
ws youyou to stand and walk
walk naturally
naturally and allows
allowsthe body’
body’s weightweight to be correctly apportioned.
appor tioned.

No laces and with the
comforcomf
ortt and easy cleaningof Nubuk.
Nubuk. Easy to fasten
fastenusing velcro
velcro.. Ideal for
for
tra
tr
aveling, especially to the
Orient.
Or
ient.

Ref. 5209
Ref.
Burgundy..
Burgundy
18,200 ptas.

Ref. 5216
Ref.
Brown.
Bro
wn.
18,200 ptas.

Ref. 5019
Ref.
Black.
Blac
k.
18,050 ptas.

Ref. 5320
Ref.
Brown
Bro
wn and blac
black.
k.
19,870 ptas.

Breathable.. The quality of the leather,Breathable
leather, lightly
dyeddy
ed using natural
natural products,
products, ensures the shoes
breathe perfectly
perfectly..

Light and summery
summer y but
but with
all the Dansk
Danskoo features
eatures..
Combination of leather andNubuk.
Nub
uk. Elegant andhardwearhardw
earing.
ing.
A special young
young style.
style.
Ref. 5373
Ref.
Blue and beige.
beige.
Nubuk.
Nubuk.
18,990 ptas.

SPORT
SPOR
T DUO
Elegant combination of two
twocolours.. Ideal forcolours
for casual
dressing. For week-ends
week-ends,,
the country
countr y, going to thematch, etc. Strong,water-resistant, comfor
comfortabtable
leand tireless companion.
Ref. 5388
Ref.
Beige and burgundy
burgundy..
Nubuk.
Nubuk.
19,870 ptas.

Ref. 5330
Ref.
Brown
Bro
wn
and blue/g
blue/grereyy.
Nubuk.
Nubuk.

SpainSko

Hardwearing. The quality and care taken
Hardtaken inproduction ensure that your
your shoes will last for
for
many
man
y years
years and are,are, therefore
therefore,, a goodinv
investment.

SPORT
SPOR
T JEANSCASE 15 SpainSko

Health. Our shoes reflect our health and hav
have abearingbear
ing on it. The special flexib
flexiblele sole has ashock-absorbing
shoc
k-absorbing effecteffect on jolts to the spine andalleviates
alleviates joints.
joints.

747

759

760

SpainSko

748

CASE 15 SpainSko

EXHIBIT 1
SpainSko (continued)
Back cover of the advertising leaflet (original size: 20 x 27 cm.)

Enjoy the most comfortable and most natural shoes in the world
Dansko seen from the inside
Enough height for
the toes.

Adjustable
light instep.

Air chambers in theside as shockabsorbers.

Long periods standing up at work, tightshoes and high heels harm your circulation
and affect the muscles.
Dansko shoes are specially suitable forjobs where comfort is an absolute
requirement, for people with sensitive feet(gout, diabetes...) and for anyone whowants to be really comfortable.

No stitching in theleather on the sole(authentic moccasins).

Flexible base.

1. Liberate your feet, especially
your toes

1. The most natural way of walking

Heel with a double
lining of leather.

2. Relax your muscles
and relieve your joints

2. Keep your spine straight and firm

Shoes with heels put too much pressure on
your joints and spine. Dansko shoes haveno heel and therefore the weight of the bodycan be spread across the entire foot. Your
posture will be natural and straight.

A Correct posture without heels: straight
back, straight stomach, relaxed legs.

B Incorrect posture with heels.

Satisfaction - Guarantee - Convenience - Exclusive Service
Satisfaction or your money back. Once you have tried the shoes
on in you home, if for any reason you are not entirely satisfied,
SpainSko S.L. will exchange them for another pair or will refund
your money.
1 year guarantee. SpainSko S.L. undertakes to replace yourshoes in the event of there being any manufacturing defect in the

All models
are available in sizes 36 to 47
In case of doubt regarding you size, stand barefoot over a ruler andmeasure the length of your foot. The centimetres will give
your size.

first year. (This guarantee excludes normal wear and tear or

cm

23

23,6

24,3

25

25,6

26,3

27

27,6

28,3

29

29,6

30,3

damage as a result of misuse.)

size

36

37

38

39

40

41

42

43

44

45

46

47

Convenient. Fill out the attached order form, using block capitals
and giving your personal details. Remember to specify the methodof payment and to sign. Place your order in an envelope and post it
to us or telephone it through. In less than two weeks you will
receive the shoes in your home (not sent by post but using a
courier service, free of charge).
Exclusive service for home trials.
Dansko shoes are suitable for all feet but if you prefer to try them
before making a decision, request this exclusive service, adding
an extra 1,250 ptas to your order.
Remember to include your telephone number so as to arrange atime for trying on the shoes. The delivery person will take care ofpayment, returns, or changes of style, size or colour.

For any further information,please contact us at:SpainSko

761

CASE 15 SpainSko

749

EXHIBIT 1
SpainSko (continued)
Front and back of the reply coupon sent out with the leaflet(93) 675 51 21

The easiest and quickest
quickest way
way to place your order
order,, with no need to fill
f ill out this form,
form,
is to telephone Monday to Friday
Friday between
between 9am and 7pm.

¨ Yes, I want
want to enjoy
enjoy the feeling of freedom and comfort
comfort of dansko shoes.
Fill out this order
order form
form and send in an envelope
envelope to:SpainSko S.L. -P Torrorrebeblanca,lanca, 2-8, 1°E -08190 Sant Cugat
Cugat del Vallés, Barcelona
Barcelona
Full Name ___________________________________________________ ID N° ________________
Address ____________________________________________________________________________
Post code ________________________________ Town _____________________________________
ProvincePro
vince ________________________________ Telephone __________Age __________________
5219
ReferenceCity
Description

Means of payment:
payment:

42Size

I authorize SpainSko
SpainSko to charge
charge theamount of the articles
articles requested.

VISA
A
¨ VIS

Black
Black
Colour18,200Price

Door to door
deliv
deli
ver
ery
y.

FREE

ExpiryExpir
y date:Signature

Total orderorder¨ I wish to try
try the shoes

Card No.
¨ Cheque (paya(payabble to SpainSko S.L.)

1,250 ptas.

on at home firstf irst072732• SpainSk
SpainSkoo S.L. is the exclusi
exclusivve importer
importer and distributor
distributorof the Dansk
Danskoo brand in Spain.
• These shoes are exclusi
exclusivve and are not av
availabailablele anyw
anywhere
here else.
• You can only
only purchase them directly
directly
from SpainSk
SpainSkoo S.L.,
which serv
serves the whole
whole of mainland Spain and theBalearic Islands.
• For
For further
further information,
information, contact us at:SpainSkoo S.L.
SpainSk
P. Tororreb
reblanca,
lanca, 2-8, 1°E
08190 Sant Cugat
Cugat del VallésBarcelona
Tel (93) 675 51 21 – Fax
Fax (93) 675 51 69

762

SpainSko

750

CASE 15 SpainSko

EXHIBIT 2
Technical Description of the ProductSpainSkoDESCRIPTIONDANSKO. A really functional shoe.
Shoes are basic requirements which help our feet to work
properly for the whole of our life.

2. The front profile of the shoe is slightly rounded,
not slanted from the big toe to the small toe. In
this way, it is suitable for almost all shapes offoot, for example if the second toe is as long as
the big toe.
3. Good height internally inthe shoe including overthe big toe, so that there isenough room for slightmovements inside the shoeup or down.

The shape and make-up of our feet is closely linked totheir function. A thorough understanding of how feetwork when we walk or run is the scientific base for goodshoe designers.
The manufacture of shoes in natural shapes has increasedin Europe over recent decades as fashion preferences
have given way to functionality.
Of course, fashion cannot be disregarded altogether, andthere are certain limitations with regard to the technology and the materials. This has on occasions prevented
knowledge about how feet work being fully applied tothe design of shoes.
DANSKO shoes are the result of the most successfulattempt to create a shoe that is highly suitable for all
modern requirements and has the shape and functions ofa good shoe.
The emergence of new materials, better manufacturing
techniques, and close collaboration between the manufacturer, the designer and the feet experts have all madeit possible to create these shoes (orthopedists, chiropodists, physiotherapists, and kinesiologists).
The following requirements were borne in mind when
designing DANSKO shoes:....................
Phalanges....................
Metatarsus....................
Tarsus....................

1. The front part ofthe shoe isshaped like afan, so that thenatural directionof the toe bones
can be kept
straight, thereby
giving themroom to expand
a bit.

4. The sole has no welts, which assists in the take-off
movement over the big toe. With regard to width, as
the line of the sole is parallel to the stitching on themoccasin, it makes the shoe look narrower.
5. A relatively small narrow opening to the shoe, and a
relatively long area where it does up are combinedwith a cup-shaped heel and a slightly raised area
under the rear of the arch. This ensures firm support
in the back half of the shoe and effectively preventsthe foot sliding forward.
6. The raised area under the back of the arch mentioned in the previous paragraph, just in front of theheel support, prevents the foot turning inwards
when standing (knock-knees). It does not support
the arch (which can move freely). Only the rear
third of the arch is supported.
Tak
ake-off
e-off
supportt at lev
supporlevelof 1st radius
radiusCentralCentr
al axis of the footfootIV Toe support
suppor t

Apex
Apex of footfoot support
suppor t
III Foot
Foot support
suppor t
Suppor t on
Support
1st metatarsal
head
EXTERNAL LINE
OF THE SHOE

Suppor t zone
Supportzone on the
5th metatarsal

II “Isthm“Isthmus”
us”

Apex
Ape
x of heel support
suppor t
I Heel support
suppor t

SPAINSKO. S.L. A. Torreblanca, 2-8, 1° E-08190 S.Cugat del Vallés. Barcelona. Tel: (93) 675.51.21 Fax: (93) 675.51.69 - NIF B 60498250

763

SpainSko

CASE 15 SpainSko

751

EXHIBIT 2
Technical description of the product (continued)
7. Independent of the cup-shaped support that holds
the heel in place, the inner sole of the shoe is flat orlevelled between the heel support and the forward
support of the foot (II: the “isthmus,” see Fig 2).
This part of the foot has no external curvature andneeds constant contact with the sole.
8. In the part below the toe and foot supports, the soleof the shoe has a malleable layer beneath the leather.
Each user shapes this part of the sole individuallyby compressing it and establishing the greatest areaof contact. This leads to the formation of a slightridge between the foot support and the toes.
Together with the support mentioned in points 5
and 6, this prevents the foot from slipping forward(see Fig. 2).
9. The shoe has a zero heel, inother words, it has no raisedheel nor any difference inlevel. We are born without
raised heels and this zerolevel is the most natural way
for the foot to carry out its
functions properly. But
remember that the shoe has a
cup and a brake in the heelto prevent knock-knees (seepoint 6). If shoes with highheels are worn, the foot’s
natural movements are
restricted and the body isforced away from its natural
centre of gravity. Even low
heels force the toes andarches to support the weightof the body.

50%

50%

10%

10. The shoe has a flexible sole that is very light andresistant to friction. This helps during the strong,
upward twist by the big toe in order to get the footoff the ground.
11. The bottom of the sole isrounded at the front and at theback, over the so-called footpropulsion line. This assists forward movement, carrying theweight from the heel across theisthmus to the front part of thefoot, allowing the foot to take off
easily and smoothly.
12. The progressively flexible soleand the shank allow the sole andthe foot in general to twist
lengthwise towards the end of
take-off, when the front part of
the foot twists anti-clockwise,
whilst the back of the foot twists
in the opposite direction (rightfoot).
13. In general, the shoe is designed with a straight axis,
that is to say that the heel directs the foot towards
the front in such a way that neither the big nor the
little toes are squeezed sideways. This is achievedby having the central axis of the foot (b) in the centre of the heel support and straight down to the second toe, dividing the foot lengthwise in a ratio 3/4.

90%

SPAINSKO. S.L. A. Torreblanca, 2-8, 1° E-08190 S.Cugat del Vallés. Barcelona. Tel: (93) 675.51.21 Fax: (93) 675.51.69 - NIF B 60498250

764

SpainSko

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CASE 15 SpainSko

EXHIBIT 2
Technical description of the product (continued)
SpainSko
As can be appreciated in the previous thirteen points, thefundamental concept of a DANSKO shoe is that the forward part of the foot is free to spread out widthwise
whilst holding the rest of the foot and giving maximum
support to the arches during the take-off movement. The
back area is designed to ensure firm support for the ankle
and the heel. In a naturally-shaped shoe, it is not enoughfor the front part of the foot to be able to move freely, it isalso very important that the heel is well supported.
By means of a decreasing angle, the bottom part of theshoe under the sole follows the lengthwise movementsof the arch in walking and the rounded edges at thefront and back of the sole permit greater surface contact
and therefore, a better distribution of weight. Having
the foot absolutely level (zero heel) ensures cooperation

between the calf muscles and the pressure muscles inthe toes.
The leather used is top quality in terms of water proofing, (6 hours water resistance) as well as flexibility andresistance to bending. The leather is dyed gently so as tomaintain its porous nature and achieve water resistanceand an ability to breathe at the same time. Thick, flexible, hard-wearing leather therefore lasts longer.
DANSKO:The shoe that lets you walk “barefoot”.
The shoe with firm support for your heel.
The shoe to wear standing up, walking and running.
Imported into Spain by

SpainSko, S.L.

tel. 93.675.51.21

765

SpainSko

CASE 15 SpainSko

753

EXHIBIT 3
Letter to Friends of Pilar and Gonzalo Goyes, Sent with an Advertising Leaflet (Exhibit 1)

We have just set up SpainSko, S.A.
We have opened an office in Sant Cugat
Av. Torreblanca, 2-8, 1°, Local E
Tel. 675.51.21 Fax.675.51.69
We will not be having an official inauguration ceremony but we hope you will call in whenever you canto have a glass of cava with us.
You will already be aware how important your help and support can be in these early days. SpainSko
imports and directly distributes Dansko shoes.
These Danish shoes have a natural shape which makes them very comfortable. They are not orthopedic orcorrective shoes, they are just very comfortable.
They are manufactured to very high quality standards and in spite of seeming quite expensive, their durability makes them very economical. They are anatomical, water-proof, flexible, made of leather, authentic
moccasins (like a glove), recyclable, etc.
They are particularly good for people who suffer from aching feet or who appreciate comfort above all
else, such as:- Those of us who are past the stage of wearing sneakers at week-ends.
- For all the football fans who claim to be sufferers (or not) at matches.
- For those who travel, visit trade fairs, or whose hobbies make them abuse their feet (walking, water,
cold, standing, etc).
- For older people whose feet ache, diabetics, those who suffer from high levels of uric acid, or who arejust up to date in ecology and natural health.
I am sure that you must know a few of these people. They are our target market.
These shoes are not sold in shoeshops, just directly by us, and it is for this reason that your spreading theword about the product is so important to us in helping to get the business going. If you know anyone
who might be interested, call us or send us a fax with their address so that we can contact them.
Very many thanks

766

SpainSko

754

CASE 15 SpainSko

EXHIBIT 3 (continued)
Letter to Pharmacists, Sent with a Leaflet (Exhibit 1)

DEAR PHARMACIST: AN OFFER FOR YOU AND YOUR EMPLOYEES.
*You know better than anyone how tired you can feel standing up all day. We would like you to be oneof our customers.

*

DANSKO shoes have the following features:** They are not meant to be corrective, just very comfortable and natural.
** They respect the natural shape of the foot. They are good for one’s circulation.
** They exert no pressure of any kind on the toes, either from the front, from the sides or from thetop. (Within normal shapes and sizes).
** They are held in place exclusively by the cup-shaped heel and the fastening.
** Authentic moccasins, with a single piece of leather enclosing the bottom and the sides of the foot.
Like a glove.
** Flexible rubber sole that helps the foot to twist. Act as a spring, assisting take-off.
** Hand-sewn. Manufactured with very soft top-quality leather, with a minimum thickness of
2.5mm. Water-resistant. Porous, hygienic and totally recyclable.

*

We do not sell through any wholesaler, just directly, giving each customer personal and individual
service.

*

We are writing to you as someone with a professional interest in matters of health.

*

SpainSko is the exclusive importer and distributor in Spain of DANSKO shoes.

*

If you are interested in receiving a complete report on the principles behind the design and manufacture of these shoes, or simply more brochures, please call us on:

SpainSko

Tel. (93) 675.51.21
Fax (93) 675.51.69

Edificio Torreblanca
A.Torreblanca, 2-8, 1° E
08190 San Cugat del VallésBarcelona
Pharmacies, Sept. 94

767

SpainSko

CASE 15 SpainSko

755

EXHIBIT 3 (continued)
Circular letter to the first customers

SpainSkoNews
N°l. Sept. ‘94

Dear customer,
You are one of the first people in Spain to be wearing Dansko shoes.
Last Spring, our small family company began importing and distributing DANSKO shoes in Spain on
an exclusive basis.
I have served nearly all of you or spoken to you on the telephone personally. Many of you have encouraged us to go on with your enthusiasm. It has been a success!
All of those with whom I have spoken after their purchase have commented on how comfortable theshoes are, on the quality of the leather and finishing, and particularly on the prompt delivery thanks to
MRW, the courier company used.
We would like to have more or less regular contact with you in order to serve your needs or to contact
anyone you pass on to us. We know that there are people who are interested in natural comfort who wecannot reach without your help.
Our objective is quality and comfort, and fashion is moving towards natural, comfortable products.
The Danish manufacturer of these shoes, A/S Jac. Engelbredt, has explained to us how they (a family
company), together with Mr Alfred Frank (also a family business), managed to create a group of people in several European countries who distribute and sell these shoes using the same methods as us.
We are so sure of the quality of this product that we have started a sales system in Spain that has nofear of complaints. Up to now, we have had not a single one, except for changes of sizes, which we havedone without any quibbles or delays.
We are starting to build a large Dansko Family in Spain.
Thank you for everything.

SPAINSKO. S.L. A. Torreblanca, 2-8, 1° E-08190 S.Cugat del Vallés. Barcelona. Tel: (93) 675.51.21 Fax: (93) 675.51.69 - NIF B 60498250

768

SpainSko

756

CASE 15 SpainSko

EXHIBIT 3 (continued)
Circular letter to religious centres, sent along with an advertising leaflet (Exhibit 1)

SpainSko
Many members of religious orders in Northern and Central Europe are loyal users of DANSKO shoes.
*

SpainSko is the exclusive importer in Spain of DANSKO shoes.

*

DANSKO shoes are very comfortable and natural. They help the circulation and are ergonomic.
** They respect the natural shape of the foot.
** They exert no pressure of any kind on the toes, either from the front, from the sides or from thetop.
** They are held in place exclusively by the cup-shaped heel and the fastening.
** Authentic moccasins, with a single piece of leather enclosing the bottom and the sides of the foot.
Like a glove.
** Flexible rubber sole that helps the foot to twist. Act as a spring, assisting take-off.
** Hand-sewn. Manufactured with very soft top-quality leather, with a minimum thickness of
2.5mm. Water-resistant (6 hours). Porous, hygienic and totally recyclable.

*

SpainSko does not sell through any wholesaler, just directly, giving each customer personal and individual service.

*

If you are interested in receiving a complete report on the principles behind the design and manufacture of these shoes, or simply more brochures, please call us on:

SpainSko

Tel. (93) 675.51.21
Fax (93) 675.51.69

Edificio Torreblanca
A.Torreblanca, 2-8, 1° E
08190 San Cugat del VallésBarcelona
Religious orders, April ‘94
SPAINSKO. S.L. A. Torreblanca, 2-8, 1° E-08190 S.Cugat del Vallés. Barcelona. Tel: (93) 675.51.21 Fax: (93) 675.51.69 - NIF B 60498250

769

SpainSko

CASE 15 SpainSko

757

EXHIBIT 3 (continued)
Circular letter to chiropodists, sent with an advertising leaflet (Exhibit 1)

SpainSko
Some points of interest about SpainSko*

SpainSko is the exclusive importer in Spain of DANSKO shoes.

*

DANSKO shoes are not meant to be corrective, just very comfortable and natural. They help the circulation and are ergonomic.

*

DANSKO shoes have the following features:** They respect the natural shape of the foot.
** They exert no pressure of any kind on the toes, either from the front, from the sides or from thetop.
** They are held in place exclusively by the cup-shaped heel and the fastening.
** Authentic moccasins, with a single piece of leather enclosing the bottom and the sides of the foot.
Like a glove.
** Flexible rubber sole that helps the foot to twist. Act as a spring, assisting take-off.
** Hand-sewn. Manufactured with very soft top-quality leather, with a minimum thickness of
2.5mm. Water-resistant (6 hours). Porous, hygienic and totally recyclable.

*

SpainSko does not sell through any wholesaler, just directly, giving each customer personal and individual service.

*

If you are interested in receiving a complete report on the principles behind the design and manufacture of these shoes, or simply more brochures, please call us on:

SpainSko

Tel. (93) 675.51.21
Fax (93) 675.51.69

Edificio Torreblanca
A.Torreblanca, 2-8, 1° E
08190 San Cugat del VallésBarcelona
Chiropodists, March ‘94

770

SpainSko

758

CASE 15 SpainSko

EXHIBIT 3 (continued)
Note Setting out the Special Sales Conditions for the Association of Diabetics of Catalonia (ADC)

Note on conditions for the ADC
9.3.94
1. Prices include VAT.
2. The prices are set at a level to be used with no extra discounts and are payable in advance. However, theAssociation’s case is special.
3. The Association will pay for its sales in cash on delivery of the shoes, or they will have been paid in advance by
the customer and will be sent directly to the customer by courier.
4. If the Association does not invoice but issues a delivery note, SpainSko will send the corresponding invoice tothe customer together with the shoes. SpainSko will collect cash on delivery for the shoes and will pay to the
Association the corresponding commission at the end of each month:
1,000 ptas for each order from a coupon handed out by the Association, and
2,000 ptas for each direct sale, whether by messenger or at their premises.
This commission will be invoiced by the Association with the corresponding VAT for its marketing services.
5. If the Association prefers to invoice directly, it will have to guarantee all payments, and SpainSko will invoice
every two weeks with payment by cheque within the following two weeks. The invoice will be made out for theamount shown as RRP minus the 15 percent VAT, which will be added later to the net amount.

771

SpainSko

CASE 15 SpainSko

759

EXHIBIT 4
Balance Sheet and Income Statement at 31 December 1994
AssetsUnexpected capital outlay
Fixed assets
Set-up costs
Fixed assets
Intangible fixed assets
Permanent financial investment
Depreciation
Prov. For. Depr. Of perm. Investment
Cost to be carried overProfit and loss statement0
1,923,612
830,353
1,071,903
084,600–63,24402,776,915
2,725,481
51,434

Cost of sales
Purchases of materials
Messengers
Inventory changes

1,292,234
1,989,366
165,401–862,533

Contribution margin

1,484,681

0Working assets
StocksCustomers
Tax accounts receivable
Other debts
Temporary financial investments
Cash1,533,425
862,533
64,150606,74200441,575

Total assets

3,898,612
Liabilities

EquityCapitalReserves
Profits and losses after tax
Long-term creditors
Short-term creditors
Bank debts
Accounts payable-suppliers
Accounts payable-tax
Other creditors
Accruals & prepayments
Total liabilities

Income from sales
Sales of shoes
Other income

2,854,819
7,250,000
0–4,395,181
0
1,043,793
0
264,7130779,080

Other expenses
Office materials, equipment
Administrative agents,...
Maintenance and repairs
Advertising and PR
Travel costs
VariousSalaries and wages
Social security
Rent
Miscellaneous utilities
Insurance
Tax4,908,516
351,508
97,00011,5002,841,878
443,331
156,15600405,600
541,543
060,000Cash-flow–3,423,835

Depreciation

895,831

Net operating profits–4,319,666

Financial result–75,515

Profits after tax–4,395,181

0
3,898,612

Notes: Sales in 1994 were 217 pairs, which, multiplied by the average price of the brochure, gives a figure higher than the sales in
the profit and loss statement. This is due to the significant discounts given to family and friends.
Note that there are no salaries or wages paid out or charged to this business.
The present balance sheet and profit and loss statement were established before taking into account some tax advantages. For
instance, according to Spanish tax law, and having incurred losses in 1994, SpainSko was entitled to a tax credit of 938,181 ptas.,
which could be used or compensated against future profits generated in the following seven years. Also, it was estimated thatsome 2,500,000 ptas. of advertising expenses could be offset against future profits.

772

SpainSko

760

CASE 15 SpainSko

EXHIBIT 5
Summary of the Different Marketing Activities Carried out up to December 1994
Type of action

Number of
Impacts

Result No of pairsof shoes soldCost (without 16% VAT)

Insert of 10,000 brochurestranslated into Germanin the magazine “Kontakt”

10,000120,000 ptas. + (10,000 × 21 ptas.) =330,000 ptas.

3

Arex Insert

8,677

102,800 ptas. + (8,677 × 21 ptas.)=285,017 ptas. 2 (one immediate saleand another in May)

Mailing to friends ofthe Goyles family

500

500 × 64 (1)=32,000 ptas.

44

Mailing to chiropodists

550

550 × 64
(list obtained at no cost)=

35,200 ptas.

5

Mailing to religious bodies

500

500 × 64
(list obtained at no cost)=

32,000 ptas.

13714,217 ptas.

67=833,900 ptas.

Integral = 44
Cuerpomente = 7

Mail = 115,000 + (1,550 × 21 ptas.) =ADC commission = 2,000 ptas. × 9 =Total = 147,550 + 18,000=

147,550 ptas.
18,000 ptas.
165,550 ptas.

9

Total first shots
Inserts in magazines
Integral andCuerpomente(subscribers only)
Mailing Association of
Diabetics of Catalonia(ADC)
Brochures left at theInternational Association of
Diabetic Sportsmen (IADS)
Mailing to pharmacists

20,227
16,900 + 9,000= 25,900

1,550

20

3,700

290,000 + (25,900 × 21 ptas.)

20 × 21 ptas.

=

420 ptas.

3

Cost of the list:
Total = 47,200 + 3,700 × 64 ptas.)

47,200 ptas.
284,000 ptas.

4=

1,283,870 ptas.

67 (2)

160,000 ptas.

Pharmacists = 9
Religious bodies = 8

Total actions in 1st campaign

31,170

2nd mailing to pharmacists
and religious bodies

2,500

2,500 × 64=

2nd insert in Integral andCuerpomente

39,000450,000 + (39,000 × 21 ptas.)= 1,269,000 ptas.

Integral = 52
Cuerpomente = 14

Total actions 2nd campaign

41,5001,429,000 ptas.

83 (3)

Total actions up to
December 1994

92,897

3,427,167 ptas. (4) 217 pairs soldto 187 different
clients(1) The cost of a complete mailing was: 21 ptas. for the brochure with a reply coupon + 8 ptas. for the envelope + 28 ptas.
for the stamp + 7 ptas. for the presentation letter.
(2) Of these, only 46 pairs were sold to totally new customers, and 21 were repeat orders, or pairs sold in a two-pair order.
(3) Of these, 74 pairs were sold to new customers, and 9 were repeat orders, or pairs of shoes sold in a two-pair order.
(4) The figure for the total cost of these marketing activities is calculated outside the books, and turns out to be higher than
the figure in the column for “advertising and PR” in the income statement because here it includes some costs (envelopes,
stamps, letters) which appear under other headings in the profit and loss statement.

34
CA S E 16

Coca-Cola’s Long-Term
Marketing Strategy

In May 1999, the Coca-Cola Company was
examining its long-term marketing strategy toseek growth and profitability. The person heading
this effort was none other than the company’sCEO, M. Douglas Ivester, who was appointed tolead the company in late 1997 after the death of
his predecessor, the legendary Roberto C.
Goizueta.
For the Coca-Cola Company, which rode thewave of global capitalism further than almost anyother U.S. multinational, the recent turbulence
strikes at the core of its being. After years of solid
15 percent or better annual earnings gains, Coke®
surprised Wall Street in the third quarter of 1998
with weak results. That was followed by a fourth
quarter in which earnings plunged 27 percent
from those in 1997. For the year 1998, Coke registered a 1 percent drop in operating income, to$4.97 billion on $18.8 billion in revenues, and was
likely to be flat again in 1999. To a company thathas long been considered one of America’s premier growth stocks, that’s akin to falling off acliff.
Indeed, the reaction on Wall Street has been
humbling. During Goizueta’s 16-year reign, Cokeshares rose a breathtaking 3,500 percent. But after
the bad news began to pile up in the summer of
1998, Coke’s stock fell by nearly a third, from 88 toaround 59 in April 1999. Some investors wondered
whether Coke’s days of outsize returns were gone
forever. Still, there were some who believed theworst might be over. Despite a dismal first quarter
in which operating profits fell by 9 percent, Cokeshares climbed in May 1999 to 66. Exhibit 1 summarizes Coca-Cola’s financial results. Exhibit 2
highlights Coke’s financial woes.

CRISIS IN THE OVERSEAS MARKETS
Coca-Cola derived more than three-quarters of its
profits and 71 percent of its growth outside theUnited States since summer of 1998; however, theglobal crisis had a marked impact on Coke’s performance; and its sales and profits were battered by
the turmoil abroad. In Brazil and Japan, two of
Coke’s biggest overseas markets, flattened consumer buying power left growth in 1998 almost
nonexistent. In Russia, where Coke has invested
more than $700 million over the past eight years,
the collapse of the economy left the Coke system
operating at 50 percent capacity.
The global crisis had left many thirsty people inAsia, Russia, and Latin America unable to afford a
Coke. In Brazil, its third-largest market, Coke hadlost more than one-tenth of its 54 percent market
share to low-cost local drinks produced by familyowned bottlers exempt from that country’s punitive soft-drink taxes. And in Japan, Coke’s
fourth-largest market, sales had been flattened bothby economic turmoil and an emboldened Pepsi®,
which last year signed up beverage giant Suntory
as its new Japanese distributor.
PROBLEMS AT HOME
Back at home, where Coke derived one-fifth of its
profits, it faced an entirely different order of problems. Consumers here already drank more softdrinks than in any other country outside of
Mexico—45 percent of it from the Coca-Cola Co.
Combining that with a reinvigorated Pepsi fighting
for every scrap of market share, Coke was left withless room to maneuver (see Exhibit 3). Almost

This case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

761

773

774

Coca-Cola's Long-Term Marketing Strategy

762

CASE 16 Coca-Cola’s Long-Term Marketing Strategy

EXHIBIT 1
Financial Results—The Coca-Cola Company and Subsidiaries
Consolidated Statements of Income
Year Ended December 31,

1998

1997

1996

$18,813$18,868$18,673

Cost of goods sold

5,562

6,015

6,738

GROSS PROFIT
Selling, administrative and general expenses

13,251
8,284

12,853
7,852

11,935
8,020

OPERATING INCOME
Interest income
Interest expense
Equity income
Other income-net
Gains on issuances of stock by equity investees

4,967
219
277
32
230
27

5,001
211
258
155
583
363

3,915
238
286
211
87
431

INCOME BEFORE INCOME TAXES
Income taxes

5,198
1,665

6,055
1,926

4,596
1,104

NET INCOME$ 3,533$ 4,129$ 3,492

BASIC NET INCOME PER SHAREDILUTED NET INCOME PER SHARE

$
$

$
$

$
$

(In millions except per share data)
NET OPERATING REVENUES

1.43
1.42

1.67
1.64

1.40
1.38

AVERAGE SHARES OUTSTANDING
Dilutive effect of stock options

2,467
29

2,477
38

2,494
29

AVERAGE SHARES OUTSTANDING ASSUMING DILUTION

2,496

2,515

2,523

See Notes to Consolidated Financial Statements.

anywhere it turned, it faced the prospect of having
to sacrifice profitability to increase sales.
With the average American already swilling
more than 800 servings of soda a year, skeptics
wonder how much growth could be wrung out of
the United States. The flagship brands, CokeClassic and Diet Coke, are still growing at roughly
4 percent a year, but they might be approaching thelimit. In recent years, consumers’ appetite for colas
overall have flattened—and diet soda has actually
lost ground to bottled water.

Further, at the very moment he could least afford
it, Ivester was being forced to expend precious
resources to fight off a reinvigorated PepsiCo Inc.,
which was aggressively trying to win back the market share it had lost to Coke earlier this decade.
Suddenly, Pepsi was fighting tooth and nail forevery restaurant chain, every supermarket display,and every vending machine opportunity that cameup. That new sense of purpose had forced Coke tomake much costlier concessions to retain its biggest
customers. Unlike past skirmishes, this Cola War

775

Coca-Cola's Long-Term Marketing Strategy

CASE 16 Coca-Cola’s Long-Term Marketing Strategy

EXHIBIT 1
Financial Results—The Coca-Cola Company and Subsidiaries(continued)

Consolidated Balance Sheets
December 31,

1998(In millions except share data)
ASSETS
CURRENTCash and cash equivalents
Marketable securities$ 1,648
159

Trade accounts receivable, less allowances of $10 in 1998 and $23 in 1997
Inventories
Prepaid expenses and other assets

1,807$ 1,666
890
2,017

TOTAL CURRENT ASSETS

6,380

INVESTMENTS AND OTHER ASSETS
Equity method investments
Coca-Cola Enterprises Inc.
Coca-Cola Amatil Limited
Coca-Cola Beverages plc
Other, principally bottling companies
Cost method investments, principally bottling companies
Marketable securities and other assets

584
1,255
879
3,573
395
1,863
8,549

PROPERTY PLANT AND EQUIPMENTLand
Buildings and improvements
Machinery and equipment
Containers

199
1,507
3,855
124

Less allowances for depreciation

5,685
2,016
3,669

GOODWILL AND OTHER INTANGIBLE ASSETS

547$19,145

LIABILITIES AND SHARE-OWNER’S EQUITYCURRENT
Accounts payable and accrued expenses
Loans and notes payable
Current maturities of long-term debt
Accrued income taxes
Total Current Liabilities$ 3,141
4,459
3
1,037
8,640

763

776

Coca-Cola's Long-Term Marketing Strategy

764

CASE 16 Coca-Cola’s Long-Term Marketing Strategy

EXHIBIT 1
Financial Results—The Coca-Cola Company and Subsidiaries(continued)

December 31,

1998

LONG-TERM DEBTOTHER LIABILITIESDEFERRED INCOME TAXES

687
991
424

SHARE-OWNER'S EQUITY
Common stock, $.25 par value
Authorized: 5,600,000,000 shares
Issued: 3,460,083,686 shares in 1998; 3,443,441,902 shares in 1997
Capital surplus
Reinvested earnings
Accumulated other comprehensive income and unearned compensation on restricted stock

865
2,195
19,922(1,434)

Less treasure stock, at cost (994,566,196 shares in 1998; 972,812,731 shares in 1997)

21,54813,145
8,403$19,145was shaping up to be a war of attrition, in which
the market-share winner might turn out to be theearnings loser.
STRATEGY FOR MARKETS ABROAD
In the short run, Ivester was doing whatever it
took to keep the syrup flowing. To make drinks
more affordable, Coke switched from refundable
glass packaging and introduced cheaper 6.5-oz.
bottles. It scaled back ad campaigns in favor of instore “instant win” promotions. In Poland, Coke
bundled free candy bars with its half-liter bottles—
one of several moves that had helped boost firstquarter 1999 sales there 17 percent. Costs werebeing cut, too: Coke’s Indonesian officials, forinstance, relinquished their downtown office spaceand moved into a bottling plant.
But Ivester did not manage just for the shortterm. For the long term, Ivester’s response to his
company’s myriad problems has been remarkably
consistent. Rather than pulling back as the going
got rough, Ivester had repeatedly doubled his bets
by spending lavishly in order to win an ever-bigger

slice of the global market. That meant using thedownturn as a chance to buy bottlers, distribution,and even rival brands cheap.
By investing in new capacity around the world,
he was making a bet that the global economy
would recover swiftly. On a recent swing throughBrazil, he announced that despite the 40 percent
devaluation of the real, Coke would boost its
investment in Brazil by 10 percent, to $366 million
and plow more than $1 billion into Africa over the
next three to five years, doubling Coke’s investment there. And in China, where Coke volume
grew 20 percent during 1998, Coke managers weretaking the ultimate long-term view, putting together a 100-year plan at Ivester’s request.
Ivester argued that the investments would allow
Coke to emerge from this period stronger than ever.
His view was that in any crisis there was opportunity. In effect, he was betting that the big investments made in 1999 and following years, would
buy Coke market share and growth opportunities
in the future. It was a risky bet. In the short term,
the spending spree added to the pressure on Coke’s
bottom line and hammered operating margins

777

Coca-Cola's Long-Term Marketing Strategy

CASE 16 Coca-Cola’s Long-Term Marketing Strategy

765

EXHIBIT 2
Coke’s Financial Troubles—Coca-Cola’s Long-Term Marketing Strategy

down from historical levels of over 26 percent to 21
percent by the end of 1998. Even at its current
depressed stock price, Coke traded at a priceearnings ratio of 45—a number that would surely
decline if Ivester’s strategy fell short. Already, WallStreet was becoming more skittish.
However, Ivester insisted in some cases thatprices were just too low to pass up. Coke offered$187 million to Britain’s Inchcape PLC for four bottling plants in Russia. But as the economy continued to sour, Coke eventually got them in October,
1998, for just $87 million. Still, critics warned that it
could be 15 years before Coke sees a return on its
Russian investments.
Coke pointed to Mexico as an example of thestrength of its long-term strategy. Mexican managers boosted market share in their country from 53
percent to 68 percent by investing in new plants

during the peso crisis. Coke did not break out earnings by country but says the market was “veryprofitable” and that volume rose 13 percent during
1998.
Ivester was not betting just on his ability to get
more people around the world to drink more Coke.
Having spent the past decade building a worldwide bottling system, he intended to use it to deliver any beverage that could find a big following. His
boldest gambit yet was his $1.85 billion deal toacquire rights to Canada Dry, Dr Pepper, and therest of Cadbury Schweppes PLC’s soft drinks andmixers in 120 markets outside the United States—adeal that would give Coke two more percentage
points of global market share, and probably morethan that in time.
That was a big if. The deal is facing stiff resistance from regulators in such countries as Mexico

778

Coca-Cola's Long-Term Marketing Strategy

766

CASE 16 Coca-Cola’s Long-Term Marketing Strategy

EXHIBIT 3
The Pepsi Challenge—Coca-Cola’s Long-Term Marketing Strategy
The Cola Wars used to be a walkover for Coke. As relentless as a Roman legion, it regularly humbled a distracted
Pepsi, widening its market-share lead. But Coca-Cola
Company’s easy victories are history. A newly invigorated Pepsi has launched a hellacious assault on its archrival that has forced Coke, already struggling withinternational woes, to expend huge chunks of money andtime to defend its 44 percent to 31 percent U.S. lead.
Whipping No. 2 PepsiCo Inc. into fighting trim has
been the mission of Chairman and CEO Roger A. Enrico
since he took over in 1996. Enrico has made Pepsi a leaner, feistier foe by spinning off capital-intensive distractions such as restaurants and bottling. Now, withrevved-up marketing, price wars in the stores, and an
assault on Coke’s lead in fountain and vending-machinesales, he is going after Coke with a vengeance. Says
Philip A. Marineau, Pepsi’s head of beverage operations:“We’ve reenergized our system.”
KUDOS. Nowhere is the change more visible than in
Pepsi’s marketing. After years in which it pumped out
glitzy ads that did not sell much, Pepsi is doubling
spending—to $300 million a year—to launch a fusilladeof new initiatives that are finally winning kudos frommarketing experts. In March 1999, Pepsi rolled out asplashy new campaign for its flagship Pepsi-Cola brand.
And to hype its new Pepsi One diet drink, the cheeky No.
2 is even dusting off its old “Pepsi Challenge” gambit
from the 1970s, the last time it made gains on Coke. But
perhaps its biggest move will come starting in May 1999,
with the release of Star Wars: Episode I—The Phantom
Menace. With plans to spend up to an estimated $2 billion
over the six-year, three-film deal, Pepsi has scored a big
piece of what should be one of the hottest promotional
opportunities around. Look for Pepsi to exploit the films
with toys, ads, and co-branded soft drink cans.
Out in the real world, the newly pugnacious company’s chief avenue of attack is fast-food chains. Now
accounting for one-quarter of all beverage sales, suchchains are the fastest growing distribution channel, and,with margins of 15 percent, one of the most lucrative.
Coke, with 8 of the 10 largest fast-food chains in its pocket, has a commanding 65 percent to 25 percent market
share advantage. But Pepsi has scored some minor victories, stealing seven smallish fast food accounts from
Coke, including Pizza Inn Inc. (525 outlets) andBojangles’ Restaurant Inc. (257). And its biggest victory
may have come simply from being a contender when
Coke recently renewed its contract. “The fact is, we put ascare into Coke,” says a Pepsi exec. “Wait till we go after
McDonald’s.”
Coke must also worry about Pepsi’s bid to plant moreof its blue vending machines around the landscape. Since
1997, Pepsi has added 170,000 machines nationwide, fora total of about 1 million. Today, Coke remains far ahead,with roughly 1.4 million machines. But Pepsi’s push has
made the battle to place the machines—which boast
margins of more than 30 percent—far more competitive.
SNACK TIME. Enrico also wants Pepsi to do better at
exploiting the one edge it enjoys: the combined strengthof its soft drinks, its new Tropicana juice unit, and FritoLay, the world’s largest salted-snack provider. After all,people heading to the store for a snack often pick up softdrinks at the same time. So far, the “Power of One” campaign has consisted of a few joint promotions. But Enrico
is making sales calls on supermarket-chain CEOs withthe heads of Frito-Lay, Pepsi, and Tropicana. Their pitch:
Increase your sales by moving soft drinks next to snacks.
Count on Coke, which would be at a disadvantage
because it does not sell chips or pretzels, to resist Pepsi’s
aisle-placement plans.
The reality remains that Coke can no longer coast.
“Pepsi has changed the rules,” says William W. Wilson,
CEO of independent Pepsi-Cola Bottling Co. of New
York. “It’s finally willing and able to spend big-time on
catching Coke.” No wonder Coke is looking over its
shoulder.

and Australia, where Coke already has a 65 percent
market share. Some analysts and rivals felt that the
problems stemmed as much from Coke’s intransigence as its size. In France, Coke’s proposed

takeover of the Orangina brand has been blocked
by regulators for 16 months, though analysts
believe Coke would make concessions and end theimpasse soon.

Source: Business Week, May 3, 1999, p. 151

779

Coca-Cola's Long-Term Marketing Strategy

CASE 16 Coca-Cola’s Long-Term Marketing Strategy

STRATEGY FOR THE HOME MARKETIn the United States the company intended tospend whatever it took to hold on to key customers
or sign up new ones. But not all of Coke’s U.S. marketing expenditures were likely to be that lucrative.
With Pepsi upping the ante, Coke must pay more tokeep its most important fountain contracts.
Consider the heated bidding over the 10,000-store
chain of Burger King Corp., which recently cameup for renewal. Burger King paid Coke about $220
million a year for 40 million gallons of soda syrup,
according to industry sources. Under the old contract, Coke gave back about $25 million of that inrebates to the food chain. After Pepsi pitched
Burger King for the business, Coke ended up winning, but only by doubling its rebate. That cut
Coke’s margins. Worse, the Burger King rebates
would likely jack up the price for many of Coke’s
remaining contracts.
Increasingly, Coke also had to pay top dollar tosign smaller, less traditional deals. For example, aCoke bottler agreed to pay $28.5 million over ten
years for sales rights across a single Michigan
school district, twice what Pepsi offered. Coke
thought the hefty fee, which worked out to anannual $28 per student, would pay off, since soda
loyalties were often established in the teen years.
Meanwhile, in the supermarket aisles, where margins were a paltry 3 percent, Coke’s attempts toraise prices had hurt sales.
Additionally, Ivester had set a goal of increasing
per capita U.S. consumption of all Coke productsby 25 percent a year, to five hundred 8-oz. servings.
That meant every American, on average should be
drinking close to two cups of Coke’s products
every day. To get there, he was looking for new
ways and new places to sell a thirsty public a Cokeor a Coke product.
If Ivester had his way, consumers would soon
find Coke’s red-and-white machines everywherefrom the local post office to the school cafeteria.
Although they accounted for an estimated onetenth of Coke’s system-wide sales, vending
machines carried room for a lot more. A couple ofyears ago, he asked execs at Coca-Cola

767

Consolidated—his second largest U.S. bottler—to
try an experiment. He wanted them to double thenumber of vending machines in Salisbury, North
Carolina, a small city that had been budgeted for amodest 4 percent increase in capital spending. The
result: Each machine generated a 30 percent to 50
percent annual return. Coke Consolidated is now
adding 25,000 new vending machines. Coke is also
testing a hybrid gas pump/vending machine in
Pennsylvania and was working on a similar
stamp/beverage machine for post offices. Further,
Coke has added a host of new products in the
United States, from other soft drinks such as citrusflavored Surge, to juices, teas, and now water.
Yet even as he moved to capture a larger shareof those side markets, Ivester emphatically rejected the notion that Coke had hit a permanent
plateau in the United States. He said that pundits
had predicted the passing of colas ever since the1930s. During lunch in his executive dining room,
Ivester compared consumption per capita for eachcity or region with that of another country. The
per-person consumption of Coke in Lubbock,
Texas, for instance, was no higher than in Chile;the consumption in Knoxville, Tennessee, was thesame as that in Mexico. And consumers in
Phoenix and Los Angeles—two of the lowest areas
in soft-drink consumption—drink no more Coke
than people in Hungary. “Why am I so optimistic
about the future? Look at this map,” Ivester
claimed.

IVESTER’S STYLE OF MANAGEMENT
The barrage of bad news caught Coke at a ticklish
time. Managing a downdraft is tough for anyone,
but Ivester, 52, had barely moved into the corneroffice when the numbers began to fall apart lastsummer. On top of that, he followed one of themost successful and revered CEOs in corporate
history. For all their mutual respect and long working relationship, the two men couldn’t have been
more different: Goizueta, the Cuban aristocrat, andIvester, the first in his family to attend college. The
cerebral Goizueta fancied himself the master780

Coca-Cola's Long-Term Marketing Strategy

768

CASE 16 Coca-Cola’s Long-Term Marketing Strategy

strategist who ruled at one remove. His pupil, who
put in 14-hour days and stayed in contact withmanagers worldwide through e-mail, voice mail,and an alphanumeric pager, did not hesitate to get
involved at street level, whether it was monitoringa minor acquisition in Peru or a bottler’s complaint
in South Africa.
The emphasis on nitty-gritty details and creative
solutions were vintage Ivester. And it was a sharp
departure from the arm’s-length, patrician style ofhis predecessor. Now, 18 months into his tenure,
Ivester’s style and substance were being tested inways he never could have anticipated. Although hetook over one of America’s most admired companies after spending years preparing for the role, thesoft-spoken ex-accountant was steering a company
that faced a world of trouble.
Ivester, the son of a textile-mill supervisor, gaveup the partner track at accountants Ernst &Whinney to join Coke’s finance staff in 1979 andhad since worked in nearly every corner of theCoke empire. Under Goizueta, he executed manyof the tactics that had won Coke a 50 percent shareof the worldwide soda market. In 1986, Ivester
engineered the ingenious spin-off of Coke’s bottling operations. As European chief later in thedecade, he led the push into Eastern Europe by driving a truckful of Coke into East Germany even as
the Berlin Wall was falling. And, as head of CocaCola USA from 1991 to 1994, he introduced a plastic version of Coke’s contour bottle that helped lift
Coke’s U.S. market share two percentage points.
Inside the Coke camp, few question that Ivester
had the right stuff to take Big Red back to its glory
days. Coke’s board has make it clear that Ivester
had its undiluted confidence.
Even as the economic winds battering Cokereached gale force, Ivester remained unflappable. Ina pep talk to employees in February, Ivester was resolute that the business had not fundamentallychanged, noting that Coke had weathered countless
economic crises in its 113 years. “We’re dealing withhuman thirst,” Ivester told employees in his gentle
Georgia accent. “There’s nothing about economicchange that is going to change people’s thirst.”

Ivester insisted that his strategy included nothingthat his mentor, Goizueta, would not have done. But
although Ivester might have held to his original vowof “no left turns, no right turns” after Goizueta’s
death from cancer in late 1997, these have been some
subtle changes in the Coke culture and style. While
Goizueta kept constant watch on Coke’s stock andthe analysts who followed it—sometimes critiquing
their reports with handwritten notes—Ivester
poured his energies instead into Coke’s customers,
no matter how small. J. L. “Sonny” Williams, president of Minyard Food Stores in Coppell, Tex.,
recalled how Ivester sent a red wagon after the birthof his first child last year, and then took time duringa recent stop in the Lone Star State to chat over barbecue and tour one of Minyard’s 85 stores. “It was
nice to see a CEO who was so down to earth,” said
Williams. Minyard said he had never met anyone
from Pepsi headquarters. Ivester claimed that if thecompany focuses on the customers, the business willprosper, and if the business prospers, the stock will
eventually be priced right.
Ivester also began the delicate task of shifting
Coke’s corporate culture, which had developed areputation in some quarters for arrogance andstodginess. To speed the decision-making process,
Ivester cut several layers out of Coke’s organizational hierarchy. Under Goizueta he began scrapping Coke’s grueling December planning
marathons with managers in favor of real-timebudgeting, giving his field generals more freedom
to respond to any opportunities that might arise.
And, he tried to soften Coke’s old “tough-love”
style of management. According to Ivester, “Manyemployees today did not grow up in traditional
households.” You’ve got to transition to a modern
style of motivating people.
And as part of that strategic effort, Ivester had
encouraged more of his troops to think boldly totake more risk, even encouraging one manger who
had a scheme to use a laser to beam Coke’s trademark off the moon to “go for it.” (“It actually would
have worked,” assured the manager, Steve Koonin.
“But the FAA was worried about the risk of us slicing airplanes in half.”)

781

Coca-Cola's Long-Term Marketing Strategy

CASE 16 Coca-Cola’s Long-Term Marketing Strategy

CONCLUSION
Exhibit 4 summarizes Coke’s challenges and problems. In the end, Ivester’s biggest obstacle might be
Coke’s tremendous size and success. The bigger
Coke gets, the harder it will be to reproduce the769

earnings record set by Goizueta and demanded byWall Street. The bets Ivester had placed around theglobe have added to Coke’s immediate pain. But if
he was right, the current crisis would not turn out tobe the end of an era, simply the pause that refreshes.

EXHIBIT 4
Coke’s Challenges and Solutions—Coca-Cola’s Long Term Marketing Strategy
Challenge

Solution•

Saturated U.S. Market: Americans already drink
more than two helpings of soft drinks a day on
average.

•

To grab market share. Coke is striving to makeits drinks available everywhere people gather—from the post office to the school cafeteria.

•

Rough Waters Abroad: Coke has bet on emerging
markets from Asia to South America. But with thoseeconomies devastated, getting consumers to trade
cash for a soda pop is a tough sell.

•

Coke’s answer: cheaper packaging andsmaller servings.

•

Stymied Acquisitions: Attempts to snare big
overseas brands such as Orangina, or the foreign
rights to Cadbury Schweppes’s soft drinks andmixers have been blocked by regulators.

•

Observers expect Coke to eventually makeconcessions and close the deals.

•

Resurgent Pepsi: Coke still dominates, but its
nemesis Pepsi is suddenly richer and more focused.

•

Coke is taking the long view, paying big bucks
for the chance to bond with consumers throughexclusive sales deals.

C A S E 1 7 L’Oréal Nederland B.V.:
Product IntroductionYolanda van der Zande, director of theNetherlands L’Oréal subsidiary, faced two
tough decisions and was discussing them with
Mike Rourke, her market manager for cosmetics
and toiletries. “We have to decide whether to introduce the Synergie skin care line and Belle Couleur
permanent hair colorants.” Synergie had recently
been successfully introduced in France, the homecountry for L’Oréal. Belle Couleur had been successfully marketed in France for two decades. Mr.
Rourke responded:
Yes and if we decide to go ahead with an introduction
we’ll also need to develop marketing programs for the
product lines. Fortunately, we only need to think
about marketing, since the products will still be manufactured in France.

Ms. van der Zande replied:
Right, but remember, the marketing decisions on theselines are critical. Both of these lines are part of theGarnier family brand name. Currently Ambre Solaire(a sun-screen) is the only product we distribute with
the Garnier name in the Netherlands. But headquarters would like us to introduce more Garnier productlines into our market over the next few years, and it’s
critical that our first product launches in this line be
successful.

Mr. Rourke interjected, “But we already sell otherbrands of L’Oréal products in our market. If we
introduce Garnier what will happen to them?”
After some more discussion, Ms. van der Zande
suggested:
Why don’t you review what we know about the Dutch
market. We’ve already done extensive marketing35

research on consumer reactions to Synergie and Belle
Couleur. Why don’t you look at it and get back to mewith your recommendations in two weeks.

BACKGROUND
In 1992, the L’Oréal Group was the largest cosmetics manufacturer in the world. Headquartered in
Paris, it had subsidiaries in over 100 countries. In
1992, its sales were $6.8 billion (a 12 percent
increase over 1991) and net profits were 417 million
dollars (a 14 percent increase). France contributed
24 percent of total worldwide sales, Europe (bothwestern and eastern countries excluding France)
provided 42 percent, and the United States andCanada together accounted for 20 percent. The restof the world accounted for the remaining 14 percent. L’Oréal’s European subsidiaries were in oneof two groups. (1) major countries (England,
France, Germany, and Italy) or (2) minor countries(the Netherlands and nine others).
The company believed that innovation was its
critical success factor. It thus invested heavily inresearch and development and recovered its investment through global introductions of its new products. All research was centered in France. As finishedproducts were developed, they were offered to subsidiaries around the world. Because brand life cycles
for cosmetics could be very short, L’Oréal tried to
introduce one or two new products per year in eachof its worldwide markets. International subsidiaries
could make go/no go decisions on products, butthey generally did not have direct input into the
R&D process. In established markets, such as theThis case was prepared by Frederick W. Langrehr, Valparaiso University, Lee Dahringer, Butler University, and Anne Stöcker.
This was case written with the cooperation of management, solely for the purpose of stimulating student discussion. All eventsand individuals are real, but names have been disguised. We appreciate the help of J.B. Wilkinson and V.B. Langrehr on earlier
drafts of this case. Copyright © 1994 by the Case Research Journal and the authors. It is reprinted here by permission.

770

783

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CASE 17 L’Oréal Nederland B.V.: Product Introduction

Netherlands, any new product line introduction had
to be financed by the current operations in thatcountry.
L’Oréal marketed products under its own nameas well as under a number of other individual andfamily brand names. For example, it marketedAnaïs Anaïs perfume, the high-end Lancôme line ofcosmetics, and L’Oréal brand hair care products. In
the 1970s, it acquired Laboratoires Garnier, and thisgroup was one of L’Oréal’s largest divisions. In
France, with a population of about 60 million people, Garnier was a completely separate division,and its sales force competed against the L’Oréal
division. In the Netherlands, however, the market
was much smaller (about 15 million people), andGarnier and L’Oréal products would be marketedby the same sales force.
Dutch consumers had little, if any, awareness or
knowledge of Garnier and had not formed a brandimage. The Garnier sunscreen was a new productand few Dutch women knew of the brand. It was,therefore, very important that any new Garnier
products launched in the Netherlands have astrong concept and high market potential. To
accomplish this, the products needed to offer
unique, desired, and identifiable differential
advantages to Dutch consumers. Products without
such an edge were at a competitive disadvantage,
and would be likely not only to fail, but to create anegative association with the Garnier name, causing potential problems for future Garnier productintroductions.
THE DUTCH MARKETIn the late 1980s, 40 percent of the Dutch population (about the same percentage as in France) was
under 23 years old. Consumers in this age groupwere the heaviest users of cosmetics and toiletries.
However, like the rest of Europe, the Dutch population was aging and the fastest-growing population segments were the 25 or older groups.
Other demographic trends included the increasing number of Dutch women working outside of
the home. The labor force participation rate of771

women in the Netherlands was 29 percent. Thiswas much lower than the 50 percent or above in the
United Kingdom or United States, but the numberof women working outside the home was increasing faster in the Netherlands than it was in the
United Kingdom or the United States. Dutch
women were also delaying childbirth. As a result of
these trends, women in the Netherlands were
exhibiting greater self-confidence and independence; women had more disposable income andmore of them were using it to buy cosmetics for use
on a daily basis.
Despite their rising incomes, Dutch women still
shopped for value, especially in cosmetics andtoiletries. In the European Union (EU), theNetherlands ranked fourth in per capita income;but it was only sixth in per capita spending on cosmetics and toiletries. Thus, the Dutch per capita
spending on personal care products was only 60
percent of the amount spent per capita in France or
Germany. As a result of both a small population (13million Dutch to 350 million EU residents) andlower per capita consumption, the Dutch market
accounted for only 4 percent of total EU sales ofcosmetics and toiletries.
SYNERGIE
Synergie was a line of facial skin care products consisting of moisturizing cream, antiaging day cream,
antiwrinkle cream, cleansing milk, mask, andcleansing gel. It was made with natural ingredients,
and its advertising slogan in France was “Thealliance of science and nature to prolong the youthof your skin.”
Skin Care Market
The skin care market was the second largest sectorof the Dutch cosmetics and toiletries market. For
the past five quarters, unit volume had been growing at an annual rate of 12 percent and dollar sales
at a rate of 16 percent. This category consisted ofhand creams, body lotions, all-purpose creams,
and facial products. Products within this category

L'Oreal Nederland B.V.: Product Introduction

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CASE 17 L’Oréal Nederland B.V.: Product Introduction

were classified by price and product type. Skin
care products produced by institutes such as
Shisedo or Estée Lauder were targeted at the highend of the market. These lines were expensive andsold through personal service perfumeries thatspecialized in custom sales of cosmetics and toiletries. At the other end of the price scale weremass market products like Ponds, which were soldin drugstores and supermarkets. In the last coupleof years, a number of companies, including
L’Oréal, had begun to offer products in the midprice range. For example, its Plénitude line waspromoted as a high-quality, higher-price—but stillmass market—product.
Skin care products could also be divided intocare and cleansing products. Care products consisted of day and night creams; cleansing products were milks and tonics. The current trend
in the industry was to stretch the lines by adding
specific products targeted at skin types suchas sensitive, greasy, or dry. An especially fastgrowing category consisted of antiaging and antiwrinkling creams. Complementing this trend was
the emphasis on scientific development and natural ingredients.
Almost 50 percent of the 5 million Dutch
women between the ages of 15 and 65 used traditional skin care products. The newer specialized
products had a much lower penetration, as shownin Table 1.
The sales breakdown by type of retailer for themid- and lower-priced brands is shown in Tables 2
and 3.

TABLE 2
Sales Breakdown for Skin Care Products inSupermarkets and Drugstores

TABLE 1
Usage of Skin Care Products by Dutch WomenTABLE 3
Sales Breakdown for Skin Care Products by Type ofDrugstore

Product
Day cream
Cleansers
Mask
Tonic
Antiaging cream

Percentage of Women Using
46
40
30
26
3

Type of Store

Unit Sales (%)

Dollar Sales (%)

Supermarkets
Drugstores

18
82
100

11
89
100

Competition
There were numerous competitors. Some productlines, such as Oil of Olaz (Oil of Olay in the UnitedStates) by Procter & Gamble and Plénitude by
L’Oréal, were offered by large multinational companies; other brands, for example, Dr. vd Hoog andRocher, were offered by regional companies. Somecompanies offered a complete line, while others,
like Oil of Olaz, offered one or two products.
Exhibit 1 lists a few of the available lines alongwith the price ranges and positioning statements.
The Dutch market was especially competitive
for new brands like Oil of Olaz and Plénitude. The
rule of thumb in the industry was that share ofvoice for a brand (the percent of total industry
advertising spent by the company) should be about
the same as its market share. Thus, a company with
10 percent market share should have had advertising expenditures around 10 percent of total industry advertising expenditures. However, there were
deviations from this rule. Ponds, an establishedand well-known company with loyal customers,

Type of Store
Chains
Large independent
Small independent

Unit Sales (%)

Dollar Sales (%)

57
31
12
100

37
39
24
100

785

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L'Oreal Nederland B.V.: Product Introduction

CASE 17 L’Oréal Nederland B.V.: Product Introduction

773

EXHIBIT 1
Competitive Product Lines of Cosmetics
Price Range(Guilders)*

Positioning

Lower end
Nivea Visage †Ponds

9.50–11.50
5.95–12.95

Mild, modest price, complete line
Anti-wrinkle

MiddleDr. vd Hoog

10–11.95

Oil of Olaz
(Procter & Gamble)
Plénitude (L'Oréal)

Sober, nonglamorous, no illusions, but real help, natural, efficient,
relatively inexpensive
12 (day cream only) Moisturizing, antiaging
10.95–19.95

Delay the signs of aging

Synergie

11.95–21.95

The alliance of science and nature to prolong the youth of your skin

Upper End
Yves Rocher
Ellen Betrix(Estée Lauder)10–26.95
12.95–43.50

Different products for different skins, natural ingredients
Institute line with reasonable prices, luxury products at nonluxury
prices* One dollar = 1.8 guilders; one British pound = 2.8 guilders; 1 deutschmark = 1.1 guilders.
† Although Nivea Visage had a similar price range to Dr. vd Hoog, consumer perceived Nivea as a lower-end product.

had about 9 percent share of the market (units) but
only accounted for about 2.5 percent of total industry ad expenditures. Alternatively, new brands likeOil of Olaz (10 percent market share, 26 percent
share of voice) and Plénitude (5 percent market
share, 13 percent share of voice), spent much more.
The higher ad spending for these brands was necessary to develop brand awareness and, ideally,brand preference.
Any innovative products or new product variations in a line could be quickly copied. Retailers
could develop and introduce their own private
labels in 4 months; manufacturers could develop acompeting product and advertising campaign in 6
months. Manufacturers looked for new productideas in other countries and then transferred the
product concept or positioning strategy acrossnational borders. They also monitored competitors’
test markets. Since a test market typically lasted 9months, a competitor could introduce a productbefore a test market was completed.

Consumer Behavior
Consumers tended to be loyal to their current
brands. This loyalty resulted from the possible allergic reaction to a new product. Also, facial care products were heavily advertised and sold on the basisof brand image. Thus, users linked self-concept
with a brand image, and this increased the resistance to switching. While all consumers had someloyalty, the strength of this attachment to a brandincreased with the age of the user. Finally, establishing a new brand was especially difficult since Dutch
women typically purchased facial creams only onceor twice a year. Dutch women were showing an
increasing interest in products with “natural” ingredients, but they were not as familiar as the Frenchwith technical product descriptions and terms.
Market Research Information
Earlier, Mike Rourke had directed his internal
research department to conduct some concept andL'Oreal Nederland B.V.: Product Introduction

774

CASE 17 L’Oréal Nederland B.V.: Product Introduction

use tests for the Synergie products. The researchers
had sampled 200 women between the ages of 18
and 55 who used skin care products three or moretimes per week. They sampled 55 Plénitude users,
65 Dr. vd Hoog users, and 80 users of other brands.
The participants reacted positively to Synergie
concept boards containing the positioning statement and the terminology associated with the total
product line. On a 7-point scale with 7 being themost positive, the mean score for the Synergie line
for all the women in the sample was 4.94. The evaluations of the women who used the competingbrands, Plénitude and Dr. vd Hoog, were similar, at
4.97 and 4.88, respectively.
The researchers then conducted an in-depth
analysis of two major products in the line, antiaging day cream and the moisturizing cream.

Participants reported their buying intentions after
they tried the Synergie product once and again
after they used it for a week. Some participants
were told the price and others did not know the
price. The results of this analysis are shown in
Exhibit 2.
BELLE COULEUR
Belle Couleur was a line of permanent hair coloringproducts. It had been sold in France for about two
decades and was the market leader. In France theline had 22 shades, comprising mostly natural
shades and a few strong red or very bright, lightshades. It was positioned as reliably providing natural colors with the advertising line “natural colors,
covers all gray.”

EXHIBIT 2
Buying Intentions for Synergie Products
All
ParticipantsPlénitudeUsers

Dr. vd Hoog
Users

Other Brand
Users

Price Not Known
Antiaging daycream
After trial
After use

5.37 *
5.26

5.63
5.55

5.00
5.08

5.42
5.17

Moisturizing CreamAfter trial
After use

5.34
5.51

5.60
5.74

5.38
5.56

5.11
5.22

Price Known
Antiaging daycream
After trial
After use
Certainly buy†

3.75
3.60
24%

4.13
3.76
21%

3.82
3.54
23%

3.44
3.54
27%

Moisturizing
After trial
After use
Certainly buy

4.08
4.06
39%

4.36
4.26
52%

4.17
4.13
38%

3.77
3.78
30%

* Seven-point scale with 7 being most likely to buy.
† Response to a separate question asking certainty of buying with certainty buy as the highest choice.

787

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CASE 17 L’Oréal Nederland B.V.: Product Introduction

Hair Coloring Market
There were two types of hair coloring: semipermanent and permanent. Semipermanent colors
washed out after five or six shampooings.
Permanent colors only disappeared as the hairgrew out from the roots. Nearly three-quarters (73percent) of Dutch women who colored their hairused a permanent colorant. Over the past 4 years,
however, the trend had been to semipermanent colorants, with an increase from 12 percent to 27 percent of the market. Growth in unit volume during
those years for both types of colorant had been
about 15 percent per annum. The majority of unit
sales in the category were in chain drugstores (37percent) with 40 percent equally split between large
and small independent drugstores. Food retailers
accounted for the remaining 3 percent.
Competition
In the Netherlands, 4 out of 10 total brands
accounted for 80 percent of the sales of permanent
hair colorants, compared to 2 brands in France.
Table 4 gives the market share of the leading permanent color brands in the period 1987–1989.
Interestingly, none of them had a clear advertising
positioning statement describing customer benefits. By default, then, Belle Couleur could be positioned as “covering gray with natural colors.”
Hair salons were indirect competitors in the haircoloring market. The percentage of women who
had a hair stylist color their hair was not known,
nor were the trends in usage of this method known.
It was projected that as more women worked outside the home, home coloring would probably
increase because it was more convenient.
L’Oréal’s current market entry (Recital) was theleading seller, although its share was declining.
Guhl’s and Andrelon’s increases in shares between
1986 and 1989 reflected the general trend to using
warmer shades, and these two brands were perceived as giving quality red tones. In the late 1980s,
Guhl had changed its distribution strategy, andstarted selling the brand through drug chains. In

TABLE 4
Major Brands of Hair ColorantMarket Shares %1987 1988 1989
Upper End (14.95 guilders)Recital (L’Oréal Brand)
Guhl

35
9

34
12

33
14

Belle Couleur (12.95 guilders)

—

—

—

Lower-priced (9.95 guilders)Andrelon
Poly Couleur

12
24

14
23

17
21

Others

20

17

15

Total

100

100

100

1987, less than 1 percent of sales were through drug
outlets; in the first quarter of 1990, drug-outlet sales
had reached nearly 12 percent. Guhl had also
become more aggressive in its marketing throughlarge independents, with its share in these outlets
climbing from 16 to 24 percent over the same
period. Both the increasing shares of the smaller
brands and the decreasing shares of the leaders
sparked a 60 percent increase in advertising in 1989
for all brands of hair coloring.
Consumer Behavior
Consumers perceived permanent hair color as atechnical product and believed its use was veryrisky. As a result, users had a strong brand loyalty
and avoided impulse purchasing. When considering a new brand, both first-time users and current
users carefully read package information andasked store personnel for advice.
Traditionally, hair colorants had been used primarily to cover gray hair. Recently, however, coloring hair had become more of a fashion statement.
This partially accounted for the increased popularity of semipermanent hair coloring. In one study,
the most frequently cited reason (33 percent) forL'Oreal Nederland B.V.: Product Introduction

776

CASE 17 L’Oréal Nederland B.V.: Product Introduction

coloring hair was to achieve warm/red tones;
another 17 percent reported wanting to lighten
their hair color, and covering gray was cited by 29
percent. It was likely that the trend to use colorants
more for fashion and less for covering grayreflected the increase in hair coloring by consumers
less than 33 years old. In 1989, 46 percent of Dutch
women (up from 27 percent in 1986) colored their
hair with either semipermanent or permanent haircolorants. Table 5 contains a breakdown of usage
by age of user.
Hair coloring was almost exclusively purchasedin drugstores; only 3 percent of sales were throughsupermarkets. The percentage of sales for drug outlets was: chains, 58 percent; large independents, 22
percent; and small independents, 20 percent.
Market Research
As with Synergie, Mr. Rourke also had the L’Oréal
market researchers contact consumers about theirreactions to Belle Couleur. Four hundred andtwelve Dutch women between the ages of 25 and 64
who had used haircolorant in the past 4 months
were part of a concept test, and 265 of these womenparticipated in a use test. A little over 25 percent of
the participants colored their hair every 6 weeks ormore often while another 47 percent did it every 2
to 3 months. (The average French user colored herhair every 3 weeks.) Nearly 60 percent used haircolor to cover gray, while the remainder did it forother reasons.

After being introduced to the concept andshown some sample ads, participants were asked
their buying intentions. The question was asked
three times—before and after the price was given
and after Belle Couleur was used. The results areshown in Exhibit 3.
In most product concept tests (as with the
Synergie line) buying intentions declined once theprice was revealed. For Belle Couleur, buying
intentions increased after the price was given, but
decreased after actual use. As the exhibit shows, thepercentage of participants who would probably orcertainly not buy the product after using it
increased from 13 to 32 percent. In Exhibit 4, only
participants who gave negative after-use evaluations of Belle Couleur are included, and they aregrouped according to the brands they were using at
the time.
To try to determine why some users didn’t likethe product, the dissatisfied women were asked tostate why they disliked Belle Couleur. The results
are shown in Table 6.
Many of the women thought that their hair was
too dark after using Belle Couleur, and said it“didn’t cover gray.” Those who thought theCouleur was different from expected were primarily using the blond and chestnut brown shades ofcolorant. This was expected, since in France Belle
Couleur was formulated to give a classical, con-

EXHIBIT 3
Buying Intentions

TABLE 5
Hair Coloring by Age (%)

Less than 25 years
25–34
35–49
50–64
65 and over

1986

1989

35
24
32
24
15

50
54
55
33
19

Price
Unaware

Price
Aware

After
Use

Certainly buy (5)Probably buy (4)Don’t know (3)Probably not (2)Certainly not (1)

18%
60
12
7
3

26%
57
5
7
6

29%
30
9
11
21

Total

100%

100%

100%

Mean score

3.85

3.92

3.35

789

790

L'Oreal Nederland B.V.: Product Introduction

777

CASE 17 L’Oréal Nederland B.V.: Product Introduction

EXHIBIT 4
Purchase Intentions and Evaluation of Belle Couleur by Brand Currently Used
Brand Currently Used
Total Sample Andrelon
After-use purchase intentions of Belle Couleur
Probably not (2)Certainly not (1)Overall mean score
Evaluation of final color of Belle Couleur
Very good (1)Good (2)Neither good or bad (3)Bad (4)
Very Bad (5)Mean
Comparison to expectations
Much better (1)Better (2)The same (3)Worse (4)Much worse (5)Mean
Compared with own brand
Much better (1)Better (2)The same (3)Worse (4)Much worse (5)Meanservative dark blond color without extra reflections or lightening effects and the product had notbeen modified for the Dutch test. The competing
Dutch-manufactured hair colorant competitors,
on the other hand, were formulated to give

Poly
Couleur

Guhl

Recital(L'Oréal)

11%
21

12%
24

12%
29

14%
20

5%
5

32%

36%

41%

34%

10%

3.35

3.4

3.1

3.4

3.95

25%
43
10
12
9

24%
40
10
14
12

31%
31
14
5
19

22%
44
6
18
10

35%
49
8
8
—

2.37

2.5

2.5

2.5

1.89

11%
26
29
19
15

12%
12
38
24
14

14%
21
26
19
19

14%
24
28
18
16

14%
38
32
11
5

3.0

3.17

3.07

2.98

2.57

17%
21
21
21
19

17%
19
31
12
21

24%
24
14
16
22

14%
32
30
16
8

3.05

3.02

2.88

2.73

*

stronger lightening effects. Thus, some of the negative evaluations of Belle Couleur were due to thefact that Dutch women tended toward naturally
lighter hair colors and the French toward darker
shades.

L'Oreal Nederland B.V.: Product Introduction

778

CASE 17 L’Oréal Nederland B.V.: Product Introduction

TABLE 6
Reasons for Negative Evaluations of Belle Couleur by Brand Currently Used
Brand Currently Used
Total Sample Andrelon
Hair got dark/darker instead of lighter
Irritates skinAmmonia smell
Didn’t cover gray
Color not beautiful
Color different from expected

13%
8
5
5
5
5

14%
10
7
12
7
5

Poly
Couleur

Guhl

Recital(L'Oréal)

17%
7
—
2
5
10

14%
2
2
4
6
4

5%
11
—
3
3
3

Note: Some of the cell sizes are very small and caution should be used when comparing entries of less than 10 percent.

ROLE OF DISTRIBUTORSDistributors’ acceptance of the two product lines
was critical for L’Oréal’s successful launch of both
Synergie and Belle Couleur. At one time, manufacturers had more control in the channel of distribution than retailers. Retailers, however, had been
gaining power as a result of the increasing size ofretailers, the development of chains with their central buying offices, and the proliferation of new
brands with little differentiation from brands currently on the market. Retailers had also increasingly been offering their own private-label
products, since they earned a higher percentage
profit margin on their own brands.
Following are the criteria, listed in order ofimportance (3 being “most important”), that retailers used to evaluate new products.
1. Evidence of consumer acceptance
2. Manufacturer advertising and promotion
3. Introductory monetary allowances
4. Rationale for product development
5. Merchandising recommendations

2.5
2.2
2.0
1.9
1.8

L’Oréal’s own goal for developing new products
was to introduce only those products that had a differential advantage with evidence of consumer
acceptance. It did not want to gain distribution

with excessive reliance oil trade deals or higher
than normal retail gross margins. L’Oréal also
wanted to have its Garnier product lines extensively distributed in as many different types ofretailers and outlets as possible. This approach to
new product introduction had been effective for
L’Oréal, and it currently had a positive image with
Dutch retailers. L’Oréal was perceived as offeringhigh-quality, innovative products supported withgood in-store merchandising.
For L’Oréal’s current products, 35 percent ofsales came from independent drugstores, 40 percent from drug chains, and 25 percent from foodstores. For all manufacturers, drug chains andsupermarkets were increasing in importance. These
Stores required a brand with high customer awareness and some brand preference. The brands
needed to be presold since, unlike independent
drugstores, there was no sales assistance.
Introducing a line of products, rather than just a
product or two, resulted in a greater need for retailshelf space. Although the number of new products
and brands competing for retail shelf space frequently appeared unlimited, the space itself was alimited resource. With Belle Couleur, L’Oréal had
already addressed this issue by reducing the number of Belle Couleur colorants it planned to offer in
the Netherlands. Although 22 shades were available

791

792

L'Oreal Nederland B.V.: Product Introduction

CASE 17 L’Oréal Nederland B.V.: Product Introduction

in France, L’Oréal reduced tile line to 15 variations
for the Netherlands. As a result, 1.5 meters (about 5
linear feet) of retail shelf space were needed to display the 15 shades of Belle Couleur. Synergie
required about half of this shelf space.
DECISION TIME
After reviewing the information on the market
research of the two product lines, Ms. van derZande summarized the situation. L’Oréal
Netherlands could leverage its advertising of theGarnier name by promoting two lines at once.
Consumers would hear and see the Garnier nametwice, not just once. As a result, Dutch consumers
might see Garnier as a major supplier of cosmetics
and toiletries. However, she was concerned about
the selling effort that would be needed to sell the
L’Oréal brands that were already in the Dutch market and at the same time introduce not just one, but
two, new brand name product lines. The Dutch

779

L’Oréal sales force would have to handle both family brands, since the much lower market potentialof the Netherlands market could not support a separate Garnier sales force, as in France. She was also
concerned about retailer reaction to a sales pitch for
two product lines.
Ms. van der Zande reflected that she was facing
three decision areas. First, she had to decide if sheshould introduce one or both product lines, and she
had to make this decision knowing that L’Oréal
would not reformulate the products just for the
Dutch market. Second, if she decided to introduce
either one or both of the product lines, she needed
to develop a marketing program. This meant she
had to make decisions on the promotion of the
product line(s) to both retailers and consumers, aswell as the pricing and distribution of the line(s).
Third, given that the Garnier product introductions
might negatively impact the sales of her current
product lines, she needed tactical marketing plans
for those products.

C A S E 1 8 Polaroid and theFamily-Imaging Market
Don’t do anything that someone else can do. Don’t undertake a project unless it is manifestly important and nearly
impossible.

Edwin Land
Founder, Polaroid Corporation
INTRODUCTION
At precisely 7:30 A.M. on a cold, blustery, New
England day in January 1992, Roger Clapp, project
manager for the Joshua Project, walked into theconference room near his office in Polaroid’s
Cambridge, Massachusetts, office complex known
as Technology Square. The Joshua team leaders
were already present: Vicki Thomas and Nick
Ward from marketing; Rick Kirkendall, division
vice president for Consumer Imaging; Roy
Baessler, camera engineering; Howard Fortner,
camera manufacturing; Ron Klay, film assembly
manufacturing; Roger Borghesani, film assembly
engineering; John Sturgis, film systems; Louise
Reimenschneider, photographic systems; Bob
Ruckstuhl, film programs; Harry Korotkin,finance; and Bob McCune, who served as thegroup’s organizational development/team building facilitator. The group had been meeting every
Tuesday morning since 1988 when Roger had
assumed leadership of the Joshua Project, the codename for Polaroid’s newest camera for the instantphotography market.
Roger and Hal Page, the Joshua leader before
Roger, used the meetings as a way to coordinate themany disparate efforts that went into the development of any high-technology product. Each person36

at the meeting discussed what was going on in his or
her area and what problems were being encountered. Roger believed that if everyone had lots of
information about all project areas and the project’s
overall direction, they would align their area’s activities with that direction. The meeting would produce
a self-aligning process.
As Roger said good morning, he glanced
around the room. He could tell the group members
were tired. The group had been working hard on
Joshua for a long time. They had learned that heexpected a lot from them. Five-day, 55-hour weeks
were not enough. Most team members worked 6day weeks, often working into the night. However,Roger was always there, too. He didn’t ask them todo anything he didn’t do.
From his previous work with project teams,
Roger had realized that groups went through threestages. Initially, a group felt excited as it kicked off amultimillion-dollar development project and faced
the technological, marketing and business challenges. Toward the project’s end, groups experienced the exhilaration of seeing their work come tofruition. However, the middle stage, when it
seemed that every problem or delay brought more
problems and delays, was the hardest. Group members were likely to go through an emotional dip,feeling that the project would never be completed.
There would be much frustration.
The Joshua Project was in the middle stage, andRoger and Bob McCune faced the challenge ofkeeping the group moving through this difficult
period. Although even Roger sometimes felt thatthe project was “impossible,” he knew that it wasThis case was prepared by Lew G. Brown and David R. Vestal, the University of North Carolina at Greensboro. The authors
express their appreciation to Polaroid Corporation for its cooperation in developing this case and to Morgan Stanley and the Photo
Marketing Association for providing data. This case was written solely for the purpose of stimulating student discussion. All individuals and all incidents are real.

780

793

794

Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market“manifestly important” for revitalizing Polaroid’s
instant camera sales.
“Well, let’s get started,” Roger began as heglanced at the countdown clock. During 1990,
Roger realized that he needed to create a sense ofurgency in the team. The team had a target date oflate 1992 for introduction of the camera, but Roger
worried that team members might slide into thinking that they had plenty of time or that deadlines
were flexible. Therefore, he ordered the construction of a “countdown clock,” which counted down
the number of days and hours to “zero day”—thetarget data when everything had to be ready tomeet the market introduction schedule. The clock
ran on electricity, but had a battery backup. The
group agreed to let Roger start the clock in late1990, and, once started, it could not be stopped. The
clock was Roger’s way of making clear to the groupthat there would be no on-again, off-again deadlines. It hung on the wall in the conference room,looming over their meeting sand reminding themthat time did not stand still.
Roger outlined the day’s agenda:
Besides our usual reports from each area, we have ameeting in three weeks with the corporate officers. We
need to make a presentation on Joshua’s status, so weneed to begin to prepare for that today. But mostimportantly, we need to begin to develop our marketing strategy for the U.S. market. Therefore, we’ll conclude today’s meeting with a presentation from themarketing folks that will serve as background for theirrecommended strategy, which they will present also inthree weeks. First, however, let’s start with reports ofgood news.

POLAROID’S HISTORY
Edwin Land started Polaroid Corporation in 1937
in a Cambridge garage and developed the polarization process. In 1943, while on vacation with hisfamily in Santa Fe, New Mexico, his 3-year-old
daughter asked why she could not see right away
the picture of her he had just taken. Within anhour, Land had developed a mental picture of thecamera, the film, and the chemistry that would

781

allow him to solve the puzzle his daughter had
presented.
In 1948, Land introduced the first Polaroid
instant camera. By the time he stepped down as thecompany’s chief executive officer in 1980, at age 70,
he had built Polaroid into a $1.4 billion company.
When he died in 1991, he left behind 537 patents,
second only to Thomas A. Edison. (See Exhibits 1
and 2 for Polaroid’s financial data.)Land’s single-minded pursuit of technology led
to many successes, but also to his career’s major
failure. Convinced that he needed to take his
instant photography concept from the portrait camera to the movie camera, Land and his engineersdeveloped the Polavision instant movie system,
launching it in 1977. Although Polavision met
Land’s criteria of being nearly impossible, it was
not quite manifestly important. Polavision was toolate—other companies had already invented videotape recording. Within two years, Polaroid had towrite off the project at a cost of $68.5 million.
William McCune, Jr., Polaroid’s president, feltthat the company needed to move away from its
dependence on amateur instant photography.
Rather than stand in the way, Land resigned in
1980. McCune became chairman, and led Polaroid’s
diversification efforts, moving into disk drives,
fiber-optics, video recorders, inkjet printers, andfloppy disks.
By the mid-1980s, some observers argued thatthe diversification effort was not paying off.
However, sales to amateur photographers and salesof instant cameras for business use were goingstrong. By 1986, these sales accounted for 55 percent of Polaroid’s revenues. Consumers were stillinterested in instant cameras. To stimulate thatdemand, Polaroid introduced the Spectra camera in
1986, its first major new camera since the SX-70 in
1972. Observers who predicted that Spectra, priced
at $150 to $225, was too expensive and would notsell turned out to be wrong.
Edwin Land probably felt vindicated that
Polaroid was refocusing on its core business, amateur instant photography. Polaroid had no directcompetition in the U.S. instant photography market.

Polaroid and the Family-Imaging Market

782

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 1
POLAROID CORPORATIONStatement of Earnings
Years Ended December 31(Dollar Figures in Millions)

1991

1990

1989

Net sales
United States
International$1,113.6
957.0$1,058.3
913.4$1,091.8
812.9

Total net sales

2,070.6

1,971.7

1,904.7

1,082.5

1,011.8

966.0

741.5
—

675.6
—

634.5
40.5

1,824.0

1,687.4

1,641.0

246.6

284.3

263.7

Other income/(expense)
Litigation settlement, net of employee incentives
Interest income
Other

871.6
25.6
(2.2)

—
19.7
(4.7)

—
37.2
(2.1)

Total other income
Interest expense

895.0
58.4

15.0
81.3

35.1
86.2

Earnings before income taxes
Federal, state and foreign income taxes

1,083.2
399.5

218.0
67.0

212.6
67.6

Net earnings$ 683.7$ 151.0$ 145.0

Primary earnings per common share
Fully diluted earnings per common share
Cash dividends per common share
Weighted average common shares outstanding (000s)$ 12.54$ 10.88$.60
49,943

$

2.2

$

1.96

$

.60
51,519$.60
57,568Stock price
High
Low

$ 28 1/8$ 19 5/8

Cost of goods soldMarketing, research, engineering,
and administrative expenses
Restructuring and other expense
Total costs
Profit from operations

Source: Polaroid Corporation 1991 Annual Report.

$ 48 1/8$ 20 1/4$ 50 3/8$ 27 7/8

795

796

Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market

783

EXHIBIT 1 (continued)
POLAROID CORPORATION AND SUBSIDIARY COMPANIESConsolidated Balance Sheet
Years Ended December 31(Dollar Figures in Millions)

1991

1990

1989

AssetsCurrent assets
Cash and cash equivalents
Short-term investments
Receivables, less allowances
Inventories
Other assets$ 162.9
82.3
476.1
524.3
94.3

$

83.8
114.2
441.6
519.0
81.7

$ 131.2
148.1
459.5
529.9
77.1

Total current assets

1,339.9

1,240.3

1,345.8

Property, plant, and equipment
Total property, plant, and equipment
Less accumulated depreciation
Net property, plant, and equipment

1,598.9
1,049.5549.4

1,440.0
979.0
461.0

1,326.7
895.8
430.9

Total assets$1,889.3$1,701.3$1,776.7

Liabilities and Stockholder’s Equity
Current liabilities
Short-term debt
Current portion of long-term
Payables and accruals
Compensation and benefits
Federal, state, and foreign income taxes$ 145.9
26.7
237.4
131.8
102.8

$ 168.6
79.4
218.4
123.8
41.0

$ 299.0
70.4
216.2
143.9
44.7

Total currents liabilities

644.6

631.2

774.2

Long-term debt

471.8

513.8

531.8

Redeemable preferred stock equity

—

348.6

321.9

Preferred stock

—

—

—

75.4
379.5
1,609.9
1,083.7
208.2

75.4
379.5
1,038.3
1,053.1
232.4

75.4
379.5
955.8
997.5
264.4

Common stockholders’ equity
Common stock, $1 par value, authorized 150,000,000 shares
Additional paid-in capital
Retained earnings
Less: Treasury stock, at cost
Deferred compensation—ESOP
Total common stockholders’ equity
Total liabilities and stockholders’ equity
Source: Polaroid Corporation 1991 Annual Report.

772.9

207.7

148.8

$1,889.3$1,701.3$1,776.7

Polaroid and the Family-Imaging Market

784

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 2
POLAROID CORPORATION
Income Assets by Geographic Area
Years Ended December 31(Dollar Figures in Millions)

1991

1990

1989

$1,113.6
438.5$1,058.3
421.4$1,091.8
407.7

1,552.1

1,479.7

1,499.5

624.6
287.3

598.5
159.6

504.5
167.4

911.9

758.1

671.9

332.4
51.0

314.9
11.0

308.4
9.1

383.4
(776.8)325.9(592.0)317.5(584.2)$2,070.6$1,971.7$1,904.7

United States
EuropeAsia/Pacific and Western Hemisphere
General corporate expense
Eliminations$ 120.9
94.4
40.3(18.0)
9.0$ 179.9
97.7
23.8(13.4)(3.7)$ 150.2
115.0
31.5(13.0)(20.0)

Profit from operations
Other income less interest expense

246.6
836.6

284.3
(66.3)

263.7(51.1)

Earnings before income taxes$1,083.2$ 218.0$ 212.6

AssetsUnited States
EuropeAsia/Pacific and Western Hemisphere
Corporate assets (cash, cash equivalents, and short-term investments)
Eliminations$1,153.9
548.7
165.8
245.2
(224.2)$1,055.0
507.3
160.2
198.0
(219.2)$1,054.2
475.7
168.1
279.3
(200.6)

Total assets$1,889.4$1,701.3$1,776.7

Sales
United States
Customers
Intercompany
EuropeCustomers
Intercompany
Asia/Pacific and Western Hemisphere
Customers
Intercompany
Eliminations
Net Sales
Profits

Source: Polaroid Corporation 1991 Annual Report.

797

798

Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market

The company won a patent infringement suitagainst Kodak in 1985. The court ruling required
Kodak to exit the instant photography business andpay Polaroid approximately $1 billion.
However, Land and Polaroid knew that the company faced severe competition in the broader photography market. Video camcorders, easy-to-use
35mm point-and-shoot cameras (often called 35mm
rangefinders), and 1-hour film developing were
cutting deeply into Polaroid’s market. Worldwide
sales of instant cameras had fallen from a peak of 13
million units in 1978 to about 4 million in 1991. The
new 35mm cameras were outselling instant cameras 5 to 1. Polaroid realized that it had to do something to reinvigorate the amateur photographymarket and to expand its base.
HOW INSTANT CAMERAS WORKIn black-and-white instant photography’s earlydates, the camera user had to pull the exposed
instant picture from the camera, wait about one
minute, peel off a piece of paper, and use a small
sponge to apply a chemical coating to the picture tostop its development. Then, the picture had to dry
before someone could safely handle it.
When Polaroid introduced color instant photography in 1963, the technology had advanced to thepoint that, although users still had to time the picture’s development and remove the print from thefilm sheet, they did not have to apply any chemicals. The film remained sticky for several minutes.
In 1972, Polaroid introduced the SX-70 instantcamera, which used what the company called“integral film.” As the name implied, the new film
was an integrated structure that did not require theuser to do any timing or other treatment. There
were no excess pieces of the film or paper to discard. The one-piece unit contained all the chemicals
necessary for development of the picture. The user
still had to wait several minutes for the exposed
picture to develop fully.
With integral film, within four-tenths of a second
after the user pushed the shutter release button andexposed the film, the camera partially ejected the785

exposed film unit. A battery contained in the film
cartridge powered the camera and the motor that
ejected the film. As the camera ejected the picture,
the film passed between two metal rollers. Theserollers squeezed the film, bursting a small pod at
the leading edge of the film. This pod contained
chemical reagents that spread between the film
unit’s receiving and negative layers. The chemicals
reacted with the negative layers based on the natureof the layer and the amount of each layer’s exposure
to light during the exposure process (see Exhibit 3).
These reactions determined the lightness, darkness,and color of each area of the final picture. Thischemical process was what users saw as they
watched the film develop from the plain, grayishgreen initial film color to the finished picture. All of
this development took place outside the camera infull light. Opacifying dyes in the reagent layer
blocked additional light from entering the lightsensitive layers once the film exited the camera.
Because users did not have to peel anythingfrom the film unit or apply chemicals, they were
technically able to take another picture immediately. However, because the camera only partiallyejected the picture, the user had to take the exposed
picture from the camera and find a place to put it,
usually a pocket or nearby table. If the user took asecond picture before removing the first, the second film unit would simply push the first out of thecamera, causing it to fall to the floor. (See Exhibit 4
for a description of Polaroid’s camera line.)
THE BIRTH OF A NEW PRODUCTIn the 1940s and 1950s, a product development
process called “skunkworks” sprung to life at
Polaroid. This process allowed maverick individuals or groups to pursue new product design ideas
unofficially. These individuals or groups frequently
generated technology-driven new product designs,
giving little, if any, consideration to marketing or
business strategy. Further, operating managers
often had only limited influence over the design ofmachinery. Film and camera development followed
parallel paths. Development of the film pack

Polaroid and the Family-Imaging Market

786

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 3
How Polaroid Instant Film Works

799

800

Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 4
Guide to Polaroid Instant Cameras
OneStep Flash
Built-in electronic flash folds down when not in use.
Flash range 4–10 feet.
Autofocus. Range 4 feet to infinity.
Used 600 PLUS film.
Easy to use, just point and shoot.
Suggested retail $27–33. Dealer Price $27.
Cool Cam
Built-in electronic flash folds down when not in use.
Flash range 4–10 feet.
Autofocus. Range 4 feet to infinity.
Uses 600 PLUS film.
Easy to use, just point and shoot.
Free matching camera bag with return of camera registration card.
Suggested retail $30–35. Dealer Price $27.
Impulse Cameras
Impulse:
Focus range 2 feet to infinity.
Manual dual lens for close-up shots 2–4 feet.
Pop-up flash, range 4–10 feet.
Uses 600 PLUS instant film.
Easy to use, just point and shoot.
Suggested retail $40–45. Dealer Price $36.
Impulse AF:
Has same features as Impulse plus:
Autofocus.
Self-timer
Flash range 2–14 feet.
Suggested retail $80–85. Dealer price $71.50.
Spectra Cameras
Spectra 2 AF:
Autofocus, range 2 feet to infinity.
Auto exposure, flash range 2–15 feet.
Uses spectra instant color film.
Pictures guaranteed for one full year after camera
purchase (up to a limit of 10 packs of film).
Camera folds to fit neatly in a briefcase.
Easy to use, just point and shoot.
Suggested retail $79–85. Dealer Price $74.
Spectra AF:
Has same features as Spectra 2 AF plus:
Self-timer.
Control Panel allows user to turn off automatic features.
Viewfinder displays symbols to help get best pictures.
Suggested retail $100–110. Dealer Price $85.
Source: Polaroid Corporation.

787

occurred after development of the film components. Through the 1970s, this development process
had invariably resulted in major problems whenmanagers tried to get all the parts to work together.
In 1984, a skunkworks team from camera engineering began discussing Polaroid’s next camera,
and a team from film research began to work on
possibilities for a new film. The two groups met
unofficially to share ideas. These “blue sky” meetings focused on the problems of picture quality,
film cost, and camera size. The groups soon narrowed their discussions to a film that would fit asmaller camera.
Unlike some skunkworks groups, these twogroups sought marketing’s participation. In 1984
and 1985, Polaroid’s internal market researchgroup conducted focus groups to get consumer
reactions to small, medium, and standard-sized
instant cameras with picture-storage features. The
results from these focus groups suggested thatsome consumers would be interested in the smaller
camera and its smaller pictures. Polaroid president
I. MacAllister Booth asked his assistant, Roger
Clapp, to develop the idea.
THE JOSHUA STORYEnter Joshua. Even as Polaroid introduced theSpectra camera in 1986, Booth, who had justbecome CEO, realized that the company had tocontinue work on its next new camera. He
appointed Peter Kliem as director of research andengineering, combining two departments that traditionally had separate new product development
responsibilities. Clapp took responsibility for camera engineering. Booth also asked Hal Page,
Polaroid’s vice president for quality, to become program manager for the next consumer camera. For
the first time, Polaroid had a single, high-level program manager responsible for all aspects of new
product development—for film as well as camera,
for manufacturing as well as marketing.
Page began a year-long process of reexamination
to generate ideas for a new camera. He started
brainstorming sessions by showing a training film

Polaroid and the Family-Imaging Market

788

CASE 18 Polaroid and the Family-Imaging Market

that featured a cartoon character named Joshua. In
the film, Joshua finds himself trapped in a box andtries all the obvious ways to escape. Finally, in frustration, Joshua gently taps his finger against thebox’s wall and unexpectedly finds that his finger
has poked a hole in the wall. He struggles to makethe hole bigger and escapes.
Joshua sent a message to the hundreds of people
from many functional groups who attended Page’s
brainstorming sessions. To generate truly innovative ideas for a new camera, the employees would
have to attack new problems with new ways ofthinking—”out-of-the-box” approaches. To create
something other than an extension of Polaroid’s
existing cameras, people would have to think creatively and give up old prejudices, including, perhaps, their prejudice against smaller cameras. The
brainstorming sessions also helped participants
face head-on the question of whether new products
should be technology-driven or market-driven.
Participants soon learned the answer: they had tobe both.
Hal Page also showed the groups a film that dramatically illustrated the value of internal picturestorage for the new camera. The film showed
tourists at Disney World using 35mm automatic
cameras to take picture after picture. Other tourists,
however, stood around watching their one Polaroid
picture develop and searching for a place to put it.
Page and others thought consumers would takemore pictures if they did not have to stop after each
one to find a place to put it while it developed.
Further, consumers would damage and lose fewer
pictures.
A practical storage feature, however, would
require that the camera’s film bend around a chuteafter exposure to enter the storage compartment.
Engineers told Larry Swensen, a member of themarketing department, that Polaroid’s standard
film would not bend without breaking or coming
apart. Swensen, however, refused to accept thisconventional wisdom. He made a working modelof a camera that allowed standard film to make a
180-degree U-turn during processing. The camera
released the photographs into a built-in storage

chamber where the user could view them as they
developed. No longer would the user need to interrupt picture taking to find a safe place for each picture. Out-of-the-box thinking had begun to work.
Page also used outside marketing consultants.
On the basis of studies of small cameras, conductedby Polaroid between 1984 and 1986, the consultants
concluded that there would be a market for asmaller instant camera and that the camera would
not cannibalize Polaroid’s existing lines. Additional
outside studies in 1987 and 1988 examined consumer preferences regarding camera size, camera
price, and film price. Another study estimated thesales volume that Polaroid could expect from various feature combinations.
Polaroid had based these studies on the assumption that it would set the retail price of the newcamera at $150. As the studies progressed, however, management concluded that the market at the$150 retail price would be too small and that itshould price the camera at about $100. This change
required more market studies.
In 1988, Hal Page left Polaroid and Roger Clapptook over what employees had by now dubbed the“Joshua program.” Roger had been with Polaroid
22 years, having earned a B.S. in chemical engineering at Northeastern University and an M.B.A
from Harvard. Although Page and his groups had
made much progress, many technical and marketing hurdles remained. Design engineers faced
tradeoffs between size and other features, such as
performance and cost. As a result, the planned
camera had become too large. Roger Clappremarked that it looked like a “brick.” Clapp
stopped the design process and ordered the developers to reconsider all tradeoffs. This planned 4week pause, however, turned into an 8-monthinterruption, as it opened the door for reconsideration of many still-unresolved issues.
As Clapp’s managers reviewed the Joshua
Project, they realized that they needed to clarify thecamera’s market potential at a $100 price and conduct new research to bring marketing fully behindthe program. The managers agreed that the lastmarket research hurdle would be an “assessor test”

801

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Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market

conducted by Professor Glenn Urban of MIT’s
Sloan School of Management.
The assessor test involved setting up mockstores at six geographically diverse sites in the
United States. These “stores” offered 25 different
cameras (both Polaroid’s and competing models),with prices ranging from inexpensive to expensive.
Each store had a real counter, a film rack, feature
cards, and sales clerks to answer questions. As apart of the interview process, Polaroid’s advertising agency created full-color sheets of print advertising for the new camera. Polaroid also developed
realistic Joshua camera models. Over a 1-month
period, 2,400 people participated in market interviews and testing at the six sites. Researchers carefully screened participants on factors such as age,sex, race, and economic status to make sure thegroup represented demographics of. the U.S. population as a whole.
During this time, another camera design
emerged from a one-man skunkworks. Although
the Joshua Project was well under way, Larry
Douglas had continued to work on his idea.
Douglas’s camera offered an ingenious design for acamera that popped open to take a picture, thenclosed automatically. Polaroid ordered market
research on Douglas’s camera.
The two studies provided convincing evidence
that there was a market for a smaller instant camera
and that Joshua would be the preferred product.
Polaroid’s board of directors gave Joshua the goahead in late 1989.
FROM VISION TO REALITY
Although Polaroid had devoted an extraordinary
amount of time and energy to the Joshua Project
before its final approval, the camera and the film
were still in the development stage. Polaroid
employees throughout the company still had tosolve many problems.
Manufacturing had to install a new computeraided design (CAD) system and select a new material and design for the camera’s mainframe. The
camera would employ through-the-lens viewing,789

the same viewing system found on millions of 35mm
cameras. The picture storage compartment would
have to be able to hold all ten of the pictures in a film
package. And the camera would have to pass
Polaroid’s 4-foot drop test and meet other aggressive
quality goals.
Polaroid created a cross-functional steering committee to manage the film manufacturing process.
This team addressed issues such as how to include
the battery in the smaller film pack and how todesign the film manufacturing process itself. Like
Polaroid’s other instant film, Joshua’s film would
come in a package of ten exposures and would cost
the consumer about $1.00 per picture, as compared
to about $0.40 for a conventional 35mm picture.
The picture would be about 2 1/8 by 2 7/8 inches, a
pocket-sized format that was smaller than conventional 35mm prints.
At the heart of the Joshua camera was a new
microcontroller designed by electronics engineers
to solve many longstanding technical and manufacturing problems. Using software, it provided“track and hold,” “trim and speed,” and “wink”
features to measure the light available for the picture, set the exposure, and find the distance fromthe camera to the subject. In other words, like many
35mm cameras on the market, Joshua would have“automatic everything.” In all these processes,
managers insisted on meeting the highest quality
and reliability standards.
By Labor Day 1991, the Joshua team produced 24
Joshua prototype cameras for testing by Polaroid
employees over the holiday weekend. Twentythree cameras worked. The team continued to produce cameras for weekend tests and made aconcentrated assault an any problems the tests
identified. For Christmas 1991, the team produced
300 Joshua cameras for non-Polaroid employees
from coast to coast to test. This test represented theearliest time in a product’s development that
Polaroid had ever placed cameras with outsideusers. Managers believed that they were making a
new camera that met real customer needs, but theywanted to base their decisions on market research,
not on instinct.

Polaroid and the Family-Imaging Market

790

CASE 18 Polaroid and the Family-Imaging Market

Analysis of the pictures taken in the field tests
suggested that Joshua users took more vertical pictures and more close-ups than did users of other
Polaroid cameras. Engineers adjusted the camera’s
exposure system, accordingly to perform optimallyin vertical format or close-up situations. Polaroid
also conducted market tests in foreign countries.
Polaroid calculated that by the time it announced
the camera, more than 2,000 Polaroid and nonPolaroid consumers would have made more than
55,000 images for picture analysis.
BACK AT THE MEETING: THE
U.S. FAMILY-IMAGING MARKET
After all team members made their initial status
reports, Roger turned to Vicki Thomas, senior marketing manager. Vicki had recently joined Polaroid
from GTE. She had an undergraduate degree inpolitical science from the University of Vermont
and an M.B.A. from the American Graduate Schoolof International Management (Thunderbird).
“As you know, we have been focusing on camera and film manufacturing and on market
research. It is now time for us to begin to develop
our marketing strategy for the U.S. consumer market. At our last meeting we asked Vicki to prepare
an overview of the market so we would have abackground for the marketing plans she, Nick, andRick will present later. Vicki.”Thanks, Roger. I have prepared a series of overheads
that summarize the U.S. market that I want to sharewith you now. This first overhead [Exhibit 5] presents
a U.S. economic overview. We feel that the recession isover and that economic conditions will improve
slowly during 1992 and into 1993. Disposable income
will increase about 2 percent over 1991 while theprime rate and inflation will remain relatively low.
We also believe the unemployment rate will continue
in the low 7 percent range and that consumer confidence will remain relatively unchanged at about 65
on a 0 to 100 scale. There may be some higher taxes on
individuals and corporations due to the federal government’s budgetary problems. In summary, we feelthat consumers remain cautious and that they are

increasingly searching for value in the products andservices they purchase. This concern with value puts
pressure on instant photography because many consumers feel that instant film’s price is very high compared with standard 35mm film.
This overhead [Exhibit 6] provides a societal
overview and shows that we believe that the UnitedStates is becoming increasingly fragmented. Minority
populations are becoming more significant, as is themature population. Further, we are also seeing an
explosion of specialized media and communication
channels. The United States is becoming a ‘salad bowl’
instead of a ‘melting pot.’
We now turn to the U.S. camera market itself[Exhibit 7]. This overhead uses Photo Marketing
Association Data and Morgan Stanley data to showthat although the total still-camera market (not including camcorders) is flat, 35mm rangefinder camera sales(the so-called point-and-shoot 35mm camera without
interchangeable lenses) are growing rapidly. The
35mm rangefinder has taken share from other camera
types in the last six years. The rangefinders offer excellent photo quality, automated functions, ease of use
versus traditional 33mm single-lens reflex cameras,
compact size, built-in zoom lenses in some cases, andrelatively low prices (as low as $19.95 for some simple
versions). Vivitar, Olympus, and Polaroid have seen
their total shares of the camera market grow in the past
four years while Kodak’s has fallen. Many major players are introducing new models.
We estimate that about 90 percent of households
own a still camera of some kind and about 20 percent
own an instant camera. As you know, although our
U.S. consumer business is reasonably healthy, oursales revenue has been flat since 1986, even though
our shipments and market share are up. Average
35mm rangefinder camera prices have been in the $95
range for the past five years, while average distantcamera prices are falling into the low $40 range. The
average price for 35mm single-lens reflex cameras is$333 today, as compared with about $195 in 1986.
I thought you would also be interested in camera
distribution and prices, so I included these next two
overheads [Exhibits 8 and 9, pages 793–794] basedon Photo Marketing Association data. The majorchange since 1986 has been the almost one-third
increase in our percentage distribution through discount stores, including stores such as Wal-Mart andKmart. The Photo Marketing Association’s research

803

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Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market

791

EXHIBIT 5
U.S. Economic Overview

indicates that consumers purchase 58.1 percent of
110/126/disc/instant cameras [i.e., camera sizes
other than 35mm] in discount department stores andanother 23.7 percent in other mass retail stores. The
pie charts showing the format mix of still cameras
purchased [Exhibit 8] reveal that these cameras
account for about 28 percent of the cameras sold in
discount stores and about 29 percent in other massretailers. Our own top ten accounts generated about
60 percent of our sales in 1991 versus about 45 percent in 1986.
The next overhead [Exhibit 9] reflects the importance of mass retailers (including discount stores) inthe camera market. Camera sales through these dwarf
average sales in other outlets; but, as you can see, theaverage prices are much lower.

Polaroid and the Family-Imaging Market

792

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 6
Societal Overview

EXHIBIT 7
U.S. Camera Market Overview

Demographic
Growth of minority population(33% of population by 2010)

Hispanic
Asian
African American

1983–1993

1993 % Pop

+53%
+40%
+13%

10%
3%
12%

Growth of mature population (age 50+)
67M people, 25% of U.S. population
14% growth through 2000
Psychographic
Strong adhesion to special issues••••

Alternative lifestyles
Religious rightGreen movement
Handicapped

Media
•
•
•
•
•

Increased cable penetration—64% in 1993
“500 channels” vs. 3 networks
Spanish-language networks
Increased alternative lifestyle media
Proliferation of targeted communications
Direct mail
Telemarketing
Infomercials

Implications• Increased need for segmentation strategy to reachconsumers• Need to diversify advertising vehicles and media
Source: Polaroid Corporation. Demographic data from U.S.
Census Bureau.

805

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Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 8
Still Cameras Purchased: Format Mix by Outlet Type793

Polaroid and the Family-Imaging Market

794

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 9
Camera Distribution and Prices 1991
CameraType

All Specialty
Retailers
Combined

Camera StoreNo Mini Lab

Camera Store
With Mini Lab

Standalone
Mini Lab

All Mass
Retailers
Combined

Average Number of Cameras Sold per Firm*
35MM SLR
35MM RF
110/Disc
Instant
SpectraImpulseCool Cam
Other
Total instantTotal still cameras

122
359
194

84
253
12

174
665
324

42
90
13

22
2,662
165

24
35
68
37
82
401

11
22
12
13
32
241

32
43
105
50
118
770

12
15
11
13
23
91

NA
12
NA
2,050
1,371
2,916

Average Price per Camera
35MM SLR
35MM RF
110/Disc
Instant
SpectraImpulseCool Cam
Other
Total instantTotal still cameras

$ 373
$ 205
$ 18

$ 413
$ 258
$ 25

$ 364
$ 200
$ 18

$ 391
$ 168
$ 22

$ 387
$ 37
$ 15

$ 122
$ 68
$ 35
$ 117
$ 82
$ 179

$ 143
$ 72
$ 40
$ 62
$ 108
$ 250

$ 118
$ 67
$ 34
$ 56
$ 67
$ 170

$ 136
$ 86
$ 54
$ 75
$ 97
$ 163

NA
$ 39
NA
$ 30
$ 30
$ 35

* Numbers sold are per firm, not per outlet. A firm that sells a particular camera format may not do so in all its outlets.
Source: Photo Marketing Association.

The film market graphs [Exhibit 10] use data fromthe Photo Marketing Association and Morgan Stanley
to describe the U.S. film market. As you can see, total
exposures are flat, as are our film shipments.
However, 35mm film is taking a growing market share
while our sales are relatively flat. As you know, filmpurchasing accounts for 18 percent of the $12 billion
amateur camera/film market, and film processing
accounts for 45.5 percent. Still cameras themselves
account for 13.3 percent of annual sales.
This overhead [Exhibit 11] again uses Photo
Marketing Association data to show that our dollar

volume of film sales to the amateur market has been
relatively flat since 1988, although the dollar volume
will increase slightly this year. Unit volume, however, has been declining since 1988. Instant film captures only a 1.5 percent share of the total film
exposures and only 3.7 percent of the rolls or packages of film sold. Only about 2.8 percent of households purchase instant film in a three-month periodbuying about three packs. This compares with 43
percent who purchase 35mm film, buying almost fiverolls.

807

808
Polaroid and the Family-Imaging Market

EXHIBIT 10
Film Market

CASE 18 Polaroid and the Family-Imaging Market

795

796

EXHIBIT 11
Analysis of Film Sales

CASE 18 Polaroid and the Family-Imaging Market

Polaroid and the Family-Imaging Market

809

810

Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market

I noted earlier that instant film is expensive compared to other film. This overhead shows that dramatically. In fact, the price gap between instant and 35mm
film per developed image has been widening over the
past six years. The cost per developed image for
instant film will be about $0.97 this year versus about$0.39 for 35mm film. I analyzed some Photo
Marketing Association data that indicated that consumers pay an average premium of almost 31 percent
when they select “fast” processing versus regular processing at photo-processing outlets.
Since I’m discussing processing, take a took at thenext overhead [Exhibit 12], which shows that thegrowth in minilab, 1-hour processing seems to havepeaked and that discount and grocery store processing
is actually growing faster than minilab. Most grocerydiscount stores offer one-day turnaround. This iswhere we feel the growth is.

John Sturgis put up his hand. “Vicki, while you
are on the subject of film, do you have any data on
where consumers are buying film?” he asked.
“You folks are always asking me about making
the film, but we haven’t really discussed consumer
buying habits.”
EXHIBIT 12
Minilab Processing

797

Good question, John. Let me see, I believe I have an
overhead here on that. Yes, here it is [Exhibit 13]. As I
noted earlier, we have seen a significant increase in
our camera sales in discount department stores. This
chart, which is based on Photo Marketing Association
data, shows that consumers purchased almost 37 percent of film in these stores, easily outdistancing drugstores and supermarkets. As in camera sales, our top
ten customers now account for about half of our film
shipments, up from about one-third in 1986.

“How are we doing on consumer awareness?”
Howard Fortner asked. “Like John, I worry about
making the cameras rather than selling them. But I
notice that when I meet people and tell them I workfor Polaroid, often they really don’t know muchabout us or our cameras.”“Another good question, and right on cue,
Howard,” Vicki responded. “I’ll ask Nick to show
you some overheads he prepared.”
Nick Ward had only recently joined Polaroid assenior marketing research analyst. He had previously been with Kraft/General Foods and had a
Ph.D. in experimental psychology from thePolaroid and the Family-Imaging Market

798

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 13
Percentage Breakdown of Household Film Purchased in the Past 12 Months by Outlet Type

University of Kansas and an undergraduate
degree from UCLA in mathematical psychology.
Howard, this overhead [Exhibit 14] shows someresults from the Photo Marketing Association’s mostrecent consumer tracking studies. As you can see,
Kodak has tremendous consumer awareness in both
cameras and film, while we hover in the 40 to 50 percent range. Our camera awareness is significantly
below 50 percent in terms of top-of-mind awareness.
As you know, our research shows that most Polaroid
owners also have at least one other camera in theirhome. Our advertising tracking studies show thatabout one-third of consumers see instant cameras fitting their lifestyle. However, consumer perceptions of
the quality of our cameras has fallen somewhat, probably due to our advertising our OneStep and Cool Cam
cameras at less than $30, the “under 30 clams” ads.
I guess the next logical question relates to our advertising spending. So, this overhead also compares our

U.S. advertising spending and share of voice with ourawareness. There is some lag effect here from year toyear. I’ve included a graph showing our advertising andpromotion expenses as a percent of worldwide sales.
The next two overheads [Exhibits 15 and 16, pages
800-801] summarize some Photo Marketing Association information I’ve gathered about the knowledge
and use of cameras. The pie chart on the first overhead
indicates that 53 percent of the survey’s respondents
felt they knew almost nothing or just a little aboutphotography. The bar graph compares consumers’
views of picture quality. Respondents gave instantprints the lowest rating. Our tracking studies also
show that consumers see instant cameras as being
more expensive and less flexible and compact thanother camera types.
The four bar graphs on the last overhead [Exhibit
16] again use Photo Marketing Association data toillustrate that consumers are taking fewer pictures
because they feel they have fewer opportunities much

811

Polaroid and the Family-Imaging Market

799

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 14
Advertising and Promotion

WHICH PHOT
PHOTO PRODUCTS/BRANDSPRODUCTS/BRANDS DO YOU RECALL SEEINGOR HEARING ADVER
ADVERTISED
TISED IN THE PAST
PAST 12 MONTHS?
Cameras—An
Camer
as—An y Brand
Brand

92.9

Kodak

75.8

Minolta

52.5

Canon

51.5

Polaroid

51.1

Fuji

37.9

Nikon
Nik
on

34.5

Olympus24.3

Vivitar

19

Pentax18.9

Konica13.6

Film—An y Brand
Brand

96

Kodak

92.5

Fuji

62.1

Polaroid

46.1

Store Brands
Brands12.1

Perercentcent of Households
Source: Photo Mark
Marketing Association

U.S. ADADVER
VERTISING
TISING AW
AWARENESSADVERADVERTISING
TISING AND PROMOPROMOTION
TION EXPENSES
AS A % OF SALES WORLDORLDWIDE
WIDE

ADVERTISINGADVER
TISING SPENDING (BILLIONS)

6.5%

6.0%
PERCENT OF SALES

812

5.5%

5.0%

4.5%
86

SPENDING (%)

89

90

AWARENESS (%)

91

92E

SHARE OF VOICE (%)

4.0%
86

Source: Polaroid Corpor
Cor poration
ation*Specific data points are not disclosed on the gr
graph. GrGraph
aph represents
relative
relative magnitudes of spending, aw
awarenessareness,, and share of voice
voice..

87

88

Source: Morgan Stanley
Stanley Research****Data forfor grgraph provided
provided byby Morgan Stanley
Stanley & Co.,Co.,
not byby Polaroid.
Polaroid. Use is forfor case purposes
purposes only.
only.

89

90

91

92E

Polaroid and the Family-Imaging Market

800

CASE 18 Polaroid and the Family-Imaging Market

EXHIBIT 15
Consumer Ratings of Quality and Knowledge

813

814

Camera Usage
EXHIBIT 16

Polaroid and the Family-Imaging Market

CASE 18 Polaroid and the Family-Imaging Market

801Polaroid and the Family-Imaging Market

802

CASE 18 Polaroid and the Family-Imaging Market

more than because of their concern over the cost offilm and processing. People cited their desire to preserve memories and share those memories later withothers as their main reasons for taking pictures.
Notice that the primary users of instant cameras arefemales. We also know that the average instant camera user is somewhat older than the average users ofother cameras. For example, our average user is about
46 years old versus about 41 years old for users of
35mm rangefinders. The favorite subjects for picture
taking are family celebrations and people. I should
also add that we estimate that there are approximately 9.5 million households that have and use a
Polaroid camera, about an equal number that have a
Polaroid camera but don’t use it, and about 75 million
households that don’t own a Polaroid.
Finally, our research shows that the Joshua camera
has good product imagery; that is, compared to ourother cameras, consumers see it as similar to a 35mm
camera and as having a stylish appearance and contemporary design. Consumers also found it easier tohandle, more full-featured, and more fully automaticthan our other cameras. They felt they would be more
likely to use the Joshua camera than our other cameras for vacations, weekend and day trips, and sporting events. Research also shows that consumers wanta better camera that is easier to operate and that they
can carry on trips in the U.S.

“Nick, did you find any commonalities among
the consumers who liked the Joshua camera in yourresearch?” asked Roy Baessler.

“Yes, Roy. At this time, we can say that the camera appeals to younger, upscale, career-mindedpeople who are intelligent stylish, adventurous,
and friendly,” Nick responded. “I know thoseterms sound very general to an engineer, but those
are the adjectives we’ve used to describe people
who like the new camera design.”“Roger, that’s all the background information
we wanted to present today.”THE ASSIGNMENT“Thanks, Vicki and Nick. As I said, we need tospend the time in these meetings over the next two
weeks to prepare for our meeting with the corporate officers. I’d like to ask Vicki, Nick, and Rick to
be prepared to present an outline of a U.S. marketing strategy for our family-imaging business at our
meeting in three weeks. Meanwhile, if any of you
have suggestions for them, please feel free to sharethem. I’m sure they’ll appreciate your ideas.”
As the meeting adjourned, Vicki gathered heroverheads. She glanced at the countdown clock
and then at Nick. “I’m starting to hate that clock,”she announced. “We’ve lost seven days since ourlast meeting! There’s just too much to do and too
little time.”

815

Fike’s European Strategies

In November 1992, Mr. Heikki Gronlund, senior
vice president, International Operations received
a detailed report on the European operations of theFike Corporation from Mr. Bob Michelson, themanaging director of the company’s European subsidiary, Fike Europe NV, Antwerp, Belgium. After
carefully reviewing the contents of the report, Mr.
Gronlund was wondering whether Fike Europe
NV should continue its current strategies and practices or make changes, especially in light of the
1992 greater integration of the Western European
markets. Mr. Gronlund was concerned about
strategic planning for the 1990s and beyond inEurope, which would enable Fike Europe NV toface up to the new business challenges of post
“Europe 1992.”
FIKE CORPORATIONThe Fike Corporation was started in 1945 by the
Fike family. It continues to be a family-held company. Over the past four decades, the company
has expanded its operations both in the U.S. andabroad. Currently, the Fike Corporation consistsof Fike Metal Products, New York; Fike Europe NV,
Antwerp, Belgium; Fike Japan, Tokyo, Japan; FikeSoutheast Asia, Singapore; Fike Canada, Burlington, Ontario, Canada; Fike United Kingdom,
Kaidstone, Kent, England; and Fike France, CergyPontoise, France.
Fike Metal Products is a leading developer
and manufacturer of pressure-relieving devices
commonly known as rupture disc assemblies.
Having recognized the need for this type of technology in the protection of dust and vapor-handling equipment, Fike Metal Products developed
the Fike Explosion Venting Assembly (U.S. Pat.
No. 4,067,154). Fike Explosion Vents represent the37
CA S E 19

latest advancements in low-pressure relief techniques.
Industries utilizing dust- or vapor-handlingequipment are faced with a continuous explosion
potential. The versatility and reliability of the Fike
Explosion Vent has opened new frontiers for protecting every type and configuration of dust- or
vapor-handling equipment. The types of equipment that need to be protected consist of crushers,
pulverizers, ducts, screw feed conveyors, dryers,
furnaces, blenders, pipes, silos, coating machines,
grain elevators, grinders, dust collectors, conveyors, bucket elevators, ovens, spray dryers, mixers,
bins, spreaders, and air scrubbers.
According to a sales brochure offering Fike’s
explosion testing services:
A 1991 study by Industrial Risk Insurers (IRI) showsthat explosions resulted in more damage than all otherlosses combined. The study places the average loss
due to a combustion explosion within equipment at$961,268.
The Explosion Protection Group of Fike Corporation offers a wide range of explosibility tests designed
to assist industry in mitigating explosion hazards. The
Testing Center at Fike is staffed with testing technicians under the direction of a combustion phenomena
research scientist. Among the many services offered is
explosibility testing in both small- and large-scale
explosion chambers. Fike’s test vessels are designed
and constructed to provide accurate data that can beprojected to full-scale processes.
Tests are conducted according to ASTM (American
Society for Testing and Materials) and ISO (International Standards Organization) standards. A confidential report describing the procedures used andresults obtained is provided to the customer.

According to another sales brochure on the company’s explosion isolation valve:This case was prepared by Professor C. P. Rao of Old Dominion University. It is intended as a basis for class discussion and student analysis. Printed by permission of the author.

803

817

818

Fike's European Strategies

804

CASE 19 Fike’s European Strategies

For over 40 years, we have been solving overpressureand explosion protection problems and continuously
challenge ourselves to develop innovative solutions to
our customers’ process safety needs. This commitment is illustrated by the development of the Fike
Explosion Isolation Valve by our Explosion Protection
Group. This development greatly extends the process
designer’s and plant safety personnel’s ability to limit
damage from process deflagrations. Explosion isolation is compatible with other explosion protection
methods you may be considering or currently have inplace. Explosion venting, explosion suppression orpressure containment may be combined with isolation
to best meet your overall explosion protection needs.

The above descriptions provide a brief overview
of the industrial products and services marketed by
the Fike Corporation. While a full range of explosion protection products and services are marketedin the United States, the overseas sales are limited
to only some of the products and services.
FIKE’S OVERSEAS BUSINESS OPERATIONSIn the mid-1960s, Fike started exploring overseas
business opportunities. Contacts were establishedwith a business firm in Philadelphia that was animporter into many European countries. Exclusive
national distributorships were contracted withthis Philadelphia firm. The Philadelphia firmbought the products from Fike and paid in U.S.
dollars. Fike provided technical support andsales-oriented support activities in the form oftechnical seminars. By the late 1970s, Europeansales accounted for hundreds of thousands of U.S.
dollars.
In 1982, Fike participated in a world exhibitionof chemical products in Europe. In the same year,
Mr. Gronlund was appointed as manager in chargeof the company’s international business operations.
Since Mr. Gronlund’s appointment, Fike’s commitment to the international dimension of its businesshas greatly increased. International business operations are not merely limited to exports but are also
involved in substantial investments wherever it isfelt feasible and necessary. The growth and evolu-tion of the company’s international business is outlined in the following account from the “FortiethYear Report” of the company published in 1984.
In the early years of the company, the traditional
rupture disc product line was brought to the international marketplace through conventional export
arrangements with national importers. Many of theseagents, especially in Europe, have been associated with
us for 20 years and more and enjoy considerable success.
With a Europe-wide network of specialized distributors knowledgeable in technical sales, we have beenable to win customers in fields as demanding as boththe nuclear and aerospace programs. We have also
introduced the use of rupture discs as cost-effective,
fail-safe devices into markets where they have been
largely unknown in the past.
These efforts have gained us a corporate reputation
for quality and the best service and support in theindustry. Despite national competitors in some countries, there is a large acceptance of Fike and Fike rupture discs as the ultimate in reliability.
Outside Europe, the activity was very low indeed.
Japan had long been considered a good export opportunity, but the usual problems of dealing with a complex and vastly different system had hindered real
penetration. The creation of Fike Japan Corporation asa joint venture effort in 1980 proved to be the making
of a Far Eastern success story, one of which we arevery proud.
Too often today we hear complaints by otherwise
well-informed people decrying the lack of opportunities in Japan. At Fike, we emphatically wish to state
the contrary. With the proper approach and dedication
to the market, the Japanese will accept quality products regardless of their origin.
Fike Japan looks forward to continued growth.
Current plans call for an expansion into other Far
Eastern markets and the installation of further manufacturing capabilities in Japan.
Heartened by the solid growth and success inJapan as well as in Europe, the company decided toformally recognize the importance of overseas business by establishing an International Operations center in the home office in 1982. Dedicated to seeking
opportunities in foreign markets, it is the task of thisgroup to make recommendations and manage the corporation’s involvement in all foreign ventures.

819

Fike's European Strategies

CASE 19 Fike’s European Strategies

The European countries presented an immediate
prospect for added sales. An evaluation of the various
national markets showed room for a strong entry by areputable manufacturer of top quality safety relief
products. Germany and Switzerland, in particular,
have pioneered work in industrial explosion safety
from both a scientific and practical view, and created astrong demand for our type of products. At the sametime, it was recognized that further penetration in
Europe would have to be as an EEC manufacturer toregain our cost-competitiveness against the various
local producers, and to give our customers the security of local services and support.
In the spring of 1984, a site near Antwerp,
Belgium was purchased, and Fike Europe NV wasestablished as a wholly-owned subsidiary of Fike
Metal Products. We are pleased to say that our customers have responded very favorably to this moveand 1985 will be a year of great development as we
swing into full in-house production of a large number of products.
We view the creating of a European company as amajor step in our international marketing, and as asign of our belief in the great importance of Western
Europe in all our corporate activities. Fike Europe is,furthermore, the vehicle responsible for serving the
emerging markets of Africa and the Middle East,
where we see ever-increasing activity in the “downstream” products of the petrochemical industries.
There is a definite long-term trend towards thetransfer of technology from the developed to thedeveloping nations of the world. In the core chemicaland petrochemical markets of the rupture disc product line, this means a higher rate of market growthoverseas than here at home. In the United States, weare blessed with the world’s largest domestic market,
but we cannot ignore the increasing internationalization of all business.
We are gearing our operations accordingly. With amultinational ability to exchange technical know-how
and information and productive capacity, we can meetthe needs of the world’s markets now and in the
future.
Most of the other product areas have yet to test
international waters, but as we see opportunities forbringing the specialties to foreign markets we intend
to develop them aggressively.
With so many different possibilities for tacklingcomplex markets worldwide, we remain guided by805

some very basic beliefs instilled in the company by
two generations of family leadership.
First and foremost, we shall stay true to the task ofbeing a manufacturer of our own products. By keeping control of all the quality control and production
operations, we will make a better product and serve
our customers more faithfully than our competition.
Investment in selected overseas manufacturing
sites is a must for continued growth. The days of pureexporting are long gone, even for advanced high technology products. By producing locally, we demonstrate our desire to become totally involved in themarket, and accept the necessity of modifying our
products to meet local needs.
Because we manufacture many items that are ultimate safety devices protecting peoples’ lives, we will
always be conscious of the tremendous responsibility
we have to make sure every product performs every
time. We will not take the risk of letting other people
produce our rupture discs and related safety devices
for us, and we will remain firm in our stand of retaining full control over products carrying the trusted Fike
name.

FIKE’S EUROPEAN OPERATIONSAs is evident from the account of the company’s
evolution and its approach toward its international
business operations, the Western European markets
form the major part of the total international business operations. Historically, Fike has had longer
involvement in these markets and, outside the U.S.,
the Western European markets collectively represent the largest market for the company’s products.
The overall importance of the Western European
markets is expected to increase with the full integration of these markets in 1992. Consistent with theoverall importance of the Western European markets for the international business segment of thecompany, Fike’s involvement in these markets hasgrown through expanded manufacturing and marketing activities in various European markets. As
mentioned earlier, a fully owned manufacturingsubsidiary was established in 1984 at Antwerp,
Belgium. Following this move, the marketing of thecompany’s products has been progressively

820

Fike's European Strategies

806

CASE 19 Fike’s European Strategies

changed from dependence on distributors to acompany-managed sales force. These intensified
manufacturing and marketing investments in
Western Europe required a total investment of about
U.S. $3 million. This investment represented about
one-tenth of Fike’s total investment in the company
operations. The European operations mainly consisted of manufacturing and marketing of 12 different rupture discs and vents. The rupture disc is the
major product line of Fike’s European operations.
The competitive standing of Fike for discs and ventsin seven Western European markets, which accountfor a major part of the company’s European operations, is provided in Exhibits 1 and 2.
In order to strengthen its market position in theWestern European markets, Fike Europe progressively eliminated the distributors in various
European markets. In 1992, the company sales force
marketed Fike’s products and services in Belgium,

France, Germany, Italy, and the U.K. However, Fike
Europe still continues to utilize the services of distributors in Denmark, the Netherlands, Spain,
Sweden, and Switzerland. Currently, the company isin the process of establishing direct sales offices in
Spain and the Netherlands. However, the transition
from indirect distribution through distributors to
direct distribution through a company-managed
sales force has not always been a smooth process.
For example, in the U.K., the transition from indirect
to direct distribution has been quite smooth. The distributors readily agreed to the new arrangement
without any resistance to the change. As a result of
the shift to a direct company-managed sales force,
the U.K. sales have increased by 11 times.
The problems experienced in other Western
European countries in bringing about the shift fromindirect distribution to direct distribution hasvaried from country to country. In Germany, the

EXHIBIT 1
Composition of European Market for Rupture Discs: Estimated Market Shares of Competitors in 1992
Competitors
Rank

Country

Total

Fike

A

B

C

D

E

F

Other

6

Belgium (S)

100

20

40

20

5

5

2

2

6

3

France (S)

100

20

25

20

20

2

10

3

–

1

Germany (S)

100

5

30

12

7

11

6

6

23

4

Italy (S)

100

10

23

6

20

2

–

–

39

2

U.K. (S)

100

6

28

4

38

–

23

1

–

10

Denmark (D)

100

35

40

10

5

5

–

–

5

5

Holland (D)

100

26

18

32

9

–

–

5

10

8

Spain (D)

100

14

–

71

10

–

5

–

–

9

Sweden (D)

100

38

25

10

3

10

2

3

9

7

Switzerland (D)

100

20

15

–

–

5

10

–

50

Notes: RANK—Market size rank for the 10 European countries covered.
All numbers except under column Rank are percentages.
For some countries, the percentage of market shares of various competitors do not add up to 100 due to non-availability of data.
(S) — Company direct sales to customers(D) — Sales through distributors to customers
Source: Fike Europe company records, 1992.

821

Fike's European Strategies

CASE 19 Fike’s European Strategies

807

EXHIBIT 2
Composition of European Market for Vents: Estimated Market Shares of Competitors in 1992
Competitors
Rank

Country

Total

Fike

A

B

C

D

E

F

Other

2

Belgium (S)

100

40

–

–

10

40

–

–

10

3

France (S)

100

35

2

2

35

5

20

1

–

1

Germany (S)

100

9

5

1

3

80

–

2

–

5

Italy (S)

100

25

–

–

14

61

–

–

–

6

U.K. (S)

100

27

12

–

32

2

27

–

–

8

Denmark (D)

100

33

10

–

10

5

–

–

–

4

Holland (D)

100

41

3

5

10

39

–

2

–

7

Spain (D)

100

12

–

2

10

76

–

–

–

9

Sweden (D)

100

40

15

–

7

30

8

–

–

10

Switzerland (D)

100

10

–

–

–

90

–

–

–

Notes: RANK—Market size rank for the 10 European countries covered.
All numbers except under column Rank are percentages.
For some countries, the percentage of market shares of various competitors do not add up to 100 due to non-availability of data.
(S) — Company direct sales to customers(D) — Sales through distributors to customers
Source: Fike Europe company records, 1992.

company had good relations with the distributor,
but felt that it was not getting its fair share of themarket. Through negotiations, it was agreed thatthe distributors would give their best shot, but thisarrangement did not work and expected sales did
not take place. Hence, a phasing-out program overa period of 18 months has been implemented without much of a problem. An ex-employee of the distributor joined Fike’s German office and no
significant sales dislocation was experienced. On
the other hand, in France, the distributor fought
tooth and nail. A court case initiated in 1986 is still
continuing. This dispute initially caused considerable discontinuity in the company’s business. The
managing director of Fike Europe would prefer toresolve this situation amicably through negotiations, but the company’s legal counsel believes thatthe longer the court case drags on, the more theissue becomes dormant without any adverse effects
on the company’s operations in France.

Fike Europe is in the process of establishingdirect offices in Spain and the Netherlands. In bothcountries, Fike has had long-standing relationships
with the respective distributors. Direct distribution
is used for different reasons in each of these countries. In Spain, it was observed that sales were growing very slowly; it was also felt by Fike Europe thatthe management of the distributor was somewhat
old-fashioned and not aggressive enough. In any
case, company management believed that its products were not getting proper sales attention andhence it was decided to establish a direct sales officein Spain. In contrast, different factors in the
Netherlands precipitated the move for establishinga direct sales office. The relations between the company and its distributor have been long establishedand quite satisfactory. Fike personnel have been in
constant touch with the distributor salespersons
and overall sales performance has been found to besatisfactory. However, the distributor was taken

822

Fike's European Strategies

808

CASE 19 Fike’s European Strategies

over by a Swedish company that emphasizes its
own company-manufactured products rather thantraded products. Hence, it was decided to get out of
this relationship. Fike Europe expects that the transition will be quite smooth.
According to Mr. Gronlund, Fike Europe operations possessed the following key characteristics:
1. Country managements are highly diversified. Hence,each European country management is localized.
2. Management in each country enjoys considerable
autonomy with overall control on financial performance exercised by Fike Europe and the senior vicepresident, International Operations at the U.S. head
office.
3. Management in each country decides which products and services will be offered in its own markets.
This policy is based on the fact that the country managements have the pertinent knowledge, beliefs,
and values that are relevant for each of their own
markets.
4. Although management in each country is considereda sales office of Fike Europe, each acts as if it is independent and autonomous. While the basic technicalservice components are the same in all the European
countries, management in each country sets its own
prices, specific services, and other aspects of dealing
with customers and competitors.
5. Fike management does not believe in molding one
uniform approach and does not force a single way of
doing business on its individual Western European
markets.

Fike’s business in Europe is also characterizedby significant levels of competition in all the European markets. In terms of country-of-origin, there
are two U.K. competitors, one German, one Italian,
and two U.S. competitors in the European markets.
At present, there are no Japanese competitors.
As far as Fike’s European business operations
are concerned, Mr. Gronlund thinks that EC-1992
is a non-event because Fike Europe is already aEuropean company. Currently, 60 percent of Fike
Europe’s total business is met by its own manufacturing facilities in Antwerp, Belgium. The
remaining 40 percent of Fike Europe’s businessneeds are supplied by Fike USA. Recently, Fike
Europe obtained ISO 9000 certification, whichfurther strengthens its competitive position in theEuropean markets. The only major effect of the EC92 phenomenon on Fike’s European operations is
the effect of the changed VAT (value added tax)
rules on the company’s computerized accounting
system.
The company is currently exploring businesspossibilities in Eastern Europe. Some limited sales
have been achieved in East European countries.
According to Mr. Gronlund, the major hurdle forfurther sales growth in the former communist
countries is the lack of foreign exchange experienced by most of these countries. However, in anticipation of future growth prospects in the Russian
market, a Fike Russia sales office was recently
opened in St. Petersburg, Russia.
The following assessment of the European markets, both west and east, is included in the 1992
annual report of Fike Europe:
The economic recession which started in 1991 has continued in 1992, and so far no signs of improvement are
noticed. Most of the projects that have been put on ice
in 1991 are still on ice or cancelled. An increasing number of companies are laying off people or are goingbankrupt. It seems the recession is also hurting thechemical industry. Big companies, like Bayer and
BASF, are cutting cost and production personnel andeven Monsanto is closing down part of its operation.
All in all, it seems that Fike Europe is still doing OK
as we will end up with an increase in consolidated
turnover.
On January 1st, 1993, the united European market
is a fact. The only immediate change that will happenis the difference in VAT administration (which will
make things more complicated). On rupture discs a
European standard has been finalized and this standard will be in effect somewhere mid–1995. However, the differences with today’s requirements areminimal.
The only change we can feel is that all countries of
the EC have to comply with the safety and environmental requirements as laid down in European standards. The result will be that countries which used tohave less stringent requirements on safety and environment will need to comply now. Therefore, countries such as Greece, Spain, Portugal, etc. will be more
receptive to Fike products.

823

Fike's European Strategies

CASE 19 Fike’s European Strategies

In Eastern Europe, most of the currencies now areconvertible. The only problem is exponential inflation.
On top of this is the internal political situation, which
is very uncertain. Most of the Eastern European political leaders are struggling to survive. It is clear that thepriorities do not include safety and environment.
Their major concern is food, clothing, and consumer
products. However, Eastern Europe is still a market
for the future and Fike needs to be present there tocapitalize on opportunities as they emerge.

In the 1992 annual report of Fike Europe, Mr.
Bob Michelson concluded with the following
thought:809

It seems to me that in the past Fike has always put theemphasis on marketing the products. I believe thatthe time is right for Fike to actually market the company. We are truly a different company from the competition as we have the complete line of products,
including expertise and test facilities. We need tomarket ourselves as the leader in this field. Such marketing can only be done in an organized and global
way, so that the same image is presented worldwide.
Therefore, I believe it would be right if Fike
Corporation could set up a marketing group to determine international image-building advertising andproduct introduction.

C A S E 2 0 PSA Peugeot Citroën

T

he PSA Group included two general car manufacturing companies: Automobiles Peugeot
and Automobiles Citroën. The two were linked bystrong technological, industrial, and financial synergies, although each marque kept its identity, andits own marketing and sales. In 1994, the PSA
group was the third largest car manufacturer inEurope, with 12.8 percent market share.
The year 1994 showed improved performance of
PSA, after difficulties in 1993: profitability rosefrom a Ffr1 billion loss to profits of Ffr3.1 billion,
and the sales turnover increased from Ffr145.4 billion to Ffr166.2 billion (95 percent of which was incar manufacturing). PSA employed 139,800 people
and manufactured 1,989,000 vehicles, of which
two-thirds were sold outside France in 150 countries and 22,000 sales locations. With export sales ofFfr74.9 billion, the group was the main French
exporter.
THE PSA GROUP
In 1976, Peugeot, a family-owned company, took
over Citroën. Then in 1978, it took over theEuropean subsidiaries of Chrysler. At the beginningof the 1990s, the group (Peugeot and Citroën) was
controlled by the Peugeot family, who owned 22.7
percent of the equity, the largest other shareholder
being Michelin. The rest of the equity was held byfinancial institutions and individual stockholders.
From 1980 to 1984, the PSA Group went throughfinancial difficulties, its net debts rising to Ffr33.1
billion and its equity dropping to Ffr5.3 billion in
1984. In 1983, the group lost Ffr2.6 billion. The

38

renaissance of PSA came with the hiring of a new
top manager, Jacques Calvet, and with the growthin the European market (+4 percent per year on
average) between 1985 and 1989. Jacques Calvet
became président directeur général of Peugeot,
then président directeur général of Citroën in 1983and président du directoire of the holding company in 1984. Formerly, he had been directeur dutrésor at the French Ministry of Finance and president of the Banque Nationale de Paris. Experts
believed that his skills and the rigor of his management were at the center of the recovery of the PSA
Group. Losses were cut as early as 1984, and debts
were reduced starting from 1987. At the end of
1989, the company announced net profits of Ffr10.3
billion (a net margin of 6.7 percent of turnover); thesales turnover was about Ffr153 billion and debts
had been reduced to Ffr1.9 billion.
Substantial progress in production methods was
also achieved: productivity improvement wereabout 72 percent between 1982 and 1987 (the best
European performance according to the consulting
company Luvigsen Associates), and 60 percent
during the period 1985–1989. High investments
were made to rationalize manufacturing and todevelop the company’s range of products.
In 1986, Jacques Calvet announced an ambitious
goal for PSA: to become the leading car manufacturer in the European market in terms of number ofvehicles sold. However, the aim of dominant market share was postponed with the recession of thewestern European market and the unexpected
opening of the eastern European market, which
was more favorable to competitors based inThis case was prepared by Roland Calori, Philippe Very and Michel Berthelier, professors at the Group ESC Lyon. The authors
would like to thank the PSA Group for its support in writing the case study. It is intended as a basis for class discussion and not as
illustration of either good or bad management practice. Copyright © R. Calori, P. Very and M. Berthelier, 1996. It is reproduced
here with the permission of the authors.

810

825

826

PSA Peugeot Citroen

811

CASE 20 PSA Peugeot Citroën

Germany (Volkswagen and GM-Opel). Indeed,from 1990 to 1993, with the economic recession, theEuropean car market decreased and sales and profits of the PSA Group slowly declined before the1994 revival.
Table 1 gives the main financial indicators of
PSA between 1990 and 1994, and Table 2 gives
information on the two main companies of thegroup, Automobiles Peugeot and Automobiles
Citroën.
MARKETS
Western European market shares fluctuateddepending on two main factors: significant changes
in relative prices and the success of new models.
The top management of the PSA Group was preoccupied with the price war that had been taking
place since 1990. They were also concerned with
monetary fluctuations within Europe, particularly
with the competitive devaluations of sterling, thepeseta, and the Italian firs (about 38 percent since1992), which had upset sales at the beginning of the
1990s. PSA and several other car manufacturers
were looking forward to the possibility of a single
European currency. As Jacques Calvet remarked in
the annual stockholders’ meeting in June 1995:
For Europe, which is now truly a single market, theworst wounds have come from within, with the break-down of the European Monetary System and competitive devaluations, notably of the Italian lira. Europe
will not hold up long if there is not a rapid solution tothis problem.

Moreover, new competitors were emerging. The
market share of Korean car manufacturers in
Europe (about 3 percent in 1994) was growing, particularly in the low-priced segment.
The eastern European markets stagnated ataround 1 million vehicles a year and experts forecast a maximum of 1.5 million vehicles by the year
2000. The Russian market was estimated around 2
million vehicles and moderate growth was
expected.
The North American market grew in 1992 (5percent) and in 1993 (7.3 percent), and it represented 16.5 million vehicles in 1994. ‘Light trucks’(minivans, pick-ups, four-wheel-drives) represented 40 percent of sales, with high growth.
General Motors, Ford, and Chrysler had a 73 percent market share, compared to the Japanese 23
percent, and the European car manufacturers’ 2.7
percent. PSA had left the U.S. market in 1985, since
it could not establish a significant position in thishighly competitive environment (on average theprice of cars in the United States was 30 percent
lower than in Europe).
The Japanese market showed signs of revival in1994 (an increase of 1 percent) after three years of

TABLE 1
PSA Group: Main Consolidated Financial Data

Net sales
Cash flow
Investments (tangible assets)
Net profit
Shareholder’s equity
Net financial debts
Earnings per share (Ffr)

1994

1993

1992

1991

1990

166.2
15.2
10.5
3.1
53.5
7.6
62

145.4
8.3
11.3
(–1.4)
50.5
16.7
(–28)

155.4
13.7
13.8
3.4
53.1
14.3
67

160.2
15.4
15.5
5.5
51.7
9.4
111

160.0
16.2
15.2
9.3
47.2
8.3
185

Note: Figures in million of French francs unless stated.
Source: Adapted from Annual Report, 1994.

827

PSA Peugeot Citroen

812

CASE 20 PSA Peugeot CitroënTABLE 2The Two Main Companies of the PSA Group: Automobiles Peugeot and Automobiles Citroën
Automobiles Peugeot

Automobiles Citroën

Group’s holding: 100% (full by Peugeot SA)
Plants in: Sochaux-Montebélard, Mulhouse, Poissy,
Ryton (U.K.), and Villaverde (Spain).
Plants in: Dijon, Lille, Saint Étienne, Sept-Fons,
Vesoul, Valenciennes, and Villers la Montagne

Group’s holding: 100% (fully by Peugeot SA)
Production sites in: Aulnay, Rennes, Vigo (Spain),and Mangualde (Portugal).
Plants in: Asnières, Caen, and Charleville

1994
Economic Data
Production(in number of vehicles)
Sales(in number of vehicles)
Employees
CompanyGroup
Consolidated financial data (Ffr m)
Net sales
Working capital provided fromoperations
Net income
Stockholder’s equity
Capital expenditures
Dividend

1993
Economic Data
Production(in number of vehicles)
Sales(in number of vehicles)

1,202,200

1,058,100

1,209,200

1,061,900

41,90069,20043,80073,000101,778

89,968

7,545
1,394

3,102
(958)

Consolidated financial data (Ffr m)
Net sales
Working capital provided fromoperations
Net income

30,644
6,047

29,318
5,758

Stockholder’s equity
Capital expenditures

280—

Employees
CompanyGroup

Dividend

1994

1993

787,800

693,500

779,600

702,000

28,90045,70029,90046,80070,65364,592

4,416
184

1,540
(2,341)

4,757
3,240

4,637
3,456

—

—

Source: Annual Report, 1994.

decline. It represented 6.6 million vehicles. In thismarket, dominated by Toyota (with a 41 percent market share), imports from foreign OECD countries
were marginal. German manufacturers together
exported 121,000 vehicles in 1994, Americans
exported 37,000 vehicles, and the French sold 6,800
units.
The African and Middle East markets remained
marginal (stable at around a total of 1 million vehicles a year). Two other zones experienced highgrowth: South America (2.8 million vehicles a year,with a 6 percent annual growth) and Asia (apartfrom Japan), which represented annual sales of 4.8
million vehicles (with a 9 percent annual growth).

Table 3 shows the breakdown of the sales of the
PSA Group in the world, and Table 4 gives thebreakdown of market share for the group in Europe.
At the annual stockholders’ meeting in June
1995, Jacques Calvet commented on the 1994 performance of PSA as follows:
The market share of Peugeot and Citroën in western
Europe, 12.8 percent, as compared to 12.1 percent in1992 and 12.4 percent in 1993, has grown significantly.
This commercial dynamism results both from thedeployment of our ranges of vehicles . . . and from thefavorable evolution of European markets: those where
Peugeot and Citroën have a high share have evolved
more favorably than the European average.

828

PSA Peugeot Citroen

CASE 20 PSA Peugeot CitroënTABLE 3
Worldwide Sales of the PSA Group (Passenger Cars and Light Commercial Vehicles 000s)
1994

1993

1992

430
304
737

328
250
577

437
270
707

585
416
1,000

544
399
942

617
459
1,076

Eastern Europe
Peugeot
CitroënPSA Peugeot Citroën

14
8
22

20
10
30

15
6
21

AfricaPeugeot
CitroënPSA Peugeot Citroën

24
9
34

22
7
29

31
39

America
Peugeot
CitroënPSA Peugeot Citroën

99
11
110

71
8
79

59
8
67

Asia-Pacific Area
Peugeot
CitroënPSA Peugeot Citroën

40
21
61

59
19
79

57
15
72

Special Registrations
Peugeot
CitroënPSA Peugeot Citroën

19
10
19

18
9
28

19
13
33

1,209
(40)
780
1,989

1,062
(42)
702
1,764

1,235
(27)
779
2,014

Western Europe
FrancePeugeot
Citroën
F5A Peugeot Citroën
Other Western European Countries
Peugeot
CitroënPSA Peugeot Citroën

Outside Western Europe

Total Worldwide
Peugeot(including small collections)
CitroënPSA Peugeot Citroën
Source: Annual Report 1994.

813

PSA Peugeot Citroen

814

CASE 20 PSA Peugeot CitroënTABLE 4
European Sales of the PSA Group: Share of Passenger Car Registrations (%)
1994

1993

1992

FranceAustria
Belgium-Luxembourg
Denmark
FinlandGermany
GreeceIreland
Italy
Netherlands
NorwayPortugal
Spain
SwedenSwitzerland
United Kingdom

31.1
7.8
43.7
14.8
8.4
4.5
11.3
7.0
7.0
12.1
8.9
13.3
19.9
4.6
7.9
12.1

29.7
7.5
13.6
14.8
6.9
5.1
11.5
6.9
6.7
13.1
8.0
14.0
20.3
4.3
7.9
12.6

30.4
7.0
14.2
12.3
5.7
4.5
11.2
6.7
7.1
11.0
7.5
16.2
20.7
33.2
6.6
11.8

Total Europe
Europe outside France

12.8
9.2

12.4
9.3

12.1
8.8

Note: Does not include light commercial vehicle registrations.
Source: Annual Report, 1994.

THE STRATEGY OF PSA
Jacques Calvet chose to be chairman ofAutomobiles Peugeot and chairman ofAutomobiles Citroën in order to stimulate synergies between the two companies, which kept theirown culture for several years after the merger.
Peugeot and Citroën were both involved in themain segments of the market and adopted parallelmarket positioning (see Table 5). Automobiles
Peugeot had a 7.7 percent market share in western
Europe (18.7 percent in France) and Automobiles
Citroën had a 6.1 percent market share in western
Europe (12.4 percent in France).
Some other competitors also had more than one
marque. The Volkswagen Group had several, with
Scat and Skoda at the low end of the market,
Volkswagen as a generalist, and Audi at the top endof the market. The Fiat Group had Ferrari at thevery top of the market, Alfa Romeo, Fiat itself, andLancia. Other car manufacturers such as Renault
had only one marque.
At PSA, the standardization of vehicles was relatively high between the two product lines, about
50 percent of the components being common.
These were the non-visible components—engines,
gearboxes, etc.—while the elements of the car that
could be seen were different. Joint purchasing ofcomponents through Sogedac, a group company(with an annual sales turnover of Ffr80 billion),
was seen as a source of competitive benefit by thecompany.
Part of the R&D expenses were also shared:
thanks to the two parallel model ranges, synergies in
R&D had increased, particularly in the early phasesof new product development. For instance, theCitroën XM and the Peugeot 605 were developed bya single “technical platform” (multifunctional project team). Innovations concerning new materials

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PSA Peugeot Citroen

CASE 20 PSA Peugeot Citroën

815

TABLE 5
Group production of Peugeot and Citroën Models (Number of Vehicles)
SectorMini
Super mini
Lower medium
Upper medium

Executive“Monospace”
Utility andmiscellaneous

Peugeot
Model
106
205
306
309
405
504 Paykan
505
605
806
J5, J9, Boxer

Total

Citroën
1994
340,800
146,600
380,850300
214,300
45,5509,600
19,05010,90034,0501,202,000

Model
AX

1994
198,700

ZX

251,600

XantiaBX

214,700
100

XM
Evasion
C15, C25
C35, Jumper

20,6007,200
94,900

Total

787,800

Source: Annual Report, 1994.

and new methods were shared. Industrial teams also
worked together on international operations.
Differences and separation between the two
marques were apparent in product design andstyle, the development of production processes,
and marketing and sales, with two distinct dealer
networks competing with each other. There was nointention to merge the two distribution networks,
since executives believed the weaker marque could
be disadvantaged (a problem which occurred when
Peugeot took over Chrysler-Simca in 1979).
Besides, the view was that merging the two independent distribution networks could give an
opportunity for foreign competitors to take overdealer networks.
Such a strategy required a significant effort torenew the range of models of the two companies. In
order to renew eight basic models (four Peugeot
and four Citroën) every six years, PSA would haveto launch one or two new models every year. On
average, the investment to launch a new model was
estimated at around Ffr10 billion.
The PSA Group was the world leader in diesel
cars with 957,400 vehicles in 1994, and had a signif-

icant competitive advantage in this domain. It solddiesel engines to Rover and Ford. In general,
French car manufacturers PSA and Renault had aparticularly strong position in diesel cars, with a 38
percent market share in western Europe. The top
management of PSA argued that diesel engines
consumed less and cheaper fuel, produced less pollution, and were more reliable and longer lasting
than petrol engines. The proportion of diesel cars
was very low in Japan and in the United States, but
it was significant and growing in Europe, particularly where the taxation of fuel was not unfavorable(see Table 6).
RENEWAL
Since the beginning of the 1990s, a particular effort
was made to launch new models and renew existing models. In 1994, PSA launched the 806 monospace (Peugeot) and its brother, the Evasion(Citroën). At Peugeot, the 605 was restyled andre-engined, and new versions of the 306 (a cabriolet
and a “tricorps”), and new utility vehicles (Boxerand 205 van) were launched. At Citroën, the XM

PSA Peugeot Citroen

816

CASE 20 PSA Peugeot CitroënTABLE 6Percentages of Diesel Cars in the Main EEC Countries

FranceGermany
Italy
United Kingdom
Netherlands
Belgium-Luxembourg
Spain
European-Union (12 countries)

1990

1994

33.0
9.8
7.3
6.4
10.9
31.8
14.7
14.2

47.6
16.6
8.7
21.7
12.0
41.4
28.2
23.1

Source: PSA.

was restyled and re-engined, new versions of theZX (Break) and the Xantia (Active) were produced,
and a new utility vehicle (Jumper) was launched.
Advertising and promotional budgets wereincreased to rejuvenate the image: warm andrelaxed for Citroën, humorous and lively for
Peugeot. Peugeot reinvested in the Formula I
Grand Prix and won eight podiums in 1994 with
the McLaren team; they also won “super tourism”
competitions with the 405. Citroën won the world
rally championship for the second time with its ZX.
The cooperation between Peugeot and Citroën
was crucial in order to share the efforts in renewing
products. For years, PSA also cooperated with
Renault in the development and manufacture ofcomponents as well as in research on environmentally friendly cars. At the beginning of the 1990s,
the cooperation with Fiat was strengthened inorder to share the development and manufacturingof a monospace. In 1994, the Sevelnord plant at
Valenciennea (France) started to manufacture themonospace for the four companies: Peugeot 806,
Citroën Evasion, Fiat Ulysse, and Lancia Zeta.
Sevelnord, a 60/60 joint venture between PSA and
Fiat, required a Ffr6 billion investment and were to
produce 130,000 vehicles a year. The same type ofcooperation was set up in Italy in order to share the
manufacturing of small utility vehicles: Peugeot
Boxer, Citroën Jumper, and Fiat Ducat. Sevelsud

was to manufacture 190,000 vehicles a year. The top
management of PSA viewed such focused alliancesat the best way to compete in new market niches.
From 1988 to 1990, PSA spent 3.5 percent of its
turnover on R&D. In 1994, the budget for R&D was
Ffr7.2 billion, representing 3.8 percent of the consolidated turnover, a high percentage compared toother European competitors, but lower than theJapanese Toyota and Honda (both around 5 percent). Most of the 9,200 persons employed in R&D
worked for the two marques: on the developmentof new models, on market-driven technologicalinnovations, or on manufacturing technologies andmethods. For instance, PSA participated in a joint
European program, Prometheus, to improve roadtraffic in Europe with the help of electronic systems. The group was also active in joint European
programs for the recycling of vehicles. The
improvement of subsystems such as diesel engines
and suspensions was also seen as a priority: for
instance, the launch of the Xantia Activa in 1994
was based on a new system of active suspensions.
The electric car was one of the top research priorities for PSA. In 1991, PSA was the first car manufacturer to sell electric vehicles for urban use(to Electricite de France and to local government
authorities and public institutions). The market
was estimated by executives to be around 250,000
vehicles in Europe by 1995. The large-scale

831

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PSA Peugeot Citroen

CASE 20 PSA Peugeot Citroën

manufacturing and sale of the electric Peugeot 106
and Citroën AX was planned to start in 1996. The
electric car was to become the second family car,for driving short distances mainly in towns. The
PSA executives believed they were three years
ahead of competition in this domain. The groupcooperated with several townships so as toimplant the necessary infrastructure to provide
power for recharging batteries. PSA also launched
the “tulip” project, a system of electric car rental
for the town. Small two seater Tulip cars would be
rented by subscribers in several places in a town,
and batteries would be recharged in a number ofparking places with an electric terminal. The system was experimented with in Tours at the end of
1995, and PSA decided to continue its further
development.
PRODUCTIVITY AND EFFECTIVENESS
Investment was particularly high at the beginningof the 1990s, about Ffr15 billion a year in 1990 and1991. It represented about 9.5 percent of the sales
turnover, one of the highest ratios of the industry,
and was financed internally rather than throughborrowing. Investments were aimed at renewing
the product range. They were also aimed at continuing the modernization of the industrial assets ofthe group, in order to improve productivity, flexibility, efficiency and the quality of the products’(annual report, 1990). With the crisis in 1993, investment was reduced; however, in 1994 it still represented Ffr10.5 billion.
On average, productivity was improved by 10
percent a year during this period, with a 12 percent improvement in 1994 compared to 1993.
Reductions in costs were vital. Jacques Calvet
stated that the market reversals in 1990 and 1991
and the price war made them even more so.
Purchases represented 58 percent of production
costs in 1994. Cost cutting on procurement was a
priority for the Sogedac, and productivity plans
were implemented with suppliers. On average,
suppliers increased their added value ratio by 5
percent a year.

817

In PSA’s plants, the number of hierarchical levels
was reduced and a price controller was named foreach model. His or her role was to validate suggestions for technical simplifications and cost cutting,many of which came from the workers (more than
128,700 suggestions were in 1994 compared to78,434 in 1991). Progress was also made in logistics
and manufacturing; and delivery times werereduced to 8 days from 25 days in 1994. Inventories
were reduced by Ffr2,000 million in 1993 andFfr759 million in 1994. When investments were
made, the group tended to choose simple, reliable,
less costly solutions. Cost cutting was seen as a priority, productivity improvement targets for theperiod 1995–2000 remained very ambitious, andthe simplification of product ranges and assemblylines was seen as the way to achieve these goals
and improve the quality of vehicles.
In order to improve the effectiveness of R&D,
after 1994 every development process (subsystem or
new model) was organized in a “project team”
based on a “technical platform.” This form of organization was begun in the 1980s by the Japanese inorder to reduce the development time of new models and to improve the simplicity of manufacturing.
A project leader was in charge of quality, cost, scheduling, and specific performance targets (for a newmodel, he or she reported directly to the top management of PSA). All the professions and functions
were represented within a “technical platform:”
designers, process engineers, the manufacturing,
quality, and procurement functions as well as somekey suppliers. Typically, the technical platform for a
new model would include 20–30 permanent members and a total of 200–300 people working temporarily on particular phases of the project. In 1994,
the new model development time had been reduced
to 196 weeks at PSA (compared to 250 weeks in1990); the objective was to reduce it further to 156
weeks by the year 2000. The Japanese car manufacturers and General Motors Europe (Opel Vauxhall)
had the shortest new product development times in
the industry (between 160 and 180 weeks). The only
problem with independent project teams and technical platforms was the risk of overlooking potential

PSA Peugeot Citroen

818

CASE 20 PSA Peugeot Citroën

synergies between models, creating new components, and increasing their unit costs. At PSA, theearly phases of development of new models wereshared between Peugeot and Citroën. The role ofSogedac (the group company in charge of components and procurement) also helped achieve suchsynergies. It was in the latter stages of productdevelopment, when design and the development of
production processes dominated, that the two technical platforms for Peugeot and Citroën became
more apparent.
Given the limited growth opportunities, productivity improvements led to a regular reduction in
staff, particularly in France: 139,800 employees in1994 compared to 143,900 in 1993 and 150,800 in 1992.
The forecasts for the period 1995–2000 showed a continuation of this trend. Careful personnel planningand forecasts at PSA reduced the risk of crises in thelong term. Indeed, work patterns were changing:
between 1984 and 1994 the percentage of highly
skilled workers rose from 10 to 25 percent, the percentage of technicians from 9 to 13 percent, and thepercentage of supervisors and managers from 4 to 8
percent. The group had developed an ambitious
training program, representing more than 4 percent of
the wages in 1994 (as compared to 2 percent in 1984).

THE INTERNATIONAL STRATEGY OF PSA
EuropePSA had industrial units in several countries in
Europe. In 1994, about 80 percent of manufacturing was done in France. Indeed, France was considered a competitive country in terms of
production costs. Peugeot Talbot España (with 205
and 306 manufactured at Villaverde) and Citroën
Españla (with AX, ZX and C15 manufactured atVigo) represented about 16 percent of the production. Peugeot Talbot Motors, based at Ryton(United Kingdom), manufactured the 406 until
l993 and the 306 after 1993 (76,300 vehicles in 1994,
representing about 3 percent of the total). The
Mangualde plant in Portugal manufactured 14,000
AXs. The Sevelsud joint venture with PSA Fiat

Italy manufactured small utility vehicles.
Automobiles Peugeot and Automobiles Citroën
made 87 percent of their sales in Europe; and theEuropean market was seen as a priority for the
PSA Group, particularly the large countries (seeTable 4). In the German market, seen as particularly attractive, PSA tried to strengthen its positionand developed its network of dealers. Since
Peugeot had taken over the chronically loss-making U.K. operations of Chrysler, production hadrisen from about 20,000 units in 1985 to 116,600 in
1990. It then started to decrease with the decline of
the British market. However, PSA aimed at
improving its U.K. market share for Peugeot andCitroën as the main export market of the group.
The relationships between the corporate centerin France and the foreign subsidiaries were becoming more complex as the international strategy
developed. Research and development was centralized in France; product marketing, pricing, andcommunication policies were also decided in
France; but some adaptations to particular important foreign markets were negotiated between theheadquarters and its subsidiaries.
Peugeot Talbot Motor Company Ltd. (U.K.) also
had a higher degree of autonomy than most of the
Peugeot operating businesses. From 1982 onwards,
PSA took over the marketing and design decisions
for the U.K., and disbanded the Ryton design center. However, PSA Center did realize the differences in the U.K. market, especially because of theimportance of the fleet market (car purchased centrally by companies for company personnel). Therewas, therefore, a marketing director in the U.K., butwith a strong functional reporting link through tomarketing and design in PSA Center. The degree of
autonomy was less than had been expected by
George Turnbull, the chief executive from 1978 to
1985, when he left. The increasing autonomy of thelater 1980s had been “earned,” not only by the U.K.
company delivering against its business objectives
and the improvements made in industrial relations
and productivity, but also by the “diplomatic” styleof the chief executive at that time, Geoffrey Whalen,
toward the corporate center.

833

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PSA Peugeot Citroen

CASE 20 PSA Peugeot Citroën

Europe was seen as the domestic market ofEuropean car manufacturers, and Jacques Calvet
was known for a defensive strategy against
Japanese competitors. In European Motor Business(November 1989) he stated:
We must develop a common foreign policy toward
Japan. We must limit the imports of Japanese cars aslong as we do not sell a significant number of cars inJapan, that is to say a ratio of at least one [European
car sold to Japan] for two [Japanese cars sold in
Europe]. We must also have a common policy concerning the Japanese transplants in Europe . . . weneed a significant proportion of local content [inJapanese transplants in Europe]—namely 80 percent—because this relates to the problem of employment and to sustaining technological capabilities in
Europe . . . . We should examine the suggestion madeby Gianni Agnelli [president of the Fiat Group] whosays that there should be an overall quota on theimportations of Japanese cars—wherever they comefrom—and a limitation to the manufacturing ofJapanese cars in Europe.

As far as the strategy of the PSA Group was concerned, Calvet also stated, in Le Figaro Economie(April 1991): “As long as I am president of theGroup, I will never accept an agreement with theJapanese.” It was a view he retained in 1995.
The PSA Group was actively lobbying at the EC
level to defend the argument of protection against
the Japanese, as stated in the annual report of thegroup in 1990:
The group will continue its efforts of persuasion inorder to avoid dangerous drifts in building Europe
and in the negotiations, which are badly opened,
between the 12 states of the EC and Japan . . . . Do wemake Europe for the Europeans, for employment, fortechnology, for European wealth and power or do weabandon ourselves to a competition which is not truly
based on free trade and which would lead to a weaker
Europe?

With the exception (to same extent) of the FiatGroup, the other European car manufacturers had
less intransigent positions towards Japanese competition. However, the attitude of the German companies and the subsidiaries of the North American819

companies in Europe evolved toward more protectionism between 1989 and 1991. The attitude of the
EC Commission also changed in this direction during the same period. The result was the EEC-Japanagreement of 1991. Japanese imports into Europe
would be limited to their 1990 level—that is, toabout 1.23 million vehicles a year—during a transitory period until the end of 1999. More precisely,
the quotas limiting Japanese imports in some
European countries (mainly France, Italy, andSpain) would be increased progressively. With
regard to Japanese transplants in Europe (not subject to the above limitations), both parties had
agreed to limit the production of Japanese transplants to under 1.2 million vehicles until the end of
1999. Actually, a complicated system of monitoring
was put in place, taking into account the annual
evolution of the European market in order to define
limits to Japanese growth.
As far as eastern Europe was concerned, PSA
had a prudent strategy. By 1990, the group had
established a distribution network in most of thecountries, but exports represented fewer than
22,000 vehicles in 1994.
New continents
In the 1990s, PSA started to look for growth in othercontinents. As stated in the annual report (1990):
The industrial project targets countries with a realpotential of development for the group, considering
the situation or the economy of the country, its industrial base, and the perspective of growth of the automobile market.

In his address to the annual stockholders’ meeting in June 1995, Jacques Calvet declared:
We have made great strides in extending our international presence. Our ambitious goal this year is for
Peugeot and Citroën to progressively make 26 percent of their sales outside western Europe. Advancesin this area include the new phase in Citroën manufacturing operations in China, Peugeot’s recent cooperation agreement in India, our plans to begin
production of the 306 in Argentina, and Citroën’s

PSA Peugeot Citroen

820

CASE 20 PSA Peugeot Citroën

negotiations with Proton in Malaysia, which may
soon come to a conclusion.

Peugeot had a good reputation in Africa, but thiscontinent offered limited growth opportunities.
Morocco and Egypt were the only exceptions (the405 and AX were assembled in Egypt). The further
aim was to complete the group’s representation
around the Mediterranean basin (including Turkey
and Tunisia). Iran was the main base of the groupin the Middle East, but local assembly was limited
to 8,400 vehicles in 1994.
In Asia, the Japanese market was too competitive to expect significant growth for PSA: 6,600
vehicles were sold in 1994. The Korean market was
attractive (900,000 vehicles and 1.2 million
expected in the year 2000), but it was tightly protected and dominated by local manufacturers(Daewoo, Hyundai). On the other hand, the sales of
the group were growing in Malaysia (3,400 units in1994), in Taiwan (4,500) and in Thailand. In most ofthese countries, Japanese car manufacturers
already had dominant market shares and strong
positions with their networks of local suppliers (forinstance, Toyota produced diesel engines and electrical equipment in Thailand, gearboxes and transmissions in the Philippines, petrol engines inIndonesia, steering systems in Malaysia, and coordinated activities in Singapore). The Chinese market was less structured and experts forecast annual
sales of 1.2 million vehicles in the year 2000 to be
manufactured locally. In this market European
competitors were more active, particularly
Volkswagen and PSA. Peugeot had a joint venturewith the Canton township. Guangzhou Peugeot
Automobile had the capacity to produce 45,000
vehicles a year (505 and pickup 604). Actual production was around 20,000 units a year; however,there was a project to extend capacity and to manufacture the 405 (150,000 units in the year 2000).
Dongfeng Citroën Automobile Company manufactured 8,000 Citroën ZXs in 1994 (compared to 5,000
in 1993), and new plants were being built in Wuhan
and Xiangfan in order to produce 37,000 ZXs andextend the capacity to 150,000 vehicles in the year
2000.

There were about 200 million individuals
belonging to the middle and upper classes inIndia, and the 300,000 vehicle market was expected
to become a 600,000 units annual market by theyear 2000. The Indian car industry was dominatedby Maruti, a joint venture between Suzuki and theIndian state which had a 70 percent market share(particularly with the small Maruti 800). A numberof international competitors were making agreements with local partners: Mercedes with the local
Telco, Daewoo with the local DCM, Opel with
Hindustan (objective: 12,000 vehicles) and
Volkswagen with Eicher Motors (objective: 30,000
vehicles of the Golf 4 and Audi). At the end of
1993, PSA had signed an agreement with Premier
Automobile Ltd. (the number two in India) to
manufacture the Peugeot 309 in Kalyan, startingfrom 1995. After a Ffr1 billion investment theobjective of the joint venture PAL Peugeot Ltd. wasto produce 60,000 vehicles a year. In the SouthAmerican continent, Peugeot and Citroën had significant positions in Argentina (with a 16 percent
market share) and in Chile (8,000 vehicles in 1994).
The industrial presence of Peugeot in Argentina
through the Sevel joint venture) WRS, a key success factor in the context of the new Mercosur freetrade agreement in this zone. Peugeot and Citroën
had just established sales subsidiaries in Brazil andsales grew from 3,000 vehicles in 1993 up to 10,300
in 1994.
Finally the top management of PSA was studying the opportunity of a “come back” in the North
American market. Like several other European car
manufacturers, PSA had been pushed out of the
U.S. market in the late 1980s. At the time, it distributed the 505 and the 405 through a limited numberof megadealers, in the east coast, the west coast,and the south-east. A study conducted in 1994 recommended the following:• Specific vehicles were needed (given the local
norms and preferences).
• A complete sales network was needed (because
cars travel all around the country).
• At least two and up to four models were neededin order to feed the sales network.

835

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PSA Peugeot Citroen

CASE 20 PSA Peugeot Citroën

• It was necessary to have local production (given
the evolution of the U.S. dollar and the relatively
low cost of manpower in this zone); plants could
be located in the United States, in Canada, or in
Mexico (Volkswagen had plants in Mexico;
BMW and Mercedes had plants in South
Carolina).
• Such an investment was estimated, around Ffr20
billion in four years, and the next “high cycle” ofthe U.S. market was expected in the year 2000
(after the 1994–1995 high cycle).
CHALLENGES FOR 1995–2000
Within western Europe the top management of
PSA was concerned with the decrease in consumption, as shown by the estimation of sales for 1995.
Price differentials between European countries,
mainly due to competitive devaluation, stimulated
the development of parallel distribution channels(for instance, the price of French car in Italy was 30
percent lower than in France for some models).
This situation, combined with increased competi-

821

tion in a mature market, was driving down prices.
Moreover, according to the EEC-Japan agreement,
the competition with the Japanese would be free in
Europe starting from the year 2000, and Korean
competitors were expected to sell about 1 million
vehicles in Europe by the end of the century.
Finally, the chairmanship of Jacques Calvet was
supposed to come to an end in 1997, although somebelieved that, given his success at the head of USA,he would continue. Indeed, the market value of thegroup had been multiplied by 15 in 10 years, with
the Peugeot family keeping control of the company.
In June 1995, Jacques Calvet concluded his
address to the annual stockholders’ meeting asfollows:
The challenges facing us are clear. The economic andmonetary environment and the intense competitionin our markets are serious threats. On the other hand,
the Group’s forward looking attitude and our
employees’ strong commitment to achieving our
objectives—which I greatly appreciate—are precious,
even crucial strengths. As a result, we can face thefuture with confidence.

C A S E 2 1 Carvel in BeijingIn April 1995, Greg Demadis, director of businessdevelopment for Carvel Corporation, wasreturning to the People’s Republic of China to plot
the next stage of development for the Americancompany’s fledgling interests in the Pacific Rim. As
the representative of Carvel U.S., Demadis was
already making his fourth trip to Asia in six
months.
After fact-finding stops in Hanoi and Seoul,
Demadis planned to proceed on to Beijing, where
six months earlier the Carvel Beijing joint venture
had opened its doors to Chinese consumers.
Despite moderate success and growth since theventure’s grand opening, Demadis felt that thecompany was facing its most serious challenge to
date.
With summer quickly approaching, sales for the
Carvel Ice Cream Bakery line would face its first
upward spike in what is an inherently cyclical business. The inescapable truth in the ice cream business is that the best marketing is a hot, sunny day.
Having had six months to introduce the product toChinese consumers, Demadis felt it was crucial forthe company to take advantage of its first moverstatus to establish the brand as the premium ice
cream cake and novelty company against which all
subsequent competition would be compared.
Accordingly, Demadis had to defend his position tomarket the product as a premium ice cream
demanding a premium price. Inherent in the corporate long term marketing strategy was the needto establish the brand as a premium product towhich a Chinese rank and file with increasing disposable income would aspire. However, by April,retail sales remained flat and wholesale sales were39

sluggish. This slow growth would deprive thecompany of the capital needed to fuel moreregional and, eventually, national growth.
Phil Fang (yang Dengsheng), the Taiwanese general manager of the Beijing operation, faced similarpressure. Slow sales reduced the company’s opportunity to break from the myriad of small brands
and establish itself as the first truly national brandin China. Moreover, with Baskin-Robbins, Carvel’s
main rival in the United States, already with alonger, if small, presence in Beijing, and with other
Western companies planning to enter the market,
Fang also felt the pressure to expand the company
as much as possible. Additionally, Fang must
aggressively promote Carvel in Beijing.
First, as a Taiwanese manager of a three-part
joint venture, Fang was pulled by each partner’s
differing business perspectives. Moreover, the cultural complexities of being a Taiwanese manager
for an American firm in mainland China further
complicated his role. Most important, though, Fang
questioned the American management’s decision
to price and market the product as strictly an
American ice cream. At times, Fang felt that theAmericans did not appreciate the complexities andsubtleties of doing business in China. Now, as thecompany faced its first summer sales period, Fang
would have to make some long-lasting businessdecisions.
Each manager quietly felt he understood the
problem. Demadis believed that the product wasby far the best quality ice cream in Beijing; thecompany simply needed to improve the marketing
and retailing of the product. He wanted Carvel
Beijing to increase the products price and, in turn,This case was prepared by Bill Bambara, graduate student, and Professor Subhash C. Jain for class discussion. Copyright © by
the Center for International Business Education and Research, School of Business Administration, University of Connecticut, 1997.

822

837

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Carvel in Beijing

CASE 21 Carvel in Beijing

its perceived value. Demadis feared entering a
pricing spiral would establish the product as acommodity solely marketed on price. In the end,
he was confident that once Beijing natives tasted
and recognized the product, the brand was sure to
explode in the market.
Phil Fang, however, felt that there was more to
the equation than better marketing. Fang believedthat certain pricing and product line changes might
be needed before Chinese consumers would reallytake to the new brand. Time was running out for
Carvel to seize its unique opportunity to establish
the first national brand of ice cream in the People’s
Republic of China.
COMPANY HISTORY
Carvel Corporation had one of the oldest and mostendearing histories of all the ice cream companies
in the U.S. In 1934 Tom Carvel, a Greek immigrant,parlayed a flat tire on his ice cream truck into what
would become a multimillion dollar franchise business. As the story had it, after a flat tire forced Tom
Carvel into an abandoned parking lot one summer
afternoon in 1934, Mr. Carvel quickly realized hecould sell far more product in a stationary location
than he ever could in the streets of Hartsdale, NY.
Mr. Carvel soon borrowed $100 and opened thefirst Carvel Ice Cream store.
Mr. Carvel used a combination of fresh ice creamand innovative products and manufacturing techniques to establish himself as the local, family-oriented ice cream parlor in the New York City area. In
1947, Mr. Carvel franchised his first store and proceeded to become one of the pioneers in fast foodfranchising. In fact, it was only after Tom Carvelrefused his partnership offer that Ray Kroc used
Mr. Carvel’s store design as the model for his
McDonald’s chain.
Throughout the 1960s and 70s, the gravelyvoiced Mr. Carvel used his folksy and savvy style
to dominate the greater New York area. By standardizing procedures and providing franchiseeswith exclusive product designs and marketing
material, Mr. Carvel expanded all along the East

823

Coast. By the early 1980s, there were over 800
Carvel stores in operation along the East Coast andin some Midwestern states such as Ohio andWisconsin. Included in the company chain wereover 40 stores in California. However, by the mid
1980s, the recession and the strain on Tom Carvel tomanage his business began to take its effect on the
franchise. Sales and quality control began to
decline, and events forced Mr. Carvel to consider
changes.
In 1989, at age 88, faced with diminishing sales
and increasing store closures, Tom Carvel reluctantly sold his company to Investcorp, aBahrainian-based investment banking group. The
Investcorp strategy centered on acquiring previously gainful companies whose profitability had
diminished in recent years due to recession.
Following that strategy, between 1988 and 1992
Investcorp had purchased Macy’s, Sax Fifth
Avenue, Tilecorp, and Carvel.
By infusing new capital and bringing in a new
management team headed by CEO Steve
Fellingham, the former president of Kentucky Fried
Chicken, Investcorp focused on growth andrevamping Carvel’s listless image. Management
was forced, however, to walk a fine line between
creating a new, vibrant image for Carvel and alienating longtime, loyal customers who had grown up
with Mr. Carvel’s occasionally awkward but
always folksy style.
In 1992, Carvel introduced the Ice Cream Bakery
concept to its customers. Under this program, thecompany continued to offer longtime favorites
such as Cookie Puss and Fudgie the Whale, but also
introduced a new product line that featured specialty cakes and novelty ice cream treats for special
occasions. By focusing on creating Carvel ice cream
as a bakery dessert item, Carvel hoped to reduce
both the cyclical sale pattern of the company andthe perception that an ice cream cake was only forspecial occasions. To this end, Carvel instituted its
current mission statement:
Working together, we will make Carvel the leading
choice for unique, quality frozen desserts by consistently exceeding customer expectations.

Carvel in Beijing

824

CASE 21 Carvel in Beijing

In 1993, the company initiated its grocery store
program in which Carvel displayed its own dedicated freezers in the bakery departments of supermarkets up and down the East Coast. By 1994, inthe face of industry-wide declines, Carvel decided
it was time to bring its Ice Cream Bakery to thePeople’s Republic.
CARVEL IN ASIA
It was Steve Fellingham who decided to bring
Carvel to China. Having already successfully

EXHIBIT 1
Carvel’s Organizational Arrangements in Asia

completed a marketing coup by introducing KFC
to China in 1978, Fellingham hoped to repeat thesuccess of the past. After an initial backing by
Investcorp of $4 million, Fellingham negotiated ajoint venture in which Carvel Corporation established two new enterprises. These two new enterprises were Carvel Asia, headed by Tony Wang
(Wang Da Dong), and Carvel Beijing, headed byPhil Fang. Exhibit 1 shows Carvel’s organizational arrangements in Asia.
In this arrangement, Investcorp and Carvel
Corporation provided 51 percent and 49 percent

839

840

Carvel in Beijing

CASE 21 Carvel in Beijing

respectively of the capital financing for Carvel Asia.
Carvel Asia then provided 50 percent of the equity
for Carvel Beijing. Wang Meng, president andowner of New Continent Dairy, a local dairy andproducer of low end ice cream in Beijing, contributed 30 percent of the capital financing for
Carvel Beijing. Li Shiqing, representing the government’s Beijing Food Industry Association, provided
the final 20 percent investment in Carvel Beijing.
At the same time, within Carvel Asia there were
two other regional franchises. First, Carvel agreed
to franchise the regional rights to Shandong
Province to a group of investors headed by Andrew
Tsui. Second, Carvel also agreed to franchise thenational rights to Taiwan to the CP Group, who inturn had named Bob Yein as general manager ofCarvel Taiwan.
By creating both regional partners and joint
venture partners, Carvel U.S. attempted to meet
two objectives. First, in Carvel Beijing, Carvel U.S.
hoped to create a training and marketing basefrom which to expand into other areas in China.
Second, by having regional franchises in Shandong
Province and Taiwan, Carvel hoped to jump startits presence in Asia and generate much neededcash flow to fuel the growth of Carvel Beijing. To
that end, it was the success and Crowds of Carvel
Beijing that concerned both Greg Demadis andPhil Fang.
Political and Economic Developments
After the end of the Cultural Revolution and thedeath of Mao Ze Dong in 1976, China had embarked
on a continual but vacillating course toward freemarket reforms. As has been the case in China since
Mao declared the People’s Republic from atop Qian
Men gate in 1949, China experienced intermittent
periods of moderate reform and growth in the
midst of hardline backlash and recidivism. Mao’s
Great Leap Forward, the Cultural Revolution, illustrated the tentative, and at times reactionary, road toreform the Communist government had followed.
For this reason alone, business ventures in China
today were far from secure.

825

Since the succession of Deng Xiaoping as thehead of the Communist Party in 1978, however, thepotential of the China market was as tangible now
as it had ever been in the country’s 5,000 year history. His endorsement of the “Socialism with
Chinese characteristics” policy in 1978, theCommunist government had taken steady but
reluctant steps forward improving the business climate in China. In particular, reforms in the area oftelecommunication infrastructure, business andcopyright law, and financial structures led toincreased foreign investment in China. The foreign
investment, in turn, led to significant changes inthe socioeconomic structure of China. According toa recent Gallup poll,9 several facts reflected thischange:• China’s population was currently 1.2 billion,
nearly 20 percent of the world population.
• Gross National Product reached $410 billion in1994 and was expected to grow at a national
average of 10 percent to 14 percent in 1995. The
eastern and southern regions experienced
growth of 20 percent to 30 percent in 1994.
• Annual inflation averaged 20 percent, andpeaked at 27 percent in some major cities in
1994. The Communist government targeted
1995’s annual inflation rate at 9 percent.
• Export volume grew at an average annual rateof 12 percent between 1980 and 1993. China
ranked as the world’s eighth largest exporter in
1993, up from twenty-sixth in 1980.
• China attracted $33.8 billion in foreign investment in 1994; in 1993 foreign investment totaled$27 billion.

9The Gallup Organization of Princeton, New Jersey, recently
completed the first nationwide survey of consumer behaviorand Aches in the PRC. To complete this survey, Gallup interviewed 3,400 Chinese citizens in each of the country’s provinces
except Tibet. The sample represents the entire adult population
18 years of age and older. All interviews were conducted in person in the applicant’s home between May 2 and September 15,
1994. The interview included over 400 questions and required
more than one hour to complete.

Carvel in Beijing

826

CASE 21 Carvel in Beijing

The growth had a positive impact on increasing
per capita income. The 10 cities with the highest percapita monthly income in 1994 were:
Guangthou
Shanghai
BeijingNanjing
Wuhan
Tianjin
Chongqing
Xian
Shenyang
Harbin¥416 10
¥338
¥274
¥255
¥234
¥212
¥201
¥189
¥174
¥169

In short, the apparent stability and growth in the
Chinese economy continued to offer good opportunity for profitable business, but political uncertainty still clouded the future. First, the ailing
health of paramount Communist leader Deng set
the stage for another succession struggle in the
Party. Chinese history was replete with fractious
and problematic succession battles, and financial
circles remained cautious about the political fallout
after Deng. Secondly, while the Communist government continued to court foreign investment
with assurances of improved business conditionsin China, recent events reflected the inherent risk in
the Chinese market. In particular, the Communist
governments recent summary recision of
McDonald’s lease on its celebrated Chang An
Avenue store reflected this intrinsic risk. Although
the government cited legal clauses in the leaseagreement, the move caused shockwaves in thebusiness community trying to establish long term
commitments in China. It was under these conditions that Carvel Beijing began operations in 1994.
CARVEL BEIJING
By April of 1995, Phil Fang’s operations had grown
to include one factory, two retail stores, and 17 outside accounts. Fang carried out cake production at

1 0 The exchange rate as of April 1, 1995 was 8.41/US$.

the factory, and used the stores and outsideaccounts to merchandise the product and do small
decorations and personalizing. Exhibit 2 lists thesestores and outlets. Fang classified his outlets
according to the following schedule:• A-Type Stores—These were individual retailstores that had a large holding freezer called ashock box, Taylor ice cream machines, and customer seating. A-Type stores were able to makeand decorate cakes (i.e., East Four store).
• B-Type Stores—These store were like A-Type
Stores but could not produce cakes. B-Typestores could decorate cakes, though (i.e., West
Four store).
• C-Type Stores—These stores had no customer
seating, but had Taylor ice cream machines.
They were generally mini-stores found inside in
the food court areas of large department stores.
C-Type stores also had FPD-5s (display freezers) and could do small decorations (i.e., Chang
An and Baisheng department stores).

EXHIBIT 2
Carvel in Beijing Channel Outlets

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19

Account Name

Account Type

East FourWest Four
Baisheng Department Store
Chang An Department StoreChengxiang Department Store
Fuxing Department Store
Beicheng Department Store
Canyou Department Store
Chaoyang Department Store
Friendship Hotel
Landao Department Store
Shangan Department Store
Anbao Restaurant
Apollo Club
Golden Song KTV
Minzu HotelSonghe Hotel
Xidan Shopping Center
Xingzuo Department StoreABCCCounter
Ice Cream Bakery
RetailRetailRetailRetailRetailRetailWholesale
Wholesale
Wholesale
Wholesale
Wholesale
Wholesale
Wholesale

841

842

Carvel in Beijing

CASE 21 Carvel in Beijing• Counter Stores—These sites used CMCT freezers to sell cakes and novelties. They also hadmenu boards and were similar to the grocery
store outlets in the U.S.
• Ice Cream Bakeries—These sites concentrated
on cake sales. They were generally located inside
the bakery and food court areas of department
stores and used FPD-5s and rollhards to market
the cakes. Ice Cream Bakeries had the capability
to decorate cakes on site. They did not have
Taylor ice cream machines, however.
• Retail Outlets—These sites used pushcarts or
small rollhards. Some of the current retail outlet
sights could become Ice Cream Bakeries or CType stores if space permitted.
• Wholesale Outlets—These were large accounts
which brought in huge quantities and sold the
product to different vendors in their areas aswell as retailed on their premises.
• Factory—The Beijing factory had the following
equipment:• four Taylor 771 ice cream machines• two large walk-in shock boxes• one walk-in cooler• 12 PF IK 4 rollhards small ware and utensils
to maintain three shifts of production
The factory was located on the southwest side of
Beijing, a fact that caused delivery trouble in thedense Beijing traffic. However, the production andstorage capacity of the facility was larger than mostof the American plants. Moreover, the company’s
dairy, the New Continent Dairy, was locateddirectly beside the factory. This created tremendous
ease and integration for mix production. The
potential of the factory was tremendous but still
untapped.
The East Four store was the first outlet to open in
October 1994. This large store almost exactly represented an American store and was used as the
showpiece of the joint venture’s appearance in
China. However, flat sales had yet to justify thelarge outlay to build the store. Because of decreasing cash flow, finances began to force Fang awayfrom outlets that demanded large initial costs, such827

as A-Type stores. Instead, Fang had begun to concentrate on C-Type stores to improve sales volume
and cash flow. For the same reason, Fang had
recently decided to suspend cake production at theEast Four store. Instead, all production took placeat the factory in order to reduce the idle capacity
there. Demadis and the District Manager, Li
Qunsheng, had questioned the efficacy of this decision. Although there was little doubt that the factory needed to increase production to justify costs,
both Demadis and Li agreed it was better to maintain the flexibility of the East Four production.
As for the structure within Carvel Beijing, Fang
had organized his staff as shown in Exhibit 3. Fang
hoped to increase retail sales through the various
outlets under Li’s control. While Demadis did not
disagree with this strategy, he did think that wholesale markets were underdeveloped. He felt that inorder to justify the costs of the factory, moreemphasis should be placed on the wholesale operations of Cao Donghui.
Demadis based this thinking on the success ofthe grocery store program in the U.S. In general, thecost of opening a retail outlet included the cost of
several machines. Depending on the type of outlet,
an average retail opening would include some or
all of the equipment shown in Table 1.
Also included in the cost of retail operations
were labor, rent, and a royalties fee. This fee was a

TABLE 1Item

Cost

Taylor 771 or
770 Ice Cream
Machine$11,806

FPD-5 Freezer
Cabinet2,760

CMCT-4 Rollhard
Freezer

2,550

MasterBilt Rollhard

2,350

Item

Cost

T-50 Glass-door
Upright Freezer

3,460

TM-6 Display
Freezer

3,850

Hackney Bros.
VC12-32
Vendcart

3,710

828

EXHIBIT 3
Carvel in Beijing Organizational Structure

CASE 21 Carvel in Beijing

Carvel in Beijing

843

844

Carvel in Beijing

CASE 21 Carvel in Beijing

percentage of the gross sales that Carvel paid to thelocation’s management and could range from 5
percent to 20 percent of gross sales. On the other
hand, wholesale accounts could be established forjust the cost of a T-50, TM-6, or vendcart. Moreover,since these sights took less space and were selfserving, Carvel could save on both rent and labor.
Phil Fang agreed that the sales department had
to pursue wholesale accounts. However, high rent
locations such as Chang An nearly doubled thesales of East Four. Such high volume locations provided much needed exposure, and he continued topursue such additional affordable locations. In
addition, Fang felt pressure trying to explain thefact that in China, the concept of guan xz (meaning
relations or connections) went a long way in determining what sites Carvel could enter. On manyoccasions, it was necessary to have personal recommendations from local business or government
leaders before Carvel could assume locations.
Though Fang agreed that wholesale accounts werea very cost-effective way to increase sales, theymight not be the most economically or politicallyfeasible way to increase sales at this time.
Operations
The operations of running an ice cream store parallel those of any fast food chain except for the factthat product handling is more critical to ice cream
production than it is for other food products.
Simply stated, whereas hamburgers can bereheated, a melted cake must be scrapped. For thatreason, time, temperature, and quality control are
the key factors in producing ice cream products.
There are two key elements that Tom Carvel
added to ice cream making, and Carvel Corporation still followed his innovations. The first was
the concept of overrun. Simply put, overrun is theprocess of forcing air into the ice cream as it is being
beaten and frozen in the ice cream machine. It is
Tom Carvel’s patented DL and DH ice creammachine series that first introduced this concept to
ice cream production, and it is this high overrunthat gives Carvel ice cream its traditional creamy

829

texture. In addition, higher overrun translates into
lower unit costs, since adding air to the ice creammix increases the total output of the mix.
Secondly, Tom Carvel combined creamy ice
cream and various molds to create assorted shaped
ice cream cakes. Such cakes as Fudgie the Whaleand Hug Me Bear became standards at all Carvel
stores. In fact, although Carvel always had muchcompetition with its standard ice cream offerings ofcups, cones, and fountain products, none if its
major competition ever challenged Carvel’s standing as the preeminent ice cream cake. For that reason, it is this concept on which Carvel Corporation
capitalized to create its new line of desserts andnovelties. In fact, in 1993 Carvel introduced its new“Everything Should Be Made of Ice Creams” slugline as a way to leverage its standing as the preeminent ice cream cake company.
Ice Cream Mix
The actual production of ice cream and ice cream
cakes begins with the ice cream mix. The foundation of Carvel’s success had always been the quality and creamy texture of Tom Carvel’s patented
mix formula.
There are two pasteurization processes that distinguish the mix itself. In both processes, the ingredients are the same and the processing steps arevery similar. In High Temperature Short Time
(H.T.S.T.) processing, however, pasteurization
occurs by heating the mix to 180°F and maintainingthat temperature for 20 seconds. H.T.S.T. pasteurization kills most of the bacteria and produces mix
with a shelf life of 10 to 12 days.
In Ultra High Temperature (U.H.T.) processing,pasteurization occurs by heating the mix to 285°F
and maintaining that temperature for five seconds.
The fundamental difference between the twoprocesses is that U.H.T. processing is an entirely
closed system in which the mix is never exposed tothe outside environment.
U.H.T. processing had several advantages. First,
it produced mix with a shelf life of 90 days. Second,
it preserved the mix’s natural flavor without

Carvel in Beijing

830

CASE 21 Carvel in Beijing

causing any residual cooked flavors. At the time,the mix being produced for Carvel Beijing was
H.T.S.T. mix.
New Continent Dairy produced Carvel Beijing’s
mix. The dairy, located directly next to Carvel
Beijing’s factory, used an H.T.S.T. process and produced one 75-gallon batch per week at a cost of ¥10
per kilogram.
Electricity Needs and Temperature
Clearly, the ability to maintain the product at cold
temperatures was vital throughout the production
process of the ice cream. Once the product begins tomelt, its creaminess and smoothness are lost. In
particular, placing a melting cake or novelty back inthe shock box caused ice to form on the product.
The result was a blander, less tasty ice cream.
In the same respect, a dependable supply of electricity was also crucial. Rollhards, ice creammachines, and shock boxes produced large surges
and drains on electricity. Carvel Beijing’s operations had already experienced several power problems in both its retail stores and factory.
Product Inputs
Because of the wide product line offered by Carvel,
the inputs necessary to produce Carvel’s productline were extensive. In particular, Carvel used avariety of food products, especially fruit fillings,
flavorings, and syrups. Carvel also used an assortment of baked items, including cones, cookies, andcannoli shells. Finally, Carvel included a variety ofnuts and confectionery toppings on its products.
In the same light, Carvel also used a wide selection of cake boxes and packaging to produce theproduct line. Combined with the numerous cleaning products, production tools, and utensils, Carvel
had a tremendous amount of inputs to manage inorder to produce its product line. For the time
being, most of these items were being imported
from the U.S. at a relatively high cost, an issue both
Fang and Demadis must address.

Product Delivery
Product delivery was the most crucial link in
Carvel’s production process. Because of the natureof the product, poorly designed delivery systems
could negate otherwise perfect production lines
and operations systems.
Carvel Beijing improved its delivery systems
tremendously since the opening of operations.
Currently, finished cakes were placed in Styrofoam
boxes that could hold nearly ten cakes. Two small
refrigerated trucks then transported these
Styrofoam boxes to the accounts. However, thecapacity of the trucks was only 150 cakes. As thecompany grew, it would need greater and more
flexible delivery capacity.
Quality Control
Because of the nature of ice cream, quality control
and sanitation standards are particularly important. Like milk, Carvel’s mix and ice cream must be
monitored at all levels of production to insure thatthe company provides its customers with a tasty
and safe product. Unlike flour-based cakes, ice
cream cakes must be kept at continually low temperatures, and they require that decoration be donein short intervals. As mentioned earlier, melting ice
cream is both unattractive and unsanitary, and electric supply and maintenance were a priority.
There are several factors in the Beijing environment that exacerbate quality control efforts. The
first was the inordinate amount of dust, pollution,and coal ash found in the city. This dust made it
particularly difficult to keep floors and work surface areas clean.
Secondly, the water supply in Beijing was not
potable. Therefore, it must be boiled and filtered
before it could be used in any products. Like its
electrical needs, Carvel must continually monitor
water quality.
Finally, American management had a difficult
time adapting to the traditional Chinese cultural
aversion to waste. Especially when working withdairy products, at times it was necessary to throw

845

846

Carvel in Beijing

831

CASE 21 Carvel in Beijing

out questionable products or utensils. Carvel also
used several single use items in its production
process for sanitation reasons. For their part, theChinese resisted certain procedures and standards
as too costly or wasteful.
To this end, Carvel Beijing instituted strict quality control standards and a continual internal
inspection program. Weekly bacteria reports weredone on the mix batches, and biweekly coliform
counts were checked in the retail outlets.
Financial Review
Financially, Phil Fang did not anticipate reaching
break-even sales until 1996, and the company’s
slow start in 1995 jeopardized even that prediction.
His biggest problem continued to be slow sales
growth and slow customer attachment to the highmargin cakes. As the Income Statement for 1994 in
Exhibit 4 depicts, Carvel Beijing operated at a net
loss of nearly (¥1,070,000) in 1994.
For 1995, Fang had requested an additional$800,000 from the joint venture partners and set thefollowing objectives for the year:• Sales of ¥13 million• 100,000 cakes sold• 68 total sales outlets by year end
As mentioned earlier, the company’s poor cash
flow forced Fang to reconsider his growth strategy. He would not be able to count on large retailstores like in the U.S. Instead, he planned on operating many smaller outlets that would demandless initial cash investment. His budgeted breakdown for projected outlets by the end of 1995
underlined this strategy. By the calendar and fiscal
year end of 1995, Fang aimed to have the following outlet distribution:
A & B-Type Stores
C-Type Stores
Counter Stores
Ice Cream Bakeries
Retail Outlets
Wholesale Accounts

2
11
15
20
20
10

EXHIBIT 4
Carvel in Beijing
Net Income Statement 1994
Revenues
Sales
Other Revenue
Total Revenue¥320,065
00

Expenses
Cost of Goods Sold
Mix
CommissaryLabor

98,10063,780126,099

Total Cost of Goods Sold

287,979

Operating Expenses
Administrative Expenses
Store Opening Expenses
Advertising Expenses

407,000
642,456
9,868

Total Operating Expenses

1,059,324

EBITDA
Depreciation(1,027,238)
42,325Net Income 1994(¥ 1,069,563)

Note: The exchange rate as of April 1, 1995 was ¥8.41/US$
Source: Company records.

These goals, however, were jeopardized by continual negative cash flow, which in February 1995
totaled (¥400,000).
Clearly, as the Projected Budget for 1995 in
Exhibit 5 showed, nearly 60 percent of Fang’s
investment from the joint venture partners would
go toward rent and the purchase of new equipment. In fact, by April Fang had already realizedthat the cash crunch he was under was going toforce him to revise his budget plans or to request
more capital from the joint venture partners.
Fang’s Projected 1995 Profit & Loss Statement in
Exhibit 6 reveals several factors that contributed tothis problem.

Carvel in Beijing

832

CASE 21 Carvel in Beijing

EXHIBIT 5
Carvel in Beijing Projected Budget 1995
US$¥*

$ 66,551¥ 559,025$ 251,190¥ 2,110,000

Total P&E Needs$ 406,265¥ 3,412,626

Total Cash Needs 1995

$ 724,006¥ 6,081,651

Outstanding Invoices
Invoice #66586
Invoice #66262
Invoice #68302
Invoice #68300
Invoice #68301

US$

¥*

$ 23,288$ 5,333$ 1,650$905$ 35,375¥ 195,619¥ 44,796¥ 13,860¥
7,600¥ 297,151

Total Current Invoices
Cash Flow Needs
Factory Annual Rent
Office Annual Rent
East Four Annual Rent
West Four Annual Rent

$ 113,095$ 27,381$ 26,190$ 13,095¥¥¥¥

950,000
230,000
220,000
110,000

Subtotal Rent

$ 179,762¥1,510,000

Inventory Overhead$ 71,429¥ 600,000

Total Current Cash Flow Needs
Plant & Equipment Needs
5KDC-47
15FPD-5
15CMCT-4
9 Taylor 770

10,15042,52536,76582,197¥ 85,260¥ 357,210¥ 308,826¥ 690,455

Subtotal Equipment$ 171,637¥1.441,751

Custom Tax on
Equipment (50%)$ 85,819¥ 720,875

Refurbishment of 9
C-Type Stores
60 Rollhards
2 Delivery Trucks$ 85,819$ 28,571$ 45,238¥ 720,875¥ 240,000¥ 380,000

Exchange Rate = ¥8.4/US$

Source: Company records.

$
$
$
$

847

848

Carvel in Beijing

CASE 21 Carvel in Beijing

EXHIBIT 6
Carvel in Beijing
Projected Net Income Statement 1995
Revenues
Sales
Sales Discounts and Allowances
Net Sales Before Tax(in thousands of ¥)¥ 13,000
1,170
11,830

Sales Tax

1,710

Net Sales

10,120

Expenses
Costs of Goods Sold
Mix
Commissary
PackagingLabor
Total Costs of Goods Sold
Operating Expenses
Administrative Expenses
Store Opening
Expenses
Advertising Expenses
Total Operating Expenses
EBITDA
Depreciation
Renovation Expenses
Other Expenses

2,600
1,820
1,170
1,200
6,790
1,560
2,280
180
4,020
(690)
540
850
30

833

to the import license that the government had
issued Carvel Beijing, Fang was only allowed toimport a certain amount of products each year. In
general, tariff rates averaged 50 percent of the net
value of the item as listed on the original shipping
invoice. However, some items such as syrups, whip
topping powder, and cones could have tariff rates
as high as 80 percent of their original value. For
1995, Fang faced potential tariffs of 100 percent
unless Carvel could negotiate a better license or use
guan xi to arrange a more palatable agreement.
Consequently, Fang’s projected cost of goods
sold as a percent of sales was roughly 48 percent.
He realized he would have to reduce the man hours
and capital spent to receive products from the U.S.
if he were to achieve the aggressive goals he had
established. Clearly, he must begin to locally source
as much of his inputs as he could. He had begun tocheck on local producers of refrigeration equipment, and local manufacturers were already producing several new packaging materials for the
cakes.
Demadis had established this priority to source
goods locally, but both he and Fang were wary ofthe quality standards of these goods. Especiallysince the product was still in its introduction
period, both Fang and Demadis wanted to ensurethat the public’s first impression of the product was
one of quality.
Mix

Projected Net Income 1995(¥ 2,110)

Source: Company records.

Customs and Import Duties
Customs taxes and regulations presented the single
largest day to day problem for Phil Fang. Sincenearly 90 percent of all his input products wereshipped from the U.S., arranging for delivery
through the complicated and fluid world ofChinese customs was critical. Currently, according

After labor, mix production represented the largest
expense Fang faced. Currently, mix production represented 45 percent of the cost of goods sold andnearly 20 percent of total projected sales. New
Continent Dairy, a partner in the joint venture,
charged Carvel Beijing ¥41.81 per gallon of mix,
and was averaging batch rounds of 3,000 gallons
per month.
Fang predicted that as sales increased with theweather, he would be using 12,000 gallons in Julyand 30,000 gallons total for the first six months ofthe year. This fact, combined with the fact that New
Continent still produced mix for its own ice cream

Carvel in Beijing

834

CASE 21 Carvel in Beijing

brand, led Fang to believe there were economies ofscale in the mix production cycle that could lower
his mix expense. In short, Fang would like Wang
Meng, president of New Continent, to share thosescale economies with Carvel Beijing. However,
because of the political nature of the issue, Fang
had few options to pursue in this matter.
Fang and Demadis were planning the conversion of New Continent’s Dairy facilities from
H.T.S.T. to U.H.T. In order to convert the plan,
Carvel Beijing would have to purchase a new filler,
holding tank, and vacuum pump at a cost of nearly$100,000. Fang was searching to defray some of thiscost by locally sourcing some of the pipe fitting andtank assembly parts. Once completed, Carvel’s
U.H.T. system would be the first in China, andwould have tremendous potential as Carvel
expanded in the region. By creating 90 day mix in
Beijing, Carvel could centralize mix production
throughout its chain and potentially create otherlines of mix for other companies. Fang was hopefulthat this conversion would allow him to work with
Wang Meog to reduce the cost of Carvel Beijing’s
mix.
Labor
Another of the financial restraints facing Fang waslabor. Oddly enough, although relatively inexpensive labor was one of the chief reasons firms
expanded into China, labor was not the leveraged
competitive advantage it first appeared to be. First,
although the average employee at Carvel Beijingearned ¥800 per month, there were other hidden
costs involved. In particular, for each employee,
Carvel Beijing must pay a 17 percent government
payroll tax; also, the government also required thecompany to set aside an additional 32 percent ofeach employee’s salary in a special account for
health care, training, and child care costs. Ultimately,
these costs raised labor expense to 149 percent of
their actual cost.
Secondly, the government imposed a “Luxury”
payroll tax of 5 percent to 20 percent for each
employee earning over ¥1,000 per month, of which

there were four at Carvel Beijing. With inflation
running at 16 percent in 1994 and projected at 9
percent in 1995, Fang must consider ways to reducelabor cost.
Finally, the fact that Carvel Beijing was a foreign
joint venture in China encouraged employees to
expect relatively higher wages than domestic companies offer. With over 60 employees to manage,
Fang often found himself busy with this wage
issue. He often questioned the validity of theadvantage of Cheap Chinese labor.
Sales
Sales growth continued to be a major problem forthe new franchise. By beginning operations in
October, management had run the risk of starting
the new venture in what was traditionally the slowest period of the year for Carvel. Consequently,
Fang and Demadis were still unable to identify thecause of the slow sales with any real certainty. As
the sales figures in Table 2 demonstrate, sales wereactually increasing both in gross and relative terms.
However, the true potential for the operation
remained unclear.
These sales figures followed the traditional sales
cycle of the American stores. Except for several
spikes around the six major holidays (Valentine’sDay, Easter, Mother’s Day, Father’s Day, Thanksgiving, and Christmas), weather had historicallydriven sales volume in the U.S.
To combat this cycle, Carvel U.S. introduced various measures to dispel the notion that ice cream

TABLE 2In ¥December January February

East Four StoreWest Four Store
Chang An Dept. Store
Parkson Store Dept. Store
Wholesale Accounts

57,222
24,12779,351
N/A
73,36073,42430,421
128,147
44,60994,45577,30535,585
119,167
78,32072,040Total:

234,060

371,056

382,417849

850

Carvel in Beijing

CASE 21 Carvel in Beijing

cakes were only for special occasions and warm
weather. The success of the grocery store programin the U.S. reinforced the theory that a push oriented sales program would help remind customers
that ice cream cakes were a tasty treat all yearround.
Demadis felt this was exactly the strategy toapply in China. Solid marketing could introduce
Carvel’s traditional American ice cream experience
to unfamiliar Chinese consumers. An aggressive
push campaign for outside accounts would create
brand awareness and drive sales.
Fang, however, felt that there were other market
forces at work. In particular, Fang believed that theconventional Carvel approach did not appeal to the
traditional Chinese consumers. Such cakes as rainbows and baboon cakes did not attract the typical
Chinese consumer who expected a more elaborate,
Chinese design on cakes. According to Phil Fang it
was a reluctant, unfamiliar consumer, that wasbehind the slow sales.
Both Fang and Demadis agreed that slow sales
and negative cash flow limited their options togrow the business. Analysis of the accounting
information confirmed the difficulty the retailstores had on covering their costs. On the other
hand, the success of the Chang An and Parkson
stores confirmed the fact that Carvel could produce
a profit in Beijing. Furthermore, despite continuing
losses, Fang and Demadis both agreed that the East
Four and West Four stores were necessary for the
chain to project a positive image in the city ofBeijing. What remained to be determined was how
best to improve their performance.
Meanwhile, Wang Meng presented Phil Fangwith a new option to increase wholesale sales.
Recently, he had constructed 6,000 new vendcarts
in order to merchandise his product in Beijing andTianjin. These carts closely resembled the color anddesign of the Carvel vendcarts, and Wang Meng
was willing to let Fang use the 4,000 Beijing carts tosell Carvel novelties with New Continent ice
cream. It was a tough decision for Fang to make.
On one hand, Fang could not argue with theeconomies of this proposal. Wang Meng bought his

835

carts domestically at a cost of ¥4,000 per cart.
Currently, Fang was importing Carvel carts fromthe U.S. at a cost of ¥35,000 plus the added cost of¥15,000 in customs tax. Wang Meng expected areturn of nearly ¥30,000 per month per cart. Facedwith such tight cash flow, even a small percentageof these sales offered Fang the opportunity to meethis budget and concentrate on plans for the rest of
the business. On the other hand, Fang faced harsh
opposition from Demadis on this point. Besides theapparent conflict of interest and appearance ofimpropriety, Demadis strongly argued that selling
Carvel products alongside cheaper quality New
Continent products would severely harm the longterm status and positioning of the product.
Especially with so many first time buyers during
the summer, Demadis felt selling Carvel alongside
New Continent would confuse customers and jeopardize his strategy to develop the line as a premium
product from America. This was an issue that both
had yet to agree upon.
Finally, part of the problem centered on the lackof any centralized cost accounting and transfer
pricing systems. This lack of accurate and centralized information hampered efforts to determine thecause of high costs. One of the goals Fang set for1995 was to improve the internal and corporate
reporting of information.
Product Line
Carvel Corporation offered a wide variety of ice
cream products. The company’s fundamental product, though, remained its soft serve ice cream andfountain line. Included in this category were:• cups and cones• shakes• floats• sundaes• hard ice cream—soft ice cream that is frozen in
the shock box in tubs so that it can be scoopedand served as traditional ice cream.
In order to promote the everyday nature of thebusiness, though, management had introduced

Carvel in Beijing

836

CASE 21 Carvel in Beijing

numerous new products over the last three years.
Included in this category were novelty ice creams.
Carvel classified novelty products as an individual ice cream treat which was more premium than
the traditional soft serve and fountain offerings.
The following is a sample of Carvel’s novelty line:• Flying Saucer—Carvel’s original round ice
cream sandwich• Brownie—a cube of chocolate ice cream withlayers of chocolate fudge and walnuts• Ice Cream Cannoli—a real cannoli shell filledwith soft serve ice cream and toppings• Truffle—a ball of vanilla ice cream filled withcherries, almonds, and chocolate chips inside a
chocolate shell.
Management felt that these novelties would
greatly renew and invigorate the brand’s name andimage, but Carvel’s traditional cake line remained
the high margin product that had the greatest
impact on sales. Carvel’s traditional line of cakes all
had the same recipe. Each cake was made with one
layer of vanilla ice cream, one layer of chocolate ice
cream, and a chocolate crunch cookie center. The
cakes were frosted with a vanilla whip frosting anddecorated in several fashions, including roses, balloons, and rainbows. Cakes differed, however, insize, shape, and weight. In particular, Carvel’s traditional cake line included:• Dessert Cake—a 6" round cake weighing 21
ounces• Small Round Cake—an 8" round cake weighing 43 ounces• Large Round Cake—a 10" round cake weighing
66 ounces• Small Sheet Cake—an 8" × l2" square cakeweighing 85 ounces• Large Sheet Cake—a 10" × l4" square cakeweighing 156 ounces
It was Carvel’s cake line that distinguished itfrom all the other offerings in Beijing. In particular,
Carvel’s classic cake line aimed to offer customers
more variety than the traditional chocolate andvanilla cakes. This line included:• Mint Chocolate Chip Cake—mint and chocolate ice cream with a chocolate cookie crunch
middle decorated with mint frosting, fudge,
and chocolate chips• Sinfully Chocolate Cake—chocolate ice creamwith a fudge and cookie crunch center decorated with chocolate mousse topping, hotfudge, and chocolate candy shards• Strawberry and Cream ATOP—strawberry andvanilla ice cream with a vanilla cookie crunch
center topped with vanilla frosting and wholestrawberries• Cappuccino Coffee Cake—coffee ice cream witha chocolate crunch center topped with mocha
frosting, walnuts, and vanilla cookie crunch
These cakes continued to sell well in the U.S.,
particularly in the grocery store program. Carvel
also offered various shaped cakes, including thefollowing:• Cookie Puss—a clown shaped face with an ice
cream cone nose and cookie eyes
• Fudgie the Whale—a chocolate whale cakewith fudge frosting• Hug Me the Bear—chocolate and vanilla ice
cream bear cake with a cookie crust• Holiday Cakes—including Santa, heart shaped
cakes, and turkey cakes
Finally, Carvel offered both sugar-free and fatfree frozen yogurt and a fat-free ice cream. To date,however, these products had not been introduced
to China.

Product Line Sales
With such a wide product line, Fang tried to introduce as many items as he could to the Beijing customers. However, he soon realized that certain
products were not selling. Exhibit 7 illustrates thebreakdown of product sales over the course of thefirst four months of operations.
Fang drew several conclusions from the sales
data. First, some cakes such as the Sinfully
Chocolate and Strawberry and Cream cakes had

851

852

Carvel in Beijing

CASE 21 Carvel in Beijing

837

EXHIBIT 7
Carvel in Beijing Sales Breakdown (in units sold)
Item
Small Round Cake
Large Round Cake
Small Sheet Cake
Large Sheet Cake
Small Heart Cake
Large Heart Cake
Dessert Cake
Hug Me Bear Cake
Fudgie the Whale Cake
Cookie Puss Cake
Santa Cake
Football Cake
Bunny Cake
Carvel Log
Sinfully Chocolate Cake
Fudge Drizzle Cake
Strawberry and Cream Cake
Mint Chocolate Chip Cake
Cappuccino Coffee Cake
TruffleBrownie
Dream Bar
Neapolitan
Blondie
Chocolate Flying Saucer
Vanilla Flying Saucer
Strawberry Flying Saucer
Deluxe Flying Saucer
Vanilla Mini Sundae
Strawberry Mini Sundae
Van-Straw Mini Sundae

November

DecemberJanuary

February

14
1
0
2
14
9
27
42
8
6
13
0
0
0
20
27
21
16
0
0
370
274
18
320
59
56
19
73
98
88
102

123
520
121
21
74
118
134
180
29
22
89
0
0
0
144
61
62
33
1
0
744
592
819
538
106
76
79
103
1,388
1,407
1,853

162
17
64
10
148
102
237
304
13
21
48
0
32
29
293
132
123
72
72
96
878
751
757
637
134
89
93
147
2,635
720
3,616

186
94
37
2
162
68
335
265
33
29
20
0
39
49
228
85
132
41
43
343
739
651
582
501
921
82
78
110
1,927
0
4,627

Source: Company records.

strong sales, while the Cappuccino Coffee cakes
and Mint Chocolate Chip cakes had very slow
sales. Fang felt that such relatively exotic cakes simply did not appeal to Chinese who were accustomed to traditional vanilla, chocolate, andstrawberry flavors. Demadis, on the other hand,continued to assert that consumer awareness was
the issue, not consumer taste. Second, Fang also
noticed that Hug Me Bear cakes continued to show

strong sales numbers, but Cookie Puss and Fudgie
the Whale cakes were sluggish. Again, he concluded that traditional Chinese shapes such as thebear were inherently strong sellers, while American
style cakes such as Cookie Puss simply seemed too
exotic and too foreign. Third, Fang had to face frequent comments from customers that the ice cream,
and, consequently, the ice cream mix, was too
sweet. Fang knew that Chinese traditionally did

Carvel in Beijing

838

CASE 21 Carvel in Beijing

not like very sweet desserts, and he feared that traditional American tastes might not appeal to thebroad spectrum of Chinese consumers. Changing
the mix formula might increase sales, but Demadis
strongly opposed tampering with the traditional
success of the company in any form.
Finally, Fang felt that pricing was both driving
strong cup and cone sales and inhibiting relatively
slow cake sales. For this reason, Fang had serious
doubts about the pricing strategy established last
October.
Pricing
Before Carvel Beijing opened its doors in October,
Demadis and Fang had to discuss the pricing strategy for the company. Demadis argued that prices
should be at least as high as, what he considered,
the company’s chief competitor, Baskin-Robbins.
Demadis based his rationale on the fact that Carvel
was virtually unknown in Beijing, and consequently, management had the unique opportunity
to create whatever image and market position it
wanted for the company. He argued that Carvel
Beijing should be seen as a premium ice cream thatwas not priced out of the range of the typicalBeijing resident; nevertheless, it should be priced
high enough to make people consider it a productof quality and prestige.
Fang, however, maintained that such a long term
approach to pricing would suffocate short term
sales and consequently nullify the long term benefit of such a strategy. Fang considered his chiefcompetition Walls and Bud’s, both of whom offered
novelty cups and cones throughout the city forroughly ¥4.
Both men presented their arguments in an early
October meeting. Demadis argued that since
Baskin-Robbins presented the most significant longterm threat to the Beijing ice cream market; Carvel
had to price its product in line with them. At thattime, Baskin-Robbins was asking ¥9 for an ice
cream cone. Demadis felt that pricing Carvel’s
product below that would send the wrong, initialsignal to the customers.

Fang argued that the future of the Beijing market
lay in understanding the Chinese consumer, who
was not ready to purchase ice cream cones that represented, on average, nearly 25 percent of a day’s
pay. Fang contended that Carvel should price morein line with Walls and Bud’s, both of whom had
been in the market longer than Baskin-Robbins andhad experienced annual growth and profits.
In the end, the two decided on a cost plus strategy that considered the following costs:
Mix cost
Duty on commissary
Freight charge
Carvel surcharge
East Four rentTaxes

4¢/oz.
50% to 80%
10%10%¥210,000 per year
17%

Ultimately, Fang and Demadis agreed that
Carvel’s standard small cone in the East Four store
should be priced at ¥9. However, they disagreed on
the issue of soft and hard ice cream prices. Fang
wanted to price soft serve cones at ¥7 and hard ice
cream cones at ¥9. Demadis felt that pricing one
higher than the other gave customers the impression that one ice cream cone was better than theother, when in fact they were both made from thesame soft serve ice cream. In the U.S., Demadis
argued, hard and soft serve ice cream were always
priced the same.
As for the rest of the product line, Fang again
applied a modified cost plus strategy. However,since his cost accounting system had not been
established, he had to use the cost information he
had with the production costs that Carvel U.S. had
determined for American production. Althoughboth men agreed they would have to review theseprices once Chinese cost figures were available,
they were willing to go along with the above
approach to determine prices. Table 3 lists theavailable cost and retail price information for
Carvel Beijing.
By April, however, Fang had to reconsider hiscosts and sales prices. It was clear that he had to
reduce costs. This he could accomplish by continuing to source inputs locally and increase volume
and his economies of production.

853

854

Carvel in Beijing

CASE 21 Carvel in Beijing

TABLE 3Item
Large Heart
DessertHard Ice Cream Cone(scoop)Small Cone
Small Cup
Hug Me Bear
Cookie Puss
Fudgie the Whale
Sinfully Chocolate
Strawberry & Cream

Production
Cost

Retail Sale
Price

¥30
¥12

¥130
¥49

¥1.5/¥3.0/¥4.5
¥1.5
¥1.5
¥23
¥25
¥32
¥18
¥17

¥8/¥15/¥20
¥7
¥10
¥69
¥99
¥99
¥69
¥69

839

• Radio• 5 second commercial 3 times per day for
7 days—¥1,000• 15 second commercial 3 times per day for
7 days—¥3,500• 30 second commercial 3 times per day for
7 days—¥5,000• Billboards —¥10,000 per month• Bus placards —¥40,000 for one bus on one bus
line for six months• Newspapers• 150 word ad—¥2,000 per month• color ad on front cover—¥5,000 per month• Magazines• local biweekly magazine—¥3,000• local monthly magazine—¥5,500

What was uncertain, though, was whether theseprices made Carvel products unreachable toChinese consumers. After six months, Fang felt thatslow sales had forced him to examine the decision
whether to stick with the original pricing strategy,
or redefine his product through price cuts.
Advertising
The basic drive behind the advertising campaigns
both in China and the U.S. was to use fountain andnovelty products to drive cake sales. Cake sales by
far had the most margin, and it was in cake production that Carvel had its most leveraged competitive advantage. Clearly, if Carvel was to succeed in
China, it had to do so on the back of cake sales.
Fang had several avenues to explore to promote
his product. Among the options and costs to consider were:• Television• 5 second commercial 3 times per day for
7 days—¥4,000• 15 second commercial 3 times per day for
7 days—¥10,000• 30 second commercial 3 times per day for
7 days—¥15,000

Before making his decision, Fang wanted to
examine media-related information, as shown, inExhibit 8, available from the Gallup Poll.
CONSUMER MARKET IN CHINA
The recent Gallup Poll provided interesting insights
into the burgeoning consumer market in China. The
most striking fact to emerge was that Chinese consumers were very intelligent shoppers who valued
quality and long life in their purchases. For example, only 29 percent of consumers bought on pricealone, whereas 63 percent bought on quality.
As for consumer tastes in food, the survey
revealed that, as expected, rice, tea, and pasta werethe most common foods in the Chinese household.
However, 17 percent of those polled had dairy
products in their house, and 13 percent regularly
kept frozen foods at home.
The Gallup Poll also indicated that Chinese werevery well aware of foreign brand names. The
respondents were read a list of over 100 brandnames and were asked whether they had heard of
the names. Forty-four of the names were those of
American-based companies or brands, 25 wereJapanese, 17 were European, and the other 14 were

Carvel in Beijing

840

CASE 21 Carvel in Beijing

EXHIBIT 8
Carvel in Beijing Media Usage1

1 This is based on the results of a Gallup poll in response to the question: Which of the following did you read, see, or listen to yes-

terday?
Source: Company records.

from other nations. Exhibit 9 lists the 30 most popular brand names in China, of which 14 areJapanese, 8 American, 5 European, 2 Korean, andonly 1 Chinese.

Exhibit 10 shows the Gallup Poll information
relative to fast food and soft drinks. Kentucky Fried
Chicken was the most widely recognized fast foodchain in China; McDonald’s, Burger King, and

855

856

Carvel in Beijing

CASE 21 Carvel in Beijing

841

EXHIBIT 9
Carvel in Beijing
Popular Brand Names in China
Rank

Company

Percent

Rank

Company

Percent

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

Hitachi–aCoca Cola–b
Panasonic–a
Toshiba–a
Qing Dao Beer–eToyota–a
Mickey Mouse–b
Marlboro–b
Suzuki–a
Honda
Pepsi Cola–b
Kodak–b
Sanyo–aBoeing–b
Fuji–a

65%
62%
60%
58%
56%
54%
51%
47%
44%
42%
42%
42%
42%
42%
41%

16
17
18
19
20
21
22
23
24
25
26
27
28
29
30

Nestle–c
Mitsubishi–a
Mercedes Benz–c
Head and Shoulders–b
Gold Star–d
Sharp–aPhilips–c
Sony–aVolkswagen–c
Hilton–b
Samsung–d
Nissan–aNEC–aCasio–aPeugeot–c

40%
40%
39%
36%
36%
35%
34%
33%
33%
33%
31%
26%
26%
25%
22%

Legend:a = Japanese companies
b = American companies
c = European companies
d = Korean companies
e = Chinese companies
Source: Company records.

Pizza Hut were also very recognizable throughout
China. However, as the survey concluded, the mosttelling fact about these findings was:As has been the case for almost every measure, urbanization is the factor most affecting brand recognitionlevels. Those living in urban areas are much more
likely to recognize brand names than are people
nationwide, and residents of the largest 9 cities are still
more able to recognize brand names than are urban
residents in general.

Finally, the Gallup Poll revealed some tellinginformation on buying habits in China. For example, in response to the question: “On average, about
how much do you and your household spend permonth on the following items?”, considerable differences were found between large cities, urban
areas, and the country as a whole. (See Exhibit 11.)COMPETITION
Carvel Beijing faced a very fragmented market in
Beijing. Generally speaking, several domestic andinternational companies had penetrated the market
and achieved moderate brand awareness.
However, no brand had yet to break from the packand establish itself as the market leader in ice
cream. The following breakdown describes themost dominant of these fragmented players:

Carvel in Beijing

842

CASE 21 Carvel in Beijing

EXHIBIT 10
Carvel in Beijing Brand Recognition of Fast Food and Soft Drinks

Source: Company records.

EXHIBIT 11
Spending Habits in China
Item
Food, including eating out
Family savings
Clothing
Child’s education
Home, rent, & electricity
Daily goods (non-food)Entertainment
Medical
Source: Company records.

National Response

Urban Response

Largest 9 Cities$22.10$11.40
$5.60
$4.70
$4.30
$3.50
$1.30
$2.30

$38.00$17.00
$9.00
$7.00
$8.20
$4.80
$3.20
$4.00

$53.10$20.50$10.00
$9.10
$9.80
$5.60
$4.50
$4.00

857

858

Carvel in Beijing

CASE 21 Carvel in Beijing• Walls—Walls was a Holland-based company
and one of the market leaders in Europe andAustralia. In Beijing, Walls’ product line waslimited to cups, cones, and various other novelty treats. Mainly, their distribution was limited
to roughly 3,000 rollhards from which they soldnovelty ice creams, namely cups and cones.
Walls was also available in several supermarkets.
As one of the first western ice creams in
Beijing, Walls still enjoyed the benefits of its
first mover status. Beijing customers still considered Walls to be the preeminent Western ice
cream in Beijing, simply due to breadth andduration of its presence. On average, Walls soldits products for ¥4, but recently it had raised its
prices to ¥5. It was estimated that Carvel hadtaken much of its market share from Walls.
• Bud’s—Bud’s was a San Francisco-based ice
cream company that enjoyed a wide presence
and brand awareness in Beijing. Although onlya regional brand in the U.S., in China, Bud’s
enjoyed the reputation of being the preeminent
American brand because it was the first
American brand to appear in the PRC. To date,in a country where consumers still prized acompany’s tradition and longevity, both BaskinRobbins and Carvel had not yet been able todispel Bud’s image.
Like Walls, Bud’s did not have any retailstore outlets. Instead, Bud’s sold only fromnearly 600 rollhards scattered throughout
Beijing’s markets and supermarkets. Bud’s only
produced cup and cone products, and its prices
matched those of Wall’s. Small cups were ¥4.2,
hard ice cream was ¥6, and pints sold for ¥23.
• Baskin-Robbins—Baskin-Robbins represented
the most significant long term competition to
Carvel Beijing for several reasons. First, BaskinRobbins was Carvel’s chief rival in the U.S. andits products enjoyed a more national brandawareness than Carvel’s. Secondly, BaskinRobbins was the only competitor in Beijing that
produced an all ice cream cake and had retailstores in which to promote them. Finally,

843

Baskin-Robbins had a longer and broader presence in Beijing and appeared to have the positioning strategy that Carvel had targeted.
Baskin-Robbins’ presence was mainly limited
to its two retail stores. Like Carvel, BaskinRobbins offered its customers a true ice cream
parlor experience. While Carvel’s cakes were ofbetter quality, Baskin-Robbins relied on its tradition of hard ice cream cones and fountainproducts to drive sales. Currently, BaskinRobbins charged ¥9 for a single scoop ice creamcone and ¥107 for a cake comparable to Carvel’s
small round. Baskin-Robbins did not have any
wholesale outlets at this time.
• Meadow Gold—Meadow Gold was a locally
produced product with high market saturation.
Meadow Gold’s product quality was much
lower than the above competitors, but the company’s rollhards were in twice the outlets thanWalls and the company sold its products
through a number of channels: local stores,
supermarkets, and on the street. Concentrating
on only novelty products, Meadow Goldcharged only ¥2 to ¥3 for its product line ofcups and cones.
• New Continent—As a venture partner in
Carvel Beijing, New Continent was also astrong domestic player in the novelty side of
the market. Generally speaking, New Continent
competed alongside Meadow Gold for market
share and sales, and produced novelty productsin the same factory that produced Carvel
Beijing’s ice cream mix. Most of New
Continent’s prices were ¥2 or lower.
New Continent, though, had clearly used its
partnership with Carvel to project itself deeper
into the Beijing market. The company had comeout with awning and vendcart styles thatclosely resembled the colors and logos of
Carvel. Also, with nearly 6,000 vendcarts onorder, New Continent would clearly redefine
the lower end of the ice cream market in
Beijing.
Finally, New Continent had also begun toopen mini stores along the same lines as

Carvel in Beijing

844

CASE 21 Carvel in Beijing

Carvel’s Chang An and Parkson outlets. The
company was also considering bringing out a
new line of ice cream cakes that would compete
on price with Carvel’s and Baskin-Robbins'
products.
SUBSTITUTE PRODUCTS
Beijing residents enjoyed a wide variety of dessert
products. Besides ice cream products, there werenumerous bakeries that offered a variety of traditional Chinese-designed cakes and pastries. Theseflour-based cakes were richly designed with traditional Chinese figures and styles and sold on average from ¥100 to ¥250 for an ornate wedding cake.
Other traditional treats included pastries with asweetened jelly or fruit paste filling. Chinese also
enjoyed various types of traditional dried fruits,
and they often ended each meal with a platter offresh fruit and tea. There were also many styles ofChinese and Western candies. Furthermore, a traditional sweet treat called suan niu nai literally meaning sour milks), a yogurt-like product, was soldthroughout the city for ¥1.5. Chinese of all status
enjoyed suan niu nai at all hours of the day, but it
was more closely associated with the less affluent
segments of society.
Finally, the growth of McDonald’s, Burger King,and Kentucky Fried Chicken had presented Carvel
with other possible substitute products. More andmore consumers were trying these fast food giants’
own desserts, such as apple pies, shakes, and theirown ice cream cups and sundaes.
In short, there were a wide variety of dessert andsnack treats from which Chinese consumers could
choose. What concerned Phil Fang, though, wasthat all these alternative treats were cheaper andmore widely recognized than his product line.

• Strengths• Carvel had the best ice cream cake in Beijing
and one of the best ice creams.
• Carvel had received positive reviews from its
customers.
• Training and operations had progressed welland the company was ready to increase production.
• Weaknesses• Vaguely defined management roles andobjectives hampered definitive marketing
policies.
• Inability to source inputs locally continued tohamper the bottom line.
• Too many potential customers still did notknow of Carvel Beijing.
• Opportunities• Carvel was looking into involving the foreign embassy community in its sales promotions as a means of increasing both sales andpotential outside business contracts.
• The approaching summer allowed Carvel tohave a seasonal grand opening to reintroduce the brand to first time customers.
• Wang Meng’s offer to use 6,000 New
Continent vendcarts offered Carvel theopportunity to increase greatly the brand’s
exposure at minimal cost.

CONCLUSION• Threats• The cash flow and sales problems threatened
to scuttle the proposed business plan for
1995.
• The competition, including Wang Meng,
were quickly realizing the potential of ice
cream cakes in Beijing, and Carvel’s competitive advantage in this area would bechallenged.
• The dynamic political and economic environment in China presented inherent uncertainty.

On April 30, 1995, Phil Fang gathered his management team together to perform a SWOT analysis ofCarvel Beijing. They concluded that Carvel Beijing
was operating under the following conditions:

Having done this analysis, Fang had to plot his
strategy for the rest of 1995 and beyond. More
important, he had to make some very tough decisions on where he wanted to position Carvel

859

860

Carvel in Beijing

CASE 21 Carvel in Beijing

845

Beijing as it entered its first and, arguably, mostimportant summer in Beijing. Among the mostpressing issues he had to face were:• how to produce the mix: as the original
American mix or as a less sweet mix more
appealing to traditional Chinese tastes• how to price the product: competitively or as
premium product• how to design and position the cakes: as
American products or as more traditional
Chinese products• how to confront the financial problems: withshort term or long term policies• how to respond to Wang’s vendcart proposal

What complicated these decisions were theproblems associated with a multinational joint venture: issues of personality, culture, and the joint
venture agreement itself. In the end, though, it wasPhil Fang who would have to overcome these challenges and seize upon the unique chance to create
the first truly national brand of ice cream in the
People’s Republic of China.

C A S E 2 2 KFC:Doing Chicken Rightin the U.S.Fast-Food Industry
I think our most critical issue in the future will be
our ability to handle change. We have a concept
that, in the last two years, has moved us out of the
1960s to perhaps the late 1980s. Unfortunately, it’s
1994, and we have a lot more changes that need totake place in our system. Our system is older interms of facilities and product forms, and our attitudes still don’t reflect the realities of our changing
business environment.
One of the great challenges at KFC is that there isa lot that needs fixing. It’s like being a kid in a candy
store—you don’t know where to go first. I think oneof the toughest challenges we have had is to stay
focused. That is true on the menu side as well. People
really see us as being the experts on chicken-on-thebone. There is so much we can still do with products
such as Rotisserie Chicken and different forms likethat.
We also have a significant service problem in a service-driven industry. I think we have got to figure out
a way to meet our customer service expectations,which we don’t meet today. They come to us reallybecause they love our product in spite of our service.
And you can’t survive long-term on that trail.
Kyle Craig, President,
KFC Brand Development, April 1994

In 1994, KFC remained the world’s largest
chicken restaurant chain and the world’s thirdlargest fast-food chain. It held almost 50 percent of
the U.S. market in terms of sales and ended 1993
with over 9,000 restaurants worldwide. It was
opening a new restaurant at a rate of roughly one
per day worldwide and was operating in 63 countries. One of the first fast-food chains to go international during the late 1960s, KFC has developed
one of the world’s most recognizable brands.

40

Craig found himself faced with a number of critical issues in 1994. Despite KFC’s past successes in
the U.S. market, much of KFC’s growth was now
being driven by its international operations, which
accounted for over 87 percent of all new KFC
restaurants built in 1993. Additionally, intensifiedcompetition among the largest fast-food competitors had resulted in a number of obstacles to further expansion in the U.S. market. Further
expansion of free-standing restaurants was particularly difficult. Fewer sites were available for new
construction and those sites, because of theirincreased cost, were driving profit margins down.
Profit margins were driven down further by theneed to promote the brand more rigorously, consumer pressure to reduce prices, the high cost of
bringing new products to market, and higher operating costs.
Through the late 1980s, most of KFC’s competition was limited to other fried chicken chains suchas Church’s, Popeyes, and Bojangles. Today, KFC is
faced with competition from non-fried chicken
chains such as Hardee’s and McDonald’s, whohave introduced fried chicken to their menus. With
KFC’s menu limited to chicken, it has lost businessto chains which offer customers a greater variety offood items that cut across different food segments.
In addition, a number of new, upscale chicken
chains—for example, Kenny Roger’s Roasters andBoston Chicken—have entered the market. These
new chains have focused on higher income customers by offering non-fried chicken items.
Because KFC is best known for its fried chicken
products, these new entrants are reaching out tocustomer groups which KFC is only now beginningThis case was prepared by Professor Jeffrey A. Krug of the University of Illinois, and Professor W. Harvey Hegarty of Indiana
University. It is printed here with their permission.

846

861

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KFC: Doing Chicken Right in the U.S. Fast-Food Industry

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

to tap. Even Pizza Hut, a sister company ofPepsiCo, has debated whether it should introduce
chicken products to its menu.
KFC’s early entry into the fast-food industry in1954 allowed KFC to develop strong brand namerecognition and a strong foothold in the industry.
However, its early entry into the industry has also
been the cause of many present day problems. By
the mid-1980s, many of KFC’s restaurants had
begun to age and were designed mainly for takeout. As a result, KFC had to expend significant
financial resources to refurbish older restaurants
and add additional inside seating and drive-thrus,
in order to accommodate customers’ increasing
demands for faster service.
KFC’s major problem in 1994 was how to transition the old KFC into a new KFC which appealed toconsumer demands for more healthy food items at
lower prices, greater variety in food selection, anda higher level of service and cleanliness in a greater
variety of locations. In effect, this entailed greaterreflection over its entire business strategy—its
menu offerings, pricing, advertising and promotion, points of distribution, restaurant growth, andfranchise relationships.
THE U.S. FOOD SERVICE INDUSTRY
The concept of franchising became well-established by the early 1950s. Colonel Harland Sanders
founded Kentucky Fried Chicken in 1954, Ray
Kroc opened the first McDonald’s restaurant in
1955, and Burger King quickly followed by opening its first restaurant in Miami, Florida. Other
franchises founded in the 1950s were Chicken
Delight, Burger Chef, Burger Queen, Carol’s, andSandy’s. Today, the U.S. restaurant industry ismade up of over 550,000 restaurants and food outlets, according to the National Restaurant
Association (NRA). The NRA estimates that U.S.
food service industry sales will surpass $275 billion in 1994. Exhibit 1 shows U.S. food service
industry sales segmented into 11 categories. For
the first time, the fast-food segment is expected to
become the largest segment of the U.S. food service

847

industry, with forecasted sales of $86.0 billion in
1994. This compares with an estimated $85.5 billion in sales in the full service segment.
The U.S. food service industry as a whole grewat an estimated compounded annual growth rate of
3.9 percent from 1988 to 1994, compared with anannual growth rate of 5.4 percent in the U.S. grossdomestic product. The fast-food segment of thefood industry grew at a more healthy estimatedrate of 5.6 percent, outpacing all food categories
except social caterers and ice cream stores whichgrew only slightly more quickly. The NRA estimates that the fast-food segment will grow by 6.3
percent in 1994, following a 7.0 percent growth rate
in 1993. While 11 categories of restaurants make up
the food industry, the top three—fast-food, full service, and institutions—have maintained a constantshare of about 73 percent of total industry sales.
However, the share of industry sales controlled by
the fast-food segment has risen by about 1.8 points
over the last five years, mainly at the expense of fullservice restaurants and lodging places.
THE U.S. FAST-FOOD INDUSTRY
Financial and other data for the fast-food segmentof the U.S. food service industry are most frequently reported for eight separate categories:
sandwich chains, pizza chains, family restaurants,
dinner houses, chicken chains, steak restaurants,
contractors, and hotels. Exhibit 2 shows sales forthe largest 100 U.S. fast-food chains over the last
five years. The top 100 chains have grown at a compounded annual rate of 6.4 percent over the last
five years. Only three of the nine food categories
have grown at greater than a 6.0 percent annual
rate: pizza chains (7.8 percent), family restaurants(6.1 percent) and dinner houses (11.1 percent). The
chicken segment has grown at a 4.1 percent compounded annual rate, partially reflecting the healthtrend away from fried foods and the addition offried chicken and chicken sandwiches to the menusof sandwich chains, such as McDonald’s andHardee’s. The latter have taken sales away from thechicken chains.

KFC: Doing Chicken Right in the U.S. Fast-Food Industry

848

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

EXHIBIT 1
U.S. Food Service Industry Sales($ Billions)

1989

1990

1991

1992

1993

1994

5-YearGrowthRate

Fast-Food
Full Service
Institutions
Vending
Food Contractors
Lodging Places
Bars & Taverns
Cafeterias
Social Caterers
Ice Cream
Military

65.5
73.2
25.0
18.0
13.1
14.1
9.0
4.2
2.1
2.0
1.1

69.8
75.9
26.4
16.3
14.1
14.9
8.7
4.4
2.3
2.0
1.0

73.6
79.2
27.5
19.9
15.0
14.3
8.6
4.6
2.4
2.1
1.1

75.6
80.3
28.3
20.3
15.5
15.2
9.2
4.5
2.5
2.4
1.2

80.9
83.1
29.1
20.7
15.8
15.1
8.9
4.5
2.6
2.6
1.2

86.0
85.5
29.9
21.6
16.4
15.5
8.8
4.7
2.8
2.7
1.1

5.6%
3.1%
3.7%
3.8%
4.7%
1.9%
–0.4%
2.5%
6.0%
6.2%
1.1%

Total Sales

227.2

235.8

248.0

254.9

264.6

275.1

3.9%

Source: Nation’s Restaurant News, National Restaurant Association. 1994 sales estimated.

863

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KFC: Doing Chicken Right in the U.S. Fast-Food Industry

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

EXHIBIT 2
Top 100 Fast-Food Chain Sales by Food Segment ($ Billions)($ Billions)

1988

1989

1990

1991

1992

1993

5-YearGrowthRate

Sandwich Chains
Pizza Chains
Family Chains
Dinner Houses
Chicken Chains
Steak Chains
Food Contractors
Hotels
Other

30.9
7.0
5.7
4.5
4.1
3.4
9.3
4.5
5.2

33.2
7.7
6.6
5.0
4.2
3.5
10.5
4.7
5.5

35.6
9.2
6.4
5.4
4.6
3.4
11.2
5.3
6.7

36.7
9.6
7.0
6.3
4.5
3.5
10.8
5.4
6.7

39.7
10.4
7.7
6.9
4.7
3.3
11.2
5.5
6.7

41.0
10.2
7.6
7.6
5.0
3.0
11.8
5.6
9.9

5.8%
7.8%
6.1%
11.1%
4.1%
–2.3%
4.9%
4.5%
3.7%

Total Sales

74.6

80.9

87.8

90.3

96.1

101.8

6.4%

Source: Nation’s Restaurant News.

849

KFC: Doing Chicken Right in the U.S. Fast-Food Industry

850

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

Exhibit 2 indicates that the top four fastest growing categories within the fast-food industry control
65 percent of all fast-food sales. During the last six
years, the market share held by these four categories has increased from 64.4 percent to 65.2 percent. All other categories, including the chicken
category, have lost market share during this period.
The most significant improvement in sales has
occurred in the dinner house segment. Seven of thedinner house segment’s 15 major restaurant chainsregistered double-digit sales growth in 1993:
Outback Steakhouse (80 percent), Applebee’s
Neighborhood Grill & Bar (42 percent), Ruby
Tuesday (25 percent), Red Robin Burger & Spirits
Emporium (20 percent), the Olive Garden (18 percent), and Chili’s Grill & Bar (15 percent).
Much of the improvement in sales among thedinner houses and family restaurant chains during
the last decade is partially attributable to demographic trends in the United States. In particular,
young people as a percentage of the population are
declining. nose in the 18–24 year age group, forexample, are of particular importance to fast-foodrestaurants because they consume about five meals
away from home weekly, compared to under four
meals for all consumers. While this age groupnearly doubled during the 1960–1980 period, it will
drop by about 20 percent by the year 2000. Thoseover the age of 65 tend to eat out less often, about
two times per week, and this group is the most
rapidly growing age group in the country. Olderindividuals tend to spend more time eating theirmeal, prefer sit-down restaurants, and are more
likely to choose more upscale restaurants such as
dinner houses. The higher price of the averagemeal in a dinner house is offset by the fewer times
that older individuals eat out each week.
The initial high growth rates in fast-food franchising in the United States during the late 1950s and1960s made the fast-food industry attractive to newentrants. The lack of established market share leaders and brand loyalties meant that there were relatively few companies that could defend against newmarket entrants. During this period, a number offast-food chains were acquired by larger, diversified

firms. Some of the most notable acquisitions were
Pillsbury’s acquisition of Burger King, General
Foods’ acquisition of Burger Chef (which was latersold to Hardee’s Food Systems in 1982), RalstonPurina’s acquisition of Jack in the Box, United
Brand’s acquisition of Baskin-Robbins (which it latersold in 1973), and Great Western’s acquisition of
Shakey’s Pizza.
The acquisition of a number of fast-food franchises by larger, more established marketing firms
intensified competition during the 1970s. Not only
were many fast-food chains owned by larger companies with resources enabling them to promote andinvest heavily in their respective chains, but consumers increasingly demanded more value for theirdollar. This further intensified competition and asecond wave of acquisitions followed during thisperiod. PepsiCo acquired Pizza Hut in 1977 andTaco Bell in 1978. KFC, which was sold by Heublein
to R.J. Reynolds Industries in 1982, was alsoacquired by PepsiCo, in 1986. Other notable acquisitions during this period were Hardee’s acquisitionof Roy Rogers, Popeyes’ acquisition of Church’s,
Tennessee Restaurant Company’s acquisition ofFriendly’s Ice Cream, and Gibbons, Green vonAmerongen’s acquisition of Jack in the Box. Many ofthese acquisitions were made in order to strengthen
the parent company’s position within the fast-foodindustry (e.g. PepsiCo’s decision to diversify into
fast-food by acquiring Pizza Hut, Taco Bell, andKentucky Fried Chicken). However, another factor
that led to many of these acquisitions was the deteriorating financial position of smaller competitors,brought about by a lack of resources to compete withthe market share leaders. A number of chains, therefore, became attractive takeover targets.
An interesting characteristic of the fast-foodindustry is that, in almost all cases, the leader ineach food segment controls a large relative market
share when compared to the market shares of its
nearest competitors. Exhibit 3 shows the market
share leaders in the top six fast-food categories forthe industry’s leading chains. Only the steak restaurant segment has no clear market share leader.
McDonald’s controls 35 percent of the sandwich

865

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KFC: Doing Chicken Right in the U.S. Fast-Food Industry

851

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

EXHIBIT 3
Leading U.S. Fast-Food Chains (Ranked by 1993 Sales, $ 000s)
Sandwich Chains

Sales

Share

Family Restaurants

Sales

Share

McDonald’s
Burger King
Taco Bell
Wendy’s
Hardee’s
SubwayArby’sDairy Queen
Jack in the Box
Sonic Drive-In
Roy Rogers
Other Chains
Total

14,186
6,720
3,608
3,547
3,505
2,133
1,596
1,085
1,018
650
635
2,312
40,995

34.6%
16.4%
8.8%
8.7%
8.5%
5.2%
3.9%
2.6%
2.5%
1.6%
1.5%
5.6%
100.0%

Denny’s
Shoney’s
Big Boy
Cracker Barrel
Perkins
Friendly’s
Int’l House of Pancakes
Bob Evans
Bakers Square
Waffle House
Other Restaurants
Total

1,634
1,318
1,064
640
578
611
552
480
280
275
217
7,649

21.4%
17.3%
14.0%
8.4%
7.6%
8.0%
7.2%
6.3%
3.7%
3.6%
2.8%
100.0%

Dinner Houses

Sales

Share

Pizza Chains

Sales

Share

Red Lobster
Olive Garden
Chili’s Bar & Grill
T.G.I. Friday’s
Applebee’s
Bennigan’s
Chi-Chi’s
Ruby Tuesday
Outback Steakhouse
Ground RoundOther Dinner Houses
Total

1,732
1,055
788
671
605
446
406
354
348
302
916
7,623

22.7%
13.8%
10.3%
8.8%
7.9%
5.9%
5.3%
4.6%
4.6%
4.0%
12.0%
100.0%

Pizza Hut
Little Caesers
Domino’s Pizza
Round Table Pizza
Sbarros
Chuck E. Cheese’s
Other
Total

4,800
2,150
1,877
347
346
294
407
10,221

47.9%
21.4%
18.7%
3.5%
3.5%
2.9%
2.1%
100.0%

Steak Houses

Sales

Share

Chicken Chains

Sales

Share

Ponderosa
Sizzler
Golden Corral
Ryan’sWestern Sizzlin’
Quincy’s
Total

762
672
515
450
350
279
3,028

25.2%
22.2%
17.0%
14.9%
11.6%
9.2%
100.0%

KFC
Popeyes Chicken
Church’s Chicken
Chick-fil-A
Boston Chicken
Kenny Rogers Roasters
Total

3,400
564
439
396
152
69
5,020

67.7%
11.2%
8.8%
7.9%
3.0%
1.4%
100.0%

Source: Nation’s Restaurant News, National Restaurant Association.

KFC: Doing Chicken Right in the U.S. Fast-Food Industry

852

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

segment. Red Lobster controls 23 percent of the dinner house segment. Pizza Hut and KFC, both subsidiaries of PepsiCo, Inc., control 48 percent and 68
percent of their respective food segments.
Demographically, consumers became more andmore demanding during the 1980s. In 1991, theNational Restaurant Association conducted a survey to measure consumer attitudes toward fastfood and moderately-priced restaurants. Of those
consumers who said they would rather go to a fastfood restaurant than any other type of restaurant
under most circumstances, 48 percent mentioned
being in a hurry, being busy, and wanting fast service as the major factor in their choice of a fast-foodrestaurant. Convenience, expense, “didn’t feel likecooking,” and quality were less important. This
trend was further supported in a 1992 survey by
the National Restaurant Association, which foundthat 66 percent of the respondents felt that their
expectations of the value they received at fast-foodrestaurants for the price paid was generally met.
Twenty-three percent of the respondents felt thatthe value they received for the price paid fell below
their expectations.
By 1994, however, consumers had become moredemanding. In addition to demanding faster service, consumers were increasingly demanding agreater variety of menu items, greater value for
their dollar, and fast-food available at a greaternumber of non-traditional outlets, such as airports.
This resulted in a number of fast-food chains (suchas McDonald’s, Taco Bell, and Wendy’s) offering
combinations of food items (“value meals”) at
lower prices and several fast-food chains cutting
across food segments by offering products not traditionally offered by other competitors in their foodsegment (for example, Hardee’s offering friedchicken). The latter has affected KFC, which competes exclusively within the chicken segment.
THE CHICKEN SEGMENT OF THE
FAST-FOOD INDUSTRYWorldwide sales of U.S. chicken chains surpassed$9.0 billion in 1993. KFC held a worldwide market

share of over 70 percent in both sales and restaurants. By the end of 1993, KFC had 9,033 restaurants in 63 countries. Only about one-half of all
chicken chains had established restaurants outsideof the United States by mid-1994. In contrast, KFC
opened its first restaurant outside of the U.S. in thelate 1950s. KFC’s early expansion abroad, its strong
brandname, and managerial experience operating
in international markets partially explains KFC’s
dominant market share.
KFC also leads all chicken chains in sales andunits in the U.S. market; however, it faces muchstronger competition domestically. (See Exhibit 4.)
During the last five years, KFC’s sales have grown
at a 3.2 percent annual rate, even though it has
outpaced the overall chicken segment, which has
grown at an average annual rate of 2.5 percent.
Only Chick-fil-A has gown at a rate faster thanGDP. While KFC, Popeyes, and Church’s havefocused on unique fried chicken recipes served tocustomers in free-standing restaurants, Chick-filA serves pressure-cooked and char-grilled skinless chicken breast sandwiches to customers insit-down restaurants located in shopping malls.
One of the first fast-food restaurants to break into
shopping malls, Chick-fil-A opened its firstrestaurant in the Greenbrier Mall in Atlanta in
1967.
Chick-fil-A
Chick-fil-A’s relatively high growth rate during
the last five years may at first appear surprising,considering the culture at Chick-fil-A and the management style of S. Truett Cathy, Chick-fil-A’s
founder, chairman, and chief executive officer.
Cathy, a strongly religious man, keeps all Chick-filA stores closed on Sundays. He also refuses to takethe company public, will not franchise, and does
not aggressively advertise his product or concept.
Cathy is also involved in a variety of community
activities which take him away from the day-today operations of his business, and he contributes
heavily to youth programs, charities, and scholarship funds.

867

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KFC: Doing Chicken Right in the U.S. Fast-Food Industry

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

853

EXHIBIT 4
Top U.S. Chicken Chains
Sales ($ Millions)

1988

1989

1990

1991

1992

1993

5-Year
CAGR

KFC
Popeyes
Church’s
Chick-Fil-A
Top U.S. Chains
Other Chicken Chains
Total U.S. Market

2,900
485
406
232
4,023
2,177
6,200

3,000
510
466
264
4,240
1,760
6,000

3,249
560
445
300
4,554
1,846
6,400

3,200
536
415
325
4,476
2,325
6,801

3,400
545
414
356
4,715
2,286
7,001

3,400
564
439
396
4,779
2,201
7,000

3.2%
3.1%
1.6%
11.3%
3.6%
0.2%
2.5%

Year-End Restaurants

1988

1989

1990

1991

1992

1993

5-Year
CAGR

KFC
Popeyes
Church’s
Chick-Fil-A
Top U.S. Chicken Chains
Other Chicken Chains
Total U.S. Market

4,923
715
1,363
406
7,407
N/A
7,407

4,937
739
1,111
411
7,198
N/A
7,198

5,006
778
1,059
441
7,284
N/A
7,284

5,056
794
1,021
465
7,336
N/A
7,336

5,089
775
944
487
7,295
N/A
7,295

5,128
764
932
545
7,369
N/A
7,369

0.8%
1.3%
–7.3%
6.1%
-0.1%
N/A
–0.1%

Source: Nation’s Restaurant News.

Chick-fil-A’s corporate culture and new distribution strategy, however, have helped Chick-fil-A
maintain high growth rates in sales over the last
five years despite slow overall growth in thechicken segment. For example, Cathy is wellknown for treating his employees like family members. This has resulted in low turnover rates among
both managers and part-time workers. In addition,
Cathy has taken the step to expand beyond shopping malls. As many malls have added food courts,
often consisting of up to 15 fast-food units competing side-by-side, shopping malls have become lessenthusiastic about allocating separate store space tofood chains. In addition to Chick-fil-A’s original sitdown mall stores, it has begun opening smaller
units in shopping mall food courts, free-standing
units, restaurants in hospitals and colleges, and“Dwarf Houses” (full service restaurants which
offer hamburgers and steaks as well as chicken).

Church’s and Popeyes
Much of the slow growth in sales and units inPopeyes and Church’s is a function of financial
problems during the last five years. In 1989, the San
Antonio-based Church’s Fried Chicken was
acquired in a hostile takeover by Al Copeland,owner of Popeyes Famous Fried Chicken & Biscuits.
The $400 million leveraged buy-out of Church’s was
financed through Merrill Lynch and the CanadianImperial Bank of Canada. Most of the financing wasachieved through the issue of junk bonds. Merrill
Lynch and CIBC’s fee was $58 million!
Copeland’s strategy was two-fold: (1) to convert
Church’s restaurants into Popeyes restaurants and(2) to sell off several hundred Church’s restaurants
in order to cover interest and debt payments arising from the acquisition of Church’s. Exhibit 4
shows that both sales and the number of Church’s

KFC: Doing Chicken Right in the U.S. Fast-Food Industry

854

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

restaurants began to fall in 1990. Sales began to riseagain in 1993. Popeyes achieved a five-year growthrate in sales of 3.1 percent, equal to the growth rateof KFC during this period. The growth of Popeyes
units grew at a lower 1.3 percent annual rate.
Much of this growth, of course, was achieved
through the conversion of Church’s units into
Popeyes units. In a 1992 court battle, Copeland
was forced out as owner of Popeyes and Church’s,
and the two units became divisions of America’s
Favorite Chicken Co., a subsidiary of the CanadianImperial Bank of Canada and Copeland’s major
financial backer during the 1989 takeover ofChurch’s.
A major issue facing Church’s and Popeyes in1994 was whether they could survive over the longterm. Not only were they far behind the market
share leader, KFC, but they had been unable to
make market share gains over the last 10 years. inaddition, the organization was burdened by large
debt that had accumulated as a result of Al
Copeland’s acquisition of Church’s and subsequent
financial problems, which ultimately led to
Copeland’s downfall. There was also some concernthat Church’s and Popeyes’ current owner, theCanadian Imperial Bank of Canada, did not havethe managerial knowhow or expertise to operate
Church’s and Popeyes other than as autonomous
units. The Canadian Imperial Bank’s eventual
takeover of Church’s and Popeyes was a courtapproved remedy for Al Copeland’s inability to
repay the bank for the bark’s financial support of
Copeland’s acquisition of Church’s. Therefore,
there was little strategic fit or opportunity to transfer value from the parent to the newly acquired
chicken chains.
Boston Chicken
Through the early 1980s, all of the leading chicken
chains focused on fried chicken products.
However, by the mid-1980s, all of the fast-foodchains had begun to recognize the need to introduce products which appealed to an increasing
health-conscious consumer. To address these needs,

the major chicken chains added healthier products
to their menus such as grilled chicken sandwiches
and rotisserie chicken. However, they continued toemphasize what they did best—fried chicken-onthe-bone.
In 1985, a new restaurant called Boston Chicken
was opened in Newton, Massachusetts. Instead ofoffering a wide range of fried and non-friedchicken products, Boston Chicken chose to build aconcept around a single product: marinated, slowroasted chicken. Part of Boston Chicken’s strategy
was to differentiate itself from other fast-foodrestaurants by emphasizing the “home-cooked”
nature of its products. The menu was simple.
Customers would choose a quarter or halfchicken, white or dark meat, and two side orders.
Side orders were selected from a variety of fooditems in a delicatessen-like display case. Cornbread was included with every meal. In addition
to its roasted chicken meals, the menu included
chicken sandwiches, chicken soup, chicken salad,and chicken pot pie. All food items were madefrom scratch, further enhancing the restaurant’s
image for “home-cooked” rather than “fast” food.
Units were simple and clean and the decor was
designed to give the appearance of a delicatessen.
While units were designed mainly for take-out, nodrive-thrus were used. This further enhanced its
delicatessen image. Prices were slightly higher
than other chicken chains, but this fit with the“home-cooked” image of the restaurant andappealed to professionals and other higher
income customers.
On November 9, 1993, Boston Chicken went
public. From an initial offering of $20 per share, theprice jumped to $48.50 by the close of the day, a 143
percent increase. According to NASDAQ, it was thelargest first-day increase in stock price of any new
stock in any industry in over two years. Total market capitalization was $18.6 million. Boston
Chicken’s first annual report, for the year ended
December 26, 1993, showed the company’s firstprofit; net income of $1.6 million on revenues of$42.5 million. This represented a 413 percent
increase in revenue from the previous year.

869

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KFC: Doing Chicken Right in the U.S. Fast-Food Industry

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

KENTUCKY FRIED CHICKENCORPORATION
Parent-Subsidiary Relationship
When PepsiCo, Inc. acquired KFC from RJRNabisco in 1986, KFC’s relationship with its parent
company underwent dramatic changes. RJRNabisco ran KFC as a semi-autonomous unit, satisfied that KFC management knew the fast-foodbusiness better than they. In contrast, PepsiCo
acquired KFC in order to complement its alreadystrong presence in fast-food. After its acquisition of
KFC, PepsiCo had the leading market share inchicken (KFC), pizza (Pizza Hut), and Mexican
food (Taco Bell). However, rather than allowing
KFC to operate autonomously, PepsiCo undertook
sweeping changes. These changes included negotiating a new franchise contract to give PepsiCo
more control over its franchisees, reducing staff inorder to cut costs, and replacing KFC managers
with its own. In 1987, a rumor spread throughout
KFC’s headquarters in Louisville that the new personnel manager, who had just relocated from
PepsiCo’s headquarters in New York, was overheard saying that “there will be no more homegrown tomatoes in this organization.”
Such statements by PepsiCo personnel, uncertainties created by several restructurings which led
to layoffs throughout the KFC organization, thereplacement of KFC personnel with PepsiCo managers, and conflicts between KFC and PepsiCo’s
corporate cultures created a morale problem within
KFC. “Colonel” Sanders’ philosophy when hefounded KFC was to create an organization with arelaxed atmosphere, life-time employment, good
employee benefits, and a system of relatively independent franchisees. In stark contrast to KFC’s culture, PepsiCo’s culture was characterized by astrong emphasis on performance. PepsiCo used its
Taco Bell, Pizza Hut, and KFC operations as training grounds for its future top managers and rotatedits best managers, on average, every two years
among its KFC, Taco Bell, Pizza Hut, Frito-Lay, andPepsi-Cola subsidiaries. (See Exhibit 5.) Therefore,
there was immense pressure for managers to855

continuously show their managerial prowess
within short periods, in order to maximize theirpotential for promotion. However, KFC personnel
were often chosen from outside the KFC organization or hired through executive consultants. This
practice left many existing KFC managers with thefeeling that they had few career opportunities with
the new company. One KFC manager, who asked
not to be identified, commented that a senior manager told him that “you may have performed welllast year, but if you don’t perform well this year,
you’re gone, and there are 100 ambitious guys with
Ivy League MBAs at PepsiCo who would love totake your position.”
Officially, PepsiCo managers were given autonomy to make their own decisions. In reality,
PepsiCo kept a tight reign on its units. This waspartially the result of its policy of continuously
evaluating managers for promotion. Accounting,
MIS, and financial planning systems were dictatedfrom PepsiCo and much of KFC’s capital expenditures were allocated by PepsiCo from otherPepsiCo units. For example, in 1993, KFC
accounted for 5.3 percent of PepsiCo’s consolidated
operating profit but 12.5 percent of total capitalspending. In contrast, Frito Lay accounted for 40.9
percent of PepsiCo’s overall 1993 operating profit
but 24.5 percent of capital spending.
Asked about KFC’s relationship with its parent,
Kyle Craig commented:
The KFC culture is an interesting one because I think
it was dominated by a lot of KFC folks, many of whom
have been around since the days of the Colonel. Manyof those people were very intimidated by the PepsiCo
culture, which is a very high performance, highaccountability, highly driven culture. People were concerned about whether they would succeed in the newculture. Like many companies, we have had a coupleof downsizings which further made people nervous.
Today, there are fewer old KFC people around and I
think to some degree people have seen that thePepsiCo culture can drive some pretty positive results.
I also think the PepsiCo people who have worked
with KFC have modified their cultural values somewhat and they can see that there were a lot of benefits
in the old KFC culture.

KFC: Doing Chicken Right in the U.S. Fast-Food Industry

856

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

EXHIBIT 5
PepsiCo, Inc. Organizational Chart
PepsiCo, Inc.
Somers,New York

BEVERAGESSNACK FOODSRESTAURANTS

Frito-Lay, Inc.

Pizza Hut
Worldwide

Pepsi-Cola
North
America

Plano,
Texas

Wichita,
KansasSomers,New York

Taco Bell
Worldwide
Irvine,California

PepsiCo Foods
andBeverages
International

Kentucky Fried
Chicken Corporation
Louisville,
KentuckySomers,New York

PepsiCo Food
Systems
Dallas,
Texas

Source: PepsiCo, Inc. Annual Report, 1993.

Even now, though, that is still not universally
understood. PepsiCo pushes their companies to perform strongly, but whenever there is a slip in performance, it increases the culture gap between PepsiCoand KFC. I have been involved in two downsizings
over which I have been the chief architect. They havebeen probably the two most gut-wrenching experiences of my career. Because you know you’re dealing
with peoples’ lives and their families, these changes
can be emotional if you care about the people in yourorganization. However, I do fundamentally believethat your first obligation is to the entire organization.

Financial Results
Exhibits 6 and 7 show KFC’s corporate sales andprofits since 1991. KFC corporate sales continue togrow sales at a healthy rate. Sales grew at a compounded annual growth rate of 13.6 percent during, the last five years. Sales were up 7.2 percent in
1993, mainly because of new restaurant construction outside the United States, higher pricing in
U.S. restaurants, and higher franchise royalty revenues. Foreign restaurants continue to account for

871

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KFC: Doing Chicken Right in the U.S. Fast-Food Industry

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

857

EXHIBIT 6
PepsiCo, Inc. Corporate Net Sales ($000s)

Beverages
Snack Foods
Restaurants
Pizza Hut
Taco Bell
KFC

1991

1992

1993

6,915.2
5,250.1
7,126.9

7,605.6
6,132.1
8,232.3

8,638.2
7,026.8
9,355.7

3,258.3
2,038.1
1,830.5

3,603.5
2,460.0
2,168.8

4,128.7
2,901.3
2,325.7

Total

19,292.2

21,970.0

25,020.7

Domestic
International

15,167.8
4,124.4

16,551.0
5,419.0

18,309.1
6,711.6

Total

19,292.2

21,970.0

25,020.7

Source: PepsiCo, Inc. Annual Reports.
Note: Sales data include sales from company restaurants and royalties from franchises (sales from franchises are excluded).

roughly 30 percent of KFC’s total revenues. Profits
grew at a compounded annual rate of 9.2 percent,slightly lower than sales. This was primarily the
result of higher labor, operating, and promotion
costs in the U.S. Despite an increase in 1993 sales,
1993 profits were down 9.5 percent compared to1992. Profits were affected mainly by lower international profits resulting from higher store level
operating costs, higher international administrativeand support expenses, and start-up costs associated with the roll-out of new roasted chicken products in the United States and Australia.

EXHIBIT 7
PepsiCo, Inc. Corporate Operating Profits ($000s)

Beverages
Snack Foods
Restaurants
Pizza Hut
Taco Bell
KFC
Total

1991

1992

1993

863.3
756.7
575.5

798.6
984.7
718.5

1,109.0
1,189.6
778.0

314.5
180.6
80.5

335.4
214.3
168.8

372.1
253.1
152.8

2,195.6

2,501.8

3,076.6

Unallocated Expenses–83.8–130.6–170.1

Total

2,111.8

2,371.2

2,906.5

Source: PepsiCo, Inc. Annual Reports.
Note: Operating profits include profits from company-owned restaurants only.

KFC: Doing Chicken Right in the U.S. Fast-Food Industry

858

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

Slower restaurant growth and lower profits in
the U.S. reflect a variety of factors. First, new,upscale chicken chains such as Boston Chicken and
Kenny Rogers Roasters, have attempted to cut out
a market niche by marketing non-fried chicken
products to higher income consumers. Second,
many sandwich chains have introduced friedchicken and Chicken sandwiches to their menus.
By widening their menus, sandwich chains haveappealed to families who need to satisfy different
family member preferences. Third, all competitors
in the fast-food industry have been under pressure
to lower prices while at the same time improving
menu offerings and service. All of these factors
have made it more difficult for individual KFC
restaurants to increase sales from year to year.
Exhibit 8 shows KFC’s worldwide restaurant
growth during the last eight years. Increasingly,
most of KFC’s new restaurant construction is outside of the United States. Of 304 new restaurants
built in 1993, only 39 were constructed in the U.S.
While international restaurant construction has
grown at a compounded annual rate of 11.2 percent, U.S. restaurant construction has grown at alow 1.2 percent annual rate.

Business Strategy
Before 1986, KFC’s menu offerings were relatively
limited. Its major product offerings were its
Original Recipe and Extra Crispy fried chicken
products. However, by the mid-1980s slowing per
store sales and increased competition among fastfood competitors led KFC to aggressively develop
new products to appeal to a wider variety of consumers. In 1987, Chicken Littles were introduced.
Designed as a snack product, Chicken Littles consisted of a small chicken patty in a small bun. One
year later, KFC introduced its full-size chicken filet
burger. Both products, however, were only modestly successful and ultimately withdrawn from
KFC’s menu. In 1993, KFC introduced a full-size
barbecue sandwich, which has been only modestly
received.
KFC has introduced a variety of other products
during the last four years in order to expand its
consumer base to lunch and snacks. In 1990, Hot
Wings and Spicy Chicken were introduced. In 1992,
Honey BBQ chicken, Oriental Wings, and Pop Corn
Chicken were introduced as limited time offerings
to attract new customers. In October 1993, KFC

EXHIBIT 8
KFC Worldwide Restaurant Growth
Year

U.S.
StoresNew
Builds% TotalInt’lStoresNew
Builds% TotalWorldwide
StoresNew
Builds%Total

1986
1987
1988
1989
1990
1991
1992
1993

4,720
4,814
4,899
4,961
5,006
5,056
5,089
5,128

—
94
85
62
45
50
33
39

71.8%
64.0%
63.1%
62.4%
61.1%
59.6%
58.3%
56.8%

1,855
2,708
2,862
2,987
3,181
3,424
3,640
3,905

—
853
154
125
194
243
216
265

28.2%
36.0%
36.9%
37.6%
38.9%
40.4%
41.7%
43.2%

6,575
7,522
7,761
7,948
8,187
8,480
8,729
9,033

—
947
239
187
239
293
249
304

100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%

Source: PepsiCo. Inc. Annual Reports.

873

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KFC: Doing Chicken Right in the U.S. Fast-Food Industry

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

introduced its Rotisserie Gold chicken nationally.
The introduction of Rotisserie chicken received atremendous response. During the fourth quarter of
1993, KFC reported a 10 percent increase in sales inrestaurants which offered the new roasted chicken
product.
In response to competition from sandwich
chains and the consumer trend toward increased
value, KFC made the decision to test an all-youcan-eat buffet in one of its franchises in Arkansas in1991. The buffet, which was offered for $3.99(lunch) and $4.99 (dinner) (1994 prices), offered up
to 30 food items including fried chicken, biscuits, asalad bar, and vegetable bar. The buffet was introduced into 675 units by the end of 1992. Ultimately,
KFC plans to introduce the buffet into about onehalf of its domestic restaurants.
KFC’s image as a fried chicken chain and theolder age of many of its restaurants led to a new
campaign to upgrade its restaurants in the mid1980s. By 1994, over three-fourths of all KFC restaurants in the U.S. had been refurbished. In addition,
KFC outfitted many of its restaurants with additional seating and drive-thrus, in order to accommodate increased consumer demand for bothindoor seating and faster take-out service. In 1986,
about three-fourths of KFC’s sales were take-out.
Take-out sales had fallen to about one-third of all
sales by 1988 and have continued to fall since thattime. In order to help dispel KFC’s image as a friedchicken chain, Kyle Craig made the decision in1990 to change the restaurant chain’s official logo
from Kentucky Fried Chicken to KFC. While theold Kentucky Fried Chicken signs can still be seenin KFC’s older restaurants, its newer restaurants
have signs that carry only the initials “K F C”
accompanied by the profile of Colonel Sanders,
KFC’s founder.
One of the most difficult problems for KFC in1994 was distribution. Because KFC’s domestic
restaurant construction program has slowed during, the last five years, KFC has searched for new
ways to grow the KFC brand domestically. When
asked how KFC planned to grow its brand in the
future, Kyle Craig commented:

859

You know that McDonald’s is still building a couple
hundred restaurants a year, but we are not building a
lot of traditional (free-standing) restaurants. But thebusiness is changing. It is very expensive to build
today, for us it is about a million dollars per restaurant. The returns are not what they once were so as
opposed to going in and building traditional million
dollar restaurants, we are saying, hey, does it makemore sense to go into other types of distribution centers; does it make sense to set up a delivery unit that
may be much less expensive a way to expand both ourpoints of distribution and consumer access to our
products? I think we will find much more financially
viable ways to grow the brand and we are trying to do
it both for ourselves and for our franchisees.

Franchising Problems
KFC’s ability to expand its distribution base waslimited by an on-going feud with its franchisees.
Through the mid-1980s, KFC’s franchisees had
been allowed to operate with little interference
from KFC management. This “hands-off” approach
could be traced back to the 1950s when Harland
Sanders sold his first franchise, and resulted mainly
from the Colonel’s lack of interest in franchiseaffairs. Over time, franchise independence becamea deeply rooted part of KFC’s corporate culture. As
a result of their independence, and the control they
had over their day-to-day operations, KFC franchisees developed a strong devotion to both theColonel and the KFC organization.
When PepsiCo acquired KFC in 1986, one of its
first steps was to renegotiate a new contract which
would give it more control over franchises’ menu
offerings and operations, allowed it to close unprofitable franchises, and allowed it to take over franchises that were poorly managed. Such actions wereviewed as critical to improving product and service
consistency and improving KFC’s QSCV (quality,
service, cleanliness, value) image. In addition, KFC
believed that future growth in the KFC concept
would come from smaller KFC units in shopping
malls, colleges, and hospitals. In many cases, thismeant that KFC would have to build units withinclose proximity of existing KFC franchises.

KFC: Doing Chicken Right in the U.S. Fast-Food Industry

860

CASE 22 KFC: Doing Chicken Right in the U.S. Fast-Food Industry

The last contract between KFC and its KFC’s
franchisees, prior to KFC’s acquisition by PepsiCo,
was negotiated in 1976. This contract stipulated
that KFC would not build any KFC unit within 1.5
miles of an existing franchise. This stipulation was
designed to protect existing franchises from lost
sales to new KFC units built within these 1.5 mileprotection zones. The 1976 contract also gave franchises power over supplier sourcing and the rightof automatic contract renewal. The new contract
would eliminate the 1.5 mile protection zone, eliminate automatic contract renewal, and increase
PepsiCo’s control over supplier sourcing. In 1989,
the Association for Kentucky Fried Chicken
Franchises (AKFCF) sued KFC over its new contract. In December 1993, KFC guaranteed that theywould adhere to the 1.5 mile limit for seven months
and Kyle Craig personally pledged not to open
new full-service restaurants, home delivery, or
take-out units within 1.5 miles of an existing franchise. However, the law suit remained unresolvedin a Kentucky federal court in late 1994.
CONCLUSION
KFC faced a variety of problems and issues in 1994.
Still the world’s largest chicken chain and thirdlargest fast-food chain, it continued to grow at ahealthy rate worldwide. It also continued to control
one-half of all chicken chain sales in the U.S. andhad one of the world’s most recognized brands. In
addition, its new rotisserie chicken and buffet had
been tremendously successful in those markets
where they had been introduced. However, while
prospects for continued growth internationallywere bright, continued growth within the domestic
market was threatened by a number of industry
and societal trends. Competition from sandwich
chains and new chicken chains, as well as consumer demand for a wider variety of menu offerings, forced KFC to reanalyze its product strategy.
At the same time, KFC and other fast-food competitors were forced to improve product offerings
and to serve their product faster and with better
service to consumers who increasingly demanded
greater value for their money. Asked to comment
on KFC’s situation, Kyle Craig responded:
We are in a fairly complex business with lots of agendas. Our franchises want one thing done, PepsiCo
wants something else done, and our field operators
want something done differently than the company.
There has to be a central location where key decisions
are made and a vision for the business is established.
I think I, or another leader, has to be that visionary.
Our number one issue is our ability to handle change.
We have introduced the Rotisserie product and that’s
given our franchises some confidence, but this franchise situation has been very difficult. If we canresolve that in the next year or two we really could
operate as a unified system as opposed to 3,000 franchise stores going one way and 2,000 company storesgoing another way. People do see us now as doing abetter job of meeting their variety needs and recognizethat we are not solely dependent on fried chicken, butthey don’t yet see us as contemporary, as we would
like them to in the long-term. This is particularly trueof people who do not presently patronize KFC.
Today’s consumer is less loyal, more value driven, andmuch more information based. The only thing that I
am sure of is that tomorrow’s consumer is going to beeven more demanding.

875

Lonetown Press

L

onetown Press was opened in January 1992 toprovide a highly personalized contract printing
service to artists and others devoted to handprinted lithography as a fine art medium. Foundedby Randy Folkman, a master printer with eight
years of experience, the company was capitalized
for about $30,000 of Randy’s money, which wasused for the purchase of a Griffen Press and printing materials and supplies. Lonetown was locatedabout 40 miles north of New York City in Fairfield
County of southwestern Connecticut.
Randy planned to operate as a one-man shop, atleast for the first year. As a master printer and occasional artist in his own right, he had worked at
Redvale Press, a private printing studio, for thetwo years prior to founding Lonetown. Before that,
he was employed for two years at a studio, in New
York City and for four years at a print shop in
Houston, Texas. While in Texas, he completed his
hand printing apprenticeship under the supervision of a Tamarind-trained master printer.
Randy wanted to work primarily at his printing
and was especially interested in working with upand-coming artists. Over the long term he wanted
Lonetown to become recognized as a quality,
highly personalized shop. At the same time, Randy
hoped to pay himself fairly and make some profits
as well as learn more about how prints are distributed. Otherwise, he did not want to become overly
involved in what he saw as the business or “financial” side of Lonetown.
With the founding of Lonetown Press, Randy
realized he would need to determine what price tocharge and how to quote prices. He contacted an
accountant with whom he shared his backgroundand knowledge of the business.

41
CASE 231616
HAND-PRINTED LITHOGRAPHY
Artists are attracted to hand-printed lithography
because of its mystique, the quantity of images thatare produced, and the technical results the medium
offers. Lithographs are created by drawing on astone or plate with pencils, crayons, or other materials with which artists are familiar. With a variety
of surfaces and materials available, the medium is
versatile for artists who can easily visualize fromthe drawing the resulting prints or graphics, as
they are called in the trade. The development ofhand-printed lithography in the United States is
described by Antreasian and Adams:
Although the principles of lithography are in essence
simple, the technical processes involved in the printing of fine lithographs are exceptionally complex. For
this reason, artists wishing to make lithographs have,since the early years of the nineteenth century, worked
in collaboration with master lithographic printers:
Gericault with Hullmandel and Villain, Redon with
Blanchard and Clot, Picasso and Braque with Mourlot
and Desjobert.
Any lithograph printed from a stone or plate conceived and executed by the artist is an original lithograph, whether it is printed by the artist himself or bya collaborating printer. Until late in the nineteenth
century, lithographs were rarely signed in pencil, andindividual impressions were seldom numbered. Since
that time, however, it has become customary for
artists to sign and number each impression, attestingin this way both to the authenticity of the print and toits quality. Often, prints made in a lithographic workshop also bear the printer’s bindstamp or chop. Like
the artist’s signature, this mark attests to the quality of
the work.
Original lithographs are normally printed in limited editions, although the size of the edition may varyThis case was prepared by Professor Fred W. Kniffin of the University of Connecticut, with the assistance of Amy Erlanger, as abasis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright ©
1993 by Professor Fred W. Kniffin.

861

877

878

Lonetown Press

862

CASE 23 Lonetown Pressover a wide range. In the United States, artists’ editions characteristically range from 10 to 100; in
Europe, editions of 200 or more are not uncommon.
The limiting of editions is due not so much to technical considerations as to intention. The artist may wish,
as a matter of principle, to limit editions of his work,or he may wish to avoid an undue commitment oftime or money to a single edition. . . .
By 1960, lithographic workshops had all but disappeared in this country. There were few master printers, and it was only with the greatest difficulty that an
artist might engage himself in lithography. As a result,few of the major artists working in the United States
made lithographs during the 1940s and 1950s.
In 1960, Tamarind Lithography Workshop wasestablished in Los Angeles under a grant from theFord Foundation for the primary purpose of providing a new stimulus to the art of the lithograph in the
United States. Since 1960, a number of professionallithographic workshops have opened throughout thecountry, many of them staffed by artisans trained at
Tamarind. The lithographic workshops maintained atart schools and university art departments have likewise increased in number and, under the influence of
the Tamarind program, have greatly improved inquality. Now, in the United States as well as inEurope, the artist again finds it possible to work incollaboration with skilled printers, and in these circumstances American Lithography has enjoyed anotable renaissance.

While hand-printed graphics drawn by an artist
were considered original art, they were priced
lower than original canvasses and were therefore
generally more affordable. With lower prices thancanvasses, the sales of hand-printed lithographs
held up well in periods of recession when sales of
the total art market were predictably slower.
Prices for hand-printed lithographs varied from$30 to $10,000 for modern prints; older prints of oldmasters were even higher. An artist whose canvasses commanded $20,000 might sell his handprinted graphics for $1,000 each. Typical prices for
22 × 30 inch prints ranged anywhere from $150 to$500 depending upon the artist, printer, and where
the prints were purchased.
Consumers acquired prints from art galleries,
publishing houses, and auctions and from otherindividuals such as dealers, interior decorators,
artists, and printers. Corporate art buyers often
purchased graphics for their headquarters andother executive office buildings.
The publisher of a print is anyone who pays forthe printing costs of an edition. Publishers may begalleries or publishing houses, or individuals suchas dealers, artists, or printers. When not the artist,
the publisher pays the artist a flat fee and, after
paying the printing costs, owns all the prints except
those few retained by the printer and the artist.
In response to an inquiry from Lonetown’s
accountant, a master printer stated that, in his experience, graphics or print galleries operated on a 50
percent markup from their selling price to the consumer. Of the costs that galleries paid publishers forprints, he estimated that artists’ fees accounted for
25 percent and printing costs another 25 percent
with the balance going to publishers. On this basis,a print offered by a gallery to retail at $2,000 to thebuyer entailed total printing costs of $250.
THE INDUSTRY AND LONETOWN PRESS
The hand-printed lithography business in the
United States had, perhaps, a half dozen major print
shops that generally did their own publishing.
These major shops usually employed four or moreprinters, while the balance of the industry of 50 or
so shops were one- or two-printer operations. There
were probably fewer than 60 print shops in the U.S.
accepting hand-printed lithography work in 1992.
Recent price schedules of the Tamarind Instituteand two printing companies are shown in Exhibits
1, 2, and 3.
For at least some of their business, most shops copublished. This involved a negotiation of charges inwhich the printer accepted some number of copiesof the artist’s edition in exchange for the printer’s
services. For example, Lonetown Press might retain
10 to 25 copies of a 50-print edition in lieu of thecosts for printing services rendered. In this situation, the artist would not incur an outlay for printing and Lonetown would assume responsibility for
selling the graphics to compensate for the printing.

879

Lonetown Press

863

CASE 23 Lonetown Press

EXHIBIT 1
Typical Prices for Lithographic Printing
Effective 1 January 1992
The total cost of an edition is the base charge, plus the impression charge, plus surcharges (if any), plus the cost of paper.
Paper will be billed at the most recent price paid by Tamarind with an allowance for care and shipping. The dimensions of a lithograph (paper size) are also a factor in determination of price. Tamarind’s prices for printing are established in four groups, according to dimensions, and show the maximum size allowed for that price category. Prices
for lithographs larger than 30 by 40 inches will be estimated upon request.
Base Charges
The base charges (per edition) include the services of Tamarind’s professional staff, all costs related to graining ofstones or plates, lithographic materials used in making drawings, materials and papers used in proofing, suchproofing as is reasonable and necessary to arrive at a bon à tirer impression, the printing of the first 10 proofs and/or
impressions (however they may be designated), curating services, tissues, and wrapping materials (packing forshipment, if desired, is billed separately).

One colorSize
15 by 22 in.
38 by 56 cm.

Size
19 by 25 in.
49 by 64 cm.

Size
22 by 30 in.
56 by 76 cm.

Size
30 by 40 in.
76 by 102 cm.

$140.00$200.00$240.00$ 340.00

Two colors

320.00390.00450.00580.00Three colors

450.00530.00600.00750.00

Four colors

560.00640.00710.00900.00Five colors

660.00740.00820.001,050.00

Six colors

760.00880.00930.001,200.00

Impression Charges
The first 10 proofs and/or impressions are included in the base charge; no charge is made for proofs and/or impressions rejected because of technical imperfections, or for proofs or impressions that become the property of the collaborating printers or of Tamarind. The following charges apply to all other impressions, however they may bedesignated:
Size
Size
Size
Size
15 by 22 in.
19 by 25 in.
22 by 30 in.
30 by 40 in.
38 by 56 cm.
49 by 64 cm.
56 by 76 cm.
76 by 102 cm.
One color$ 6.00$ 7.00$ 8.00$10.00

Two colors

12.00

14.00

16.00

20.00

Three colors

18.00

21.00

24.00

30.00

Four colors

23.00

25.00

27.00

33.00

Five colors

27.00

29.00

31.00

36.00

Six colors

31.00

33.00

35.00

39.00

880

Lonetown Press

864

CASE 23 Lonetown Press

EXHIBIT 1 (continued)
Surcharges
Stone charges:

Technical processes: At sizes below 22 by 30, there is no price differential for work on stone.
Surcharges for stone begin at 22 by 30 inches ($40.00) and increase proportional to size; thesurcharge for use of our largest stone (36 by 52 inches) is $165.00.

Blended inking:

A surcharge will be added for use of blended or split inking. The charge is determined by
the complexity of the blend; it will never be less than 10 percent and may be up to double
the impression charge.

Curatorial services:

When the design of a print requires special curatorial services (as examples, tearing to atemplate, cutting to irregular shapes, applying metallic leaf, etc.), surcharges will be added
proportional to the time required.

Technical processes:

Use of all standard lithographic drawing materials and processes is included in the basecharge, including direct drawing on stones or plates or through transfer methods. For use ofphotographic processes and such special techniques as image reversal, printing on chinecolle, etc., surcharges will be added proportional to the time required.

ExamplesThe cost of editions of 50 impressions of single-color lithographs at sizes 19 by 25 inches and 22 by 30 inches printed
from stone on Rives BFK, would be calculated as follows:
19 by 25 in.

22 by 30 in.

Base charge
Surcharge for stone
Impression charge (50%*)
Paper charges$200.000
350.00*50.00$240.00
40.00
400.00*50.00

Total:$600.00$730.00*This figure may be adjusted depending upon the number of trial and/or color trial proofs.

Abandoned Projects
On occasion, an artist reaches a decision to abandon a project without printing an edition. In that event, Tamarind
will refund a portion of the base charges, as follows:
1.

If the project is abandoned prior to processing and proofing of the plates and/or stones, Tamarind’s total
charge will be the sum of $100.00, plus any surcharges for stone, plus $25 for each metal plate (or small stone)
used. The remainder will be refunded or applied to another project.

2.

If the project is abandoned during or at the end of a first proofing session (a session in which all of the printing
elements are proofed, one upon another), Tamarind’s total charge will be the sum of the surcharges for stone,
and 75 percent of the base charge. The remainder will be refunded or applied to another project.

3.

If a project is abandoned at any point beyond the end of the first proofing session (as defined above), the fullbase charge will be paid.
PAYMENT OF ONE-HALF THE TOTAL ESTIMATED CHARGESIS DUE BEFORE WORK IS BEGUN.
THE BALANCE IS DUE UPON DELIVERY OF THE EDITION.

881

Lonetown Press

CASE 23 Lonetown Press

EXHIBIT 2
Vermont Graphics, Inc.*EXHIBIT 3
Oklahoma Print Shop*

Price List
September 1990
Proofing Charges (price including all materials)

Price List
For 22” × 30” Size
50 Prints
June 1992
Proofing Charges

Colors/Runs

15 × 22

22 × 30

29 × 41

One
Two
Three
Four
Five
Six
Seven
Eight
Nine
Ten

$ 78.25148.50219.00289.00359.00516.00600.00684.50768.75853.00$ 117.20
219.00320.25422.00535.50750.00872.00828.001,015.65
1,237.50$ 156.25
281.25406.25531.25656.25937.501,087.50
1,237.50
1,387.50
1,537.50

Printing Charges per Impression
One
Two
Three
Four
Five
Six
Seven
Eight
Nine
Ten

$ 7.75
14.50
21.00
27.75
34.50
49.00
57.00
65.18
73.20
81.00

$ 10.25
18.50
27.00
35.50
52.75
62.70
72.75
82.80
93.00
103.00$ 13.30
23.70
34.30
44.80
55.30
79.00
91.50
103.25116.75129.50*Disguised name.

A variation on co-publishing occurred when printers gave discounts in exchange for a part of the edition. These types of agreements were believed to beparticularly appealing to up-and-coming artists towhom Randy wished to cater.
Lonetown’s accountant had developed estimatesof both annual and per job costs for the shop, since
she was thinking of adding a markup to labor
and/or material costs as the basis for creating a
price schedule. Randy, however, was somewhat
skeptical of this approach because he had concerns
about pricing too high or too low in relation tocompetition. He wanted to price high enough to betaken seriously, but low enough to attract initial

865

Colors/Runs
One
Two
Three
Four
Five
Six
Seven
Eight
Nine
Ten

$120.00
170.00235.00285.00350.00420.00495.00575.00665.00735.00Printing Charges per Impression
Colors/Runs
One
Two
Three
Four
Five
Six
Seven
Eight
Nine
Ten

$ 7.20
10.80
16.80
21.60
25.20
28.80
32.40
36.00
39.60
43.20

business. The accountant figured business expenses
would run $11,000 annually, not including Randy’ssalary needs of $30,000 per year.
Lonetown Press Annual Expenses
Public relations (personal entertainment)
Advertising
Travel expenses
Depreciation
Lawyer & accountant fees
Insurance, electricity, heat
Property taxes
Total$ 3,000
2,000
2,000
1,300
1,000
1,000
700
$11,000

882

Lonetown Press

866

CASE 23 Lonetown Press

In addition to the master printer’s labor hours,
cost estimates that could be directly traced to eachjob were:
5-Color—50 Print Edition
Item

Cost

Standard paper
Ink
Printing plates
Various chemicals

$ 175
10
95
20

Total costs per job$ 300

The most comfortable edition size for Lonetown
Press was 50 prints; and editions over 200 prints
were definitely less desirable. With editions of 150
and over, the master printer in a one-person shop
often encountered some tedium, which could
adversely affect the quality of his work.
At Lonetown, the largest acceptable print was
30 × 40 inches, since this was the maximum sizethat the Griffen Press could accommodate. Smaller
paper sizes presented no problems.

Although four to five colors appealed most to
Randy, the number of colors in a print was not ofgreat importance. However, since each color in a
print must be printed separately, printing additional colors required additional printing time.
A typical or average job for Lonetown might bea 5-color 22” × 30” edition of 50 prints. Randy feltthat he could produce 25 such editions per year, or
about one such edition every two weeks. Working
at this rate would leave him barely sufficient timeleft over to consult with artists and galleries and do
his bookkeeping and purchasing.
Randy felt confident about the long-term successof Lonetown; however, his immediate concern was
quoting prices on several pending inquiries. He
had decided that his price schedule should haveseparate prices for proofing and printing, prices forthree sizes (18” × 24”, 22” × 30”, 30” × 40”) andprices for one to 10 colors. In addition, he wanted
his price schedule to, in some way, reflect his preference for printing smaller editions.

Middlesex Mutual Assurance
Company

42
CASE 24M

iddlesex Mutual Assurance Company (MMA)
was a small 150-year-old property casualty
insurer that did 95 percent of its business in Connecticut. It sold insurance strictly through the independent agency system. About 25 percent of theagents in Connecticut represented MMA. MMA’s
forte was homeowners’ insurance; it was the market leader in this line of insurance with approximately 10 percent of the market.
The key success factor for MMA had been excellent rapport with its independent agency force:
agents enjoyed personalized service from company
personnel who knew the Connecticut market quite
well. MMA’s main weakness was that it essentiallyoffered only homeowners’ insurance; it did notparticipate in any life or health insurance. However, these markets were of crucial importance toindependent agents.
Recently, the coverage line for homeowners’
insurance had been aggressively sought after byother insurance companies, and MMA was not confident that it could maintain market leadership in
this line. Competition was becoming intense fromsectors within and outside the independent agency
system.
In the fall of 1990, Mr. Roger Smith, executive
vice president of marketing at MMA, wondered
what changes (if any) MMA could make in its distribution system to help ensure continued market
leadership in the homeowners’ insurance line.

The industry has been very profitable for mostparticipants, particularly during the 1983–1987
period. The average ROE for the property casualty
insurance industry during this period was 18.5
percent versus 14 percent for Standard and Poor’s
Top 500. The tremendous profitability in the industry for this time period can be explained as follows. Operations for 1980 and 1981 produced anunderwriting loss; that is, companies paid out
more in claims and operating expenses than theyreceived in premium dollars. Because of thisunderwriting loss, companies sought and received
large rate increases, which greatly increased premium income. At about the same time, interest
rates on investable funds rose dramatically as aresult of the general economic conditions that prevailed at the time. Thus, insurers not only received
a large increase in premiums but were able to earnvery attractive rates of return on the premiums
they collected. Insurers could earn investment dollars on premiums until the premiums were actually paid out in claims. Often, claims were not paid
until many years after premiums had been paid.
This was particularly true in commercial lines
where claims were not realized for many years(consider product liability where faulty parts
cause an airplane to crash five years after they
have been installed).
Naturally, the increase in premium levels
and windfall investment income greatly increased insurers’ profits. Increased profits led toincreased capacity in the industry for two reasons:

INDUSTRY BACKGROUND
Financial

1. Insurers, who were making high profits, wanted toprovide more insurance coverage.
2. High profits attracted new entrants into the business.

Property casualty insurance has characteristically
been a good, healthy business to be in. Premium
growth has been improving steadily since the1950s, as shown in Exhibit 1.

Adequate insuring capacity to support society’s
needs was surpassed by an overcapacity, a “glut,”in effect, of available insurance, as shown in
Exhibit 2.

This case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

867

883

884

Middlesex Mutual Assurance Company

868

CASE 24 Middlesex Mutual Assurance Company

EXHIBIT 1
Middlesex Mutual Assurance Company
Property Casualty Insurance Premium Growth, 1972 to 1988

Source: Best’s Aggregates and Averages.

At first, companies could sustain an underwriting loss but still make a profit because of investment income on premium dollars. However, pricecutting continued to a point where investment
income could no longer offset huge underwriting
losses, and companies began to lose money. Worse,interest rates began to decline rapidly with the
improving overall economy. By early 1990, many
insurers were on the verge of becoming financiallyinsolvent. In order to remain solvent, many insurers began to raise premium rates; others wereforced to cancel many policies or provide more
restrictive coverage.
In general, the commercial lines market wasmost subject to the volatility described above—risks in commercial lines generated larger premiums and more investment income. Personal lines
pricing, profitability, and availability were much
more stable during this time.

Distribution
The insurance industry employed two basic meansof distribution: independent agents and direct writers. Independent agency companies essentially
acted as wholesalers—their insurance was marketed by agents who represented their companies
as well as competitors. Direct writers, on the other
hand, employed their own sales forces, or marketed their products through print or television
media. (Note: Insurance for very large corporations
is typically supplied by brokers who operate inmuch the same way as independent agents except
that, unlike an agent, a broker represents the client
rather than the insurer.)
Agency companies have been in business since
before the turn of the century, whereas most direct
writers gained prominence after World War II. In
their traditional roles, agents, who were thought of885

Middlesex Mutual Assurance Company

CASE 24 Middlesex Mutual Assurance Company

869

EXHIBIT 2
Middlesex Mutual Assurance Company
Growth in Policyholders’ Surplus, 1972 to 1988

Source: Best’s Aggregates and Averages.

as professionals similar to lawyers or accountants,
would tailor programs of insurance to the needs oftheir clients. Direct writers approached insurance
as more of a commodity; personal service was sacrificed for low price. Direct writing lent itself wellto the personal lines business (i.e., auto and homeowners’ insurance) because personal lines coverages are less complex and the personal lines
customer generally does not require the degree ofservice that a commercial customer requires.
During the past 20 years, agents tended towardcommercial lines business—an area they continued
to dominate. Direct writers had advanced dramatically in the personal lines. To illustrate the point,
Exhibit 3 shows the direct writers’ share in the
homeowners’ business.
Direct writers did not generally fare well in commercial lines. Their market shares remained low,
and they were much less profitable in this area thanagency companies. Most of their growth in commercial lines came from very small, unsophisti-

cated accounts. However, the traditional roles ofthe direct writer and agency company had beensomewhat changed, mainly for these reasons:
1. Agency companies were placing less emphasis oncommercial lines. The chief factor was the terrible
financial results they recently experienced in commercial lines. Their managements were under pressure to improve operating results, and emphasis on
personal lines was the easiest way to accomplish thesame. Further, as shown in Exhibit 4, the commerciallines market available to the independent agent was
shrinking. On the other hand, the personal lines represented an area of potential growth.
2. Direct writers had come a long way in improving
their level of service to the client. Direct writers had
invested a great deal of time and effort in streamlining their operations. In some cases, direct writers
provided service equal to or better than the level provided by agency companies.
3. Direct writers had begun to pursue commercial lines,
especially small businesses. Many small businessowners viewed insurance as a commodity; indeed,886

Middlesex Mutual Assurance Company

870

CASE 24 Middlesex Mutual Assurance Company

EXHIBIT 3
Middlesex Mutual Assurance Company
Market Share Trends in Homeowners’ InsuranceMarket Share
Year

AgencyDirect

1972

72%

28%

1978

59%

41%

1982

54%

46%

1983

53%

47%

1985

50%

50%

Source: Best Executive Data Service.

there was little coverage difference in small businessinsurance, and the required service level was similar
to personal lines (i.e., relatively low). Further, thesmall business was becoming highly important to the
U.S. economy: over 600,000 new businesses werestarted each year. According to Naisbitt, author of
Megatrends, the United States would be in an “entrepreneurial explosion” to the end of this decade. The
implication was that there will be no shortage ofsmall commercial lines prospects for some time tocome. In order to preserve their dominance in thecommercial lines, agency companies would need to
become adept at handling small businesses that
required commodity-oriented insurance.

It was generally conceded that the direct writers
enjoyed a 10 percent distribution cost advantage

over the agency companies. This advantage wasdue to the fact that the direct writers, owing to lackof a “middleman,” were able to save on business
distribution costs because their business systems
were more streamlined. Further, they enjoyed amore efficient allocation of tasks: the producer
spent time selling, while the company’s wholesale
function was to support the salesperson. Withagency companies, the agent performed a great
many activities (other than selling) that could be
performed more efficiently at the company level,albeit at a less personalized level (e.g., claims handling, billing, etc.).
The agency companies realized that theywould have a tough task invading the personallines market and protecting their dominance inthe small business commercial lines market.
Significant portions of each of these markets
demonstrated the belief that insurance is a commodity. Of necessity, the winner in a commodity
market is the contestant who can offer the lowest
price and still make a profit, and the direct writers generally had a 10 percent cost advantage
with which to work.
Agency companies were observed taking the following actions in the personal lines and small business commercial lines markets:
1. Agency companies had halted the rapid advance ofthe direct writers by pricing under costs. Such action
could not be sustained indefinitely.

EXHIBIT 4
Middlesex Mutual Assurance Company
Market Shares by Distribution Channel in the Commercial Lines Market
Market Share
Year

Risk
Retention

Captive

Brokers

Independent
AgentsDirectWriters

1980

10.2%

2.3%

26.4%

44.5%

16.6%

1982

12.1%

4.6%

21.9%

45.0%

16.4%

1985

13.9%

7.2%

23.0%

40.2%

15.7%

1995*

15.0%

11.0%

24.0%

35.0%

15.0%

Source: Best Executive Data Service.
*Data for 1995 are projections.

887

Middlesex Mutual Assurance Company

CASE 24 Middlesex Mutual Assurance Company

2. Efforts were made to improve efficiency of independent agency distribution channel by:a. Increasing emphasis on automation. Many companies pursued electronic interface with theiragencies; however, agents represent several companies, and they must interface with each one
separately, which drastically decreases efficiency
and increases agents’ expenses. Lately, consulting
firms have emerged, whose purpose is to standardize company/agency interface so that anagency can interface with all the companies it represents. This would substantially lower costs andenable companies to more effectively competewith direct writers. However, at the time of writing this case, the standardized system had not
enjoyed widespread use.
b. Experimenting with alternative distribution systems. Hartford Insurance Group began marketing
auto insurance directly to the consumer; they
directly solicited consumers who were membersof the American Association of Retired Persons.
Other companies actively pursued relationships
or joint ventures with banks.
c. Beginning to pay agents lower commissions. In
return for accepting lower commissions, agentswould need to perform fewer administrative andservice tasks. The company would largely assume
these tasks. Agents would spend more time selling rather than servicing.
d. Dealing with fewer agents. Economies of scale
could be realized if companies could deal withfewer agencies, with each agency producing
higher amounts of premium.
e. Introducing product innovations. Several insurers developed combination auto-homeowners’
policies with broadened coverage. The slightly
broadened coverage altered the commodity
nature of the product. Further, an account withboth auto and homeowners in one policy was lessexpensive to sell and service. Direct writers had
yet to mimic this product. Other innovations
included premium payment by credit cards.
f. Using sophisticated marketing techniques.
Agency companies woke up and realized that
consumers would not beat a path to their door tobuy insurance. Companies started to mimic andimprove some of the direct writers’ effective promotion and pricing strategies.

871

As if the threat from existing direct writers wasn’t
enough, a significant threat was posed from newentrants, chiefly banks. Banks have intimate contact
with all homeowners and automobile owners, notonly because most people have checking and savings
accounts, but because people utilize the bank forauto and homeowner mortgages and loans. Attitude
surveys have shown that the average consumer
places more credibility in a banker’s advice than in
an insurance agent’s advice. Banks would possess anenormous competitive advantage because they see alarge audience of insurance prospects on a daily
basis. Further, as Exhibit 5 shows, the public as awhole would be predisposed to buy insurance froma banker if the purchase of insurance would enhance
the likelihood of obtaining a loan.
Further trends affecting the industry were (a) the
public’s perception that it understood more about
insurance than previously and (b) the increased
level of information available to consumers.
According to the Public Attitude Monitor, people are more aware of what insurance is and does.
(See Exhibit 6.) More-informed people might rely
less on the advice of an agent and be attracted tocommodity-like pricing.
In regard to level of information, the day is not
far off when people will have access to insurance
pricing over personal computers at home.
To the extent that people are familiar with insurance and view it as a commodity, pricing will playa more important role in determining where insurance is purchased.
MMA PERSPECTIVESMMA had been extremely profitable, althoughindustry performance as a whole had deteriorated
markedly during the last few years. The homeowners’ insurance business (MMA’s forte) had beenmuch more stable than commercial lines. Further,
MMA had been operating in an unusually favorable competitive environment for these reasons:
1. Direct writers were not as strong in Connecticut (themain geographic area in which MMA operated) as
they were on a countrywide basis. (See Exhibit 7.)

888

Middlesex Mutual Assurance Company

872

CASE 24 Middlesex Mutual Assurance Company

EXHIBIT 5
Middlesex Mutual Assurance Company
Public Perceptions Regarding Relationships between Financial Transactions by Banks and Insurance Companies
All Respondents
Strongly
Agree

Agree

Probably
Agree

Probably
DisagreeDisagreeStrongly
DisagreeNo
Answer

If banks sold auto insurance,
people would be expected tobuy auto insurance there inorder to get an auto loan.

6%

25%

24%

14%

23%

6%

1%

If auto insurance companies
owned banks, people would be
expected to finance cars there inorder to get or keep auto
insurance coverage.

5

28

26

15

20

5

1

If banks sold home insurance,
people would be expected tobuy homeowners’ insurance
there in order to get a mortgage
loan.

5

26

27

16

20

5

1

If home insurance companies
offered mortgage loans, people
would be expected to getmortgages there in order to get
homeowners’ insurance.

5

24

29

16

20

5

1

Situation

Number = 1.516
Source: Public Attitude Monitor, December, 1989.

Clearly, MMA’s homeowners’ insurance businesshad yet to be subjected to the degree of direct writererosion exhibited in other areas of the country.
2. Despite the agency companies’ dominance in theConnecticut personal lines market, most of their marketing thrust was directed toward commercial lines.
Agency companies were not particularly aggressivein personal lines; they had really been asleep inregard to personal lines and were merely resting on
their laurels.

Due to the relative weakness of direct writers inConnecticut and apathy on the part of agency companies, MMA had thrived and become the market
leader in the homeowners’ insurance business,with a 10 percent market share. However, thefavorable competitive environment enjoyed by
MMA could deteriorate for the following reasons:

1. Increased competition— In addition to the growing
threat posed by direct writers and new entrants,
agency companies could begin to emphasize personal lines coverage instead of commercial lines coverages. Agency companies were awakened from theirslumber and were using sophisticated and aggressive marketing techniques to obtain homeowners’
insurance. Profitability in the homeowners’ insurance line was expected to deteriorate rapidly as competition intensified.
Of special concern to MMA was the degree ofleverage that the large agency companies had over
MMA agents (keep in mind that agents are independent and represent several companies). Large companies usually offer a full line of insurance services totheir agents: personal lines (including personal auto),
commercial lines, life and health insurance, andfinancial planning services. In order for independent889

Middlesex Mutual Assurance Company

CASE 24 Middlesex Mutual Assurance Company

873

EXHIBIT 6
Middlesex Mutual Assurance Company
Percentage of Men and Women Saying They Consider
Themselves Well Informed about Auto Insurance

name, most agents were highly independent innature, and did not take kindly to insurance companies dictating business practice to them. However,agents were under a great deal of competitive pressure, and many had no choice but to submit to thedemands of large full-service companies.
2. Consumer trends— There was increasing evidence
that personal lines coverages were becoming viewed
as more and more of a commodity, especially among
the middle and lower socioeconomic classes. These
people could be expected to seek out the lowest
available price. As mentioned earlier, those persons
wanting low price would be aided in the future byincreasing access to information, probably by way ofcomputer terminals.
3. Distribution— MMA did business exclusively
through independent agents. The viability of theagency system, especially in personal lines, wasbeing severely challenged by direct writers and newentrants. As previously mentioned, many companies
weren’t tying themselves directly to the fate of the
independent agency system; many were beginning todevelop alternative distribution mechanisms.

Source: Public Attitude Monitor, March 1990.

MMA corporate culture strongly opposed any
experimentation with an alternative distribution
system. The reasoning was simple. MMA was nota full-service company; it essentially offered only
homeowners’ insurance. MMA was viewed byagents as a nice company to represent but mostoften wasn’t perceived as a bread-and-butter company. Other companies would be very happy towrite an agent’s homeowners’ insurance book ofbusiness, albeit at a slightly lower service level.
Because MMA was not an essential company torepresent, agents could cease doing business with
MMA without jeopardizing the viability of theirown operations. Further, one of MMA’s key success factors was its excellent rapport with agents.
To damage this rapport was viewed as a serious
mistake.
As previously mentioned, larger companies wereactively reducing the number of agents throughwhich they wrote business and were demandingthat their remaining agents place higher amounts ofpremium with them. MMA executives believed thatlarge companies, with their large overheads, could
not economically service the small agent. MMA, on

agents to survive, they needed to have all of these
services available to their clients. Large agency companies realized how important they were to agents,
and they also realized that their agents were givingmuch homeowners’ insurance business to MMA.
Homeowners’ insurance was now recognized as aprofitable line, and companies became upset when
agents were placing homeowners’ insurance with
MMA, only to place the less desirable lines of business with them. Many companies offered MMA
agents lucrative deals for books of MMA homeowners’ insurance business. Others threatened to terminate their relationship with MMA agents unless thecompanies targeted their agents who were also
MMA agents with promotional policyholders (manyof whom presumably had homeowners’ insurancewith MMA) indicating they would receive a 10 percent discount on both the auto and homeowners’
policies if they would place both coverages with
their company.
The “strong-arm tactics” referred to above wereusually resisted by independent agents because they
wished to retain their independence as to the company where they placed their clients. True to their890

Middlesex Mutual Assurance Company

874

CASE 24 Middlesex Mutual Assurance Company

EXHIBIT 7
Middlesex Mutual Assurance Company
Competitive Position of Agency Companies versus Direct Writers
Personal Auto Insurance
1988 U.S.
Market Share1988 CT
Market Share

Agency companies

38.2%

58.0%

Direct writers

61.8%

42.0%

Agency companies

53.7%

74.3%

Direct writers

46.3%

25.7%

Homeowners’ Insurance

Source: A.M. Best Company, A7 reports, 1989.

the other hand, had a strong local presence in Connecticut and could economically service smaller
agents that larger companies could not. Industry
data indicated that there were plenty of small
agents in existence, with new agencies being created every day. These small agencies may not generate enough premium to quench the appetite oflarge companies, but MMA believed that enoughsmall agents would survive and prosper to warrant
consideration as a viable target market for MMA.
In short, Mr. Smith realized that the distributionof homeowners’ insurance could change rapidly,
and this was of great concern to him. After muchdeliberation, he felt that MMA should consider thefollowing alternative courses of action:
1. Do nothing; just continue to sell homeowners’ insurance through independent agents.
2. Continue selling just homeowners’ insurance
through agents but streamline the distribution system by using automation and more efficient allocation of tasks between company and agency.

3. Become a more important market to the agents byadding automobile insurance coverage. Otherwise,business as usual.
4. Become a more important market to the agent byadding automobile insurance, while adding the efficiency measures mentioned in Step 2.
5. Develop direct writing capabilities that would
bypass the agent.

Mr. Smith decided on the following criteria toevaluate potential alternative actions:
1. Action must be of benefit to independent agents;
agent alienation must be avoided.
2. Action must be within reasonable current capabilities
of MMA.
3. Action must ensure short-term growth and viabilityof MMA in the homeowners’ insurance market.
4. Action must ensure long-term growth and viabilityof MMA in the homeowners’ insurance market.

The alternative courses of action and the criteria
by which they were evaluated are summarized in adecision matrix in Exhibit 8.

EXHIBIT 8
Middlesex Mutual Assurance Company—Evaluation of Alternative Actions
Criteria
Action must ensure shortterm growth and viabilityof MMA homeowners’
insurance productAction must ensure longterm growth and viabilityof MMA homeowners’
insurance product

Total

3

2

2

0

7

2

2

3

2

9

4

3

3

2

12

4

3

3

4

14

0

2

0

3

5

1—Somewhat negative
effect2—Neutral effect

3—Somewhat beneficial
effect4—Very beneficial effect

Alternatives
1. Do nothing; continue
to sell just homeowners’
insurance coveragethrough independent agents.

2. Continue selling homeowners’ insurance coverage through independent
agents but streamline
distribution process by useof automation and more
efficient allocation of tasks
between agent and company.
3. Become a more important market to the agent byoffering personal auto
insurance; otherwise,business as usual.
4. Become a more important market to the agent
by offering personal auto
insurance; also increase
efficiency by taking actions
outlined in alternative (2).
5. Develop direct writing
capabilities that bypass
the agent.
Values0—Very negative effectSource: Company records.
MMA executives selected alternative 4; it had the highest score of 14.

Middlesex Mutual Assurance Company

Action must complement
and be compatible
with MMA internal
operations

CASE 24 Middlesex Mutual Assurance Company

Action must benefit
independent agents;
alienation must be
minimized or avoided

875

891

C A S E 2 5 Discount Retailing Battlefield:
Kmart vs.Wal-MartI

n June 1995, Floyd Hall took over as the CEO of
Kmart Corporation. His predecessor, Joseph
Antonini, who ran the company for seven years,
was forced to resign three months earlier due tocontinued lukewarm performance of the company
vis-à-vis its archrival Wal-Mart. A winning strategy
for the company must now be chalked out.
DISCOUNT RETAILING ARENA
For seven years, Joseph Antonini led a discountstore to battle against what appeared to be its twin.
The two chains looked alike, sold the same products, and sought each other’s customers. The competition, however, was over: Sam Walton’s
Wal-Mart Stores Inc. had won.
So bleak were the prospects for Kmart Corp. thatin February 1995 an advertising agency bidding for
its business, N.W. Ayer & Partners, recommended
that it stop competing against Wal-Mart and transform itself into a big convenience chain where customers could go for milk and cigarettes. “It seems
that the only way for [Kmart] to survive is to find adifferent niche,” summarized the N.W. Ayer’s presentation. Kmart, of course, rejected the idea.
Though the new leader could spark high hopes
for ringing cash registers, Kmart still had major
operational and managerial issues to deal with.
While an air of inevitable defeat had recently
settled over Kmart, a short look back found manyobservers believing deeply in Kmart and Mr.
Antonini. In fact, many of the investors who
demanded his ouster as president and chief executive officer had gambled on him to outfox his
counterparts at Wal-Mart not so long ago. They
questioned some of the strategies of Mr. Walton,

43

Wal-Mart’s founder. They also thought Mr. Antonini
had more pizazz, better locations, and a solid turnaround plan.
“He’s taken a tired, dispirited company andrevived it,” declared a prominent retail analyst in a1991 Forbes magazine article that described WalMart’s stock as overpriced and Kmart as a goodbet.
Considering the similarity of their stores andmissions, analysts attributed the different fates ofKmart and Wal-Mart primarily to management.
Sam Walton, they said, was smarter than Mr.
Antonini.
When Mr. Antonini took the reins of Kmart in
1987, he had his hands full. He inherited somestores that were as old as 17 years, with waterwarped floors, broken light fixtures, shelves
placed too close together, and cheap displays set
in the middle of aisles. Also, his predecessors
had neglected to implement the sophisticatedcomputer systems that were helping Wal-Mart
track and replenish its merchandise swiftly andefficiently.
Overall, however, Kmart was way ahead. It had
nearly twice as many discount stores, 2,223 to
1,198. The Troy, Michigan, chain also had sales of$25.63 billion, compared with $15.96 billion for
Wal-Mart. Thanks to advertising and its large
urban presence, Kmart and its red “K” logo also
had greater visibility.
Although Wal-Mart had a more consistentrecord of earnings and revenue growth, in the eyesof many experts it had never played in the major
leagues. Unlike Kmart, whose stores sat on expensive urban real estate and competed against otherbig discounters, Wal-Mart sat in pastures outside

This case was prepared by Juan M. Florin, doctoral student at the University of Connecticut, and the author as a basis for classdiscussion rather than to illustrate either effective or ineffective handling of an administrative situation.

876

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Discount Retailing Battlefield: Kmart vs. Wal-Mart

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

small towns and picked off the customers fromaging mom-and-pop shops.
Like the minor leaguer admiring a star in thebigs, Mr. Walton regarded Kmart with awe. “Somuch about their stores was superior to ours,” Mr.
Walton said in his autobiography, “that sometimes
I felt like we couldn’t compete.” On the other
hand, Mr. Antonini was heard by company insiders to dismiss Wal-Mart executives as “snake-oilsalesmen.”
So rapidly was Wal-Mart multiplying across therural landscape that an invasion of urban
America—and a confrontation with Kmart—became inevitable. To prepare for the encounter,
Mr. Antonini focused on his own strengths: marketing and merchandising. A self-promoter with aboisterous voice and a wide smile, Mr. Antonini
invested heavily in national television campaigns
and glamorous representatives such as Jaclyn
Smith, a former “Charlie’s Angels” television star
who had her own line of clothes for Kmart.
That effort only widened a public-awarenessgap between the two retailers. Even before the successful campaign with Ms. Smith, Kmart’s “bluelight special” was famous around the country.
Meanwhile, as recently as the late 1980s, mostAmericans had never seen a Wal-Mart advertisement, not to mention a store.
Mr. Walton did little to change that. He avoided
publicity. Instead of marketing, he became
obsessed with operations. He invested tens of
millions of dollars in a companywide computer
system linking cash registers to headquarters, enabling him to quickly restock goods selling off the
shelves. He also invested heavily in trucks anddistribution centers, around which he located his
stores. Besides enhancing his control, these moves
sharply reduced costs.
That was a gamble. While Kmart tried to
improve its image and cultivated store loyalty, Mr.
Walton kept lowering costs, betting that pricewould prove more important than any other factor.
As discounting fever deepened across America,
analysts and shareholders came to expect huge
growth from these retailers. In trying to meet these877

expectations, Messrs. Antonini and Walton once
again trod different paths. Mr. Antonini tried bolstering growth by overseeing the purchase of othertypes of retailers: the Sports Authority sportinggoods chain, OfficeMax office-supply stores,
Borders bookstores, and Pace Membership Warehouse clubs. Besides additional revenue, thesechains would decrease dependence on profits fromdiscounting. “It’s the way of the future,” Mr.
Antonini declared of such diversification.
In Bentonville, Arkansas, meanwhile, Mr. Walton
was taking precisely the opposite tack—betting
everything on discount retailing. He started Sam’s
Club, a deep-discount, members-only retailer thatwas modeled after California-based Price Club,
which devised the concept. Then, Mr. Walton tried abrand of discounting that Kmart had already tried
and abandoned in the 1960s—groceries. His firstexperiment, a massive Hyper-mart more than
230,000 square feet in size, suffered. Customers
complained that the produce wasn’t fresh or wellpresented—and that they were having trouble
finding things in stores so big that stockers wore
roller skates. The Hypermart, Mr. Walton conceded, didn’t work. Undaunted, he launched arevised concept: the Supercenter, a combination
discount store and grocery that was smaller thanthe Hypermart.
By 1991, three years after Mr. Antonini tookcharge of Kmart, Wal-Mart surpassed it. For theretail year that ended in January 1991, Wal-Mart
had sales of $32.6 billion, compared with Kmart’s$29.7 billion. (See Exhibit 1.) For Kmart, the scarypart was that Wal-Mart still had fewer stores—
1,721 to Kmart’s 2,330.
However, Mr. Antonini and other Kmart supporters took comfort in knowing that Wal-Mart
was running out of small towns to conquer. To continue growing, it would need to invade Kmart’s
turf: the more expensive and competitive big city.
To prepare for that invasion, Mr. Antonini launched
a $3.5 billion, five-year plan to renovate, enlarge, or
replace Kmart’s oldest and shabbiest stores.
Analysts called him a “visionary,” and often joined
him on tours of prototype stores.

Discount Retailing Battlefield: Kmart vs. Wal-Mart

878

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

EXHIBIT 1
Changing Fortune

Source: Company annual reports.

However, the least visible difference between
Wal-Mart and Kmart was beginning to matter a lot.
Wal-Mart’s incredibly sophisticated distribution,
inventory, and scanner systems meant that customers almost never encountered depleted shelves
or price-check delays at the cash register. The hallsof Kmart, meanwhile, were filled with distribution
horror stories. Joseph R. Thomas, who oversaw distribution, said that, in retrospect, he should havesmelled trouble when he found warehouses stuffed
full of merchandise on Dec. 15, the height of theChristmas season.
Although Mr. Antonini poured a fortune into a
frantic attempt to catch up, Kmart was so far
behind that a November 1993 internal company
report found that Kmart employees woefully
lacked the training and skill to plan and control
inventory. Kmart’s cash registers often didn’t haveup-to-date information and would enter wrong
prices. That led to a lawsuit by the Riverside
County district attorney’s office, claiming that 72

California Kmart stores had overcharged customers. In May 1994, Kmart settled for $985,000.
Consider the case of Anita Joy Winter. She went
to a Naperville, Illinois, Kmart with three items on
her list: underwear for her husband, contact-lenscleaner, and dish towels. The store was out of
everything but the towels, and even then didn’t
have the beige color she wanted. After that, the register rang up a price more than 70 cents above what
the shelf advertised, which took 10 minutes tostraighten out. The consequence? “It’s been ‘Thank
God for Wal-Mart’ ever since,” says Ms. Winter,
who shops at a suburban Chicago Wal-Mart at least
twice a week.
To the surprise of many, the higher cost andgreater competitiveness of big cities hardly registered at Wal-Mart, now under the leadership ofDavid Glass, the successor to Mr. Walton, whodied in 1992 at age 74. The company had pared
costs so aggressively in so many areas that it was
passing on the high cost of, say, Long Island, New
York, real estate and was still easily under pricing
Kmart. Moreover, its stores were often twice aslarge as older Kmarts. The effect, when Wal-Mart
put in a 125,000 square-foot, slick new store acrossfrom an old 60,000 square-foot competitor, was justdevastating.
Of the two retailers’ diversification efforts,
Kmart again proved the least successful. Mr.
Antonini’s plan to make Kmart a combination discount and specialty-retailing empire began tounravel at the end of 1993. While the specialty
stores—those offering books, office supplies, orsporting goods—had contributed 30 percent ofsales the year before, they only made up 15 percent
of operating profit. Kmart’s discount stores werequickly losing market share to Wal-Mart.
Shareholders demanded Mr. Antonini get rid of his
prize jewels and focus on the discount stores. At
the insistence of shareholders and against Mr.
Antonini’s wishes, Kmart announced, at the end of
1994, a plan to sell majority stakes in three of its
specialty retail chains.
Wal-Mart, meanwhile, couldn’t roll out its new
Supercenters fast enough. The concept of buying

895

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Discount Retailing Battlefield: Kmart vs. Wal-Mart

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

general merchandise and groceries in one store—ata discount—was proving successful around thecountry, prompting Kmart to start a similar chain.
However, the cost of opening Super Kmarts only
detracted from the continuing, and largely disappointing, effort to renovate general-merchandise
Kmarts. Though the stores were all supposed tohave a new look by 1996—with wider aisles,
gleaming floors and expanded departments—athird of them remained untouched. Those that had
been renovated weren’t producing the sales gains
that had been expected.
As a result, even after $1.8 billion in asset sales in
1994, Kmart’s operating profit was so disappointing that the company could barely cover its 96cents-a-share annual dividend and had to scaleback capital spending to about $800 million from atleast $1 billion. (See Exhibit 2.)
The most telling statistic: Kmart’s market shareof total discount sales in 1995 had dropped to 22.7

EXHIBIT 2
Diverging Paths: Wal-Mart vs. Kmart

Sources: Company annual reports, Baseline.

879

percent from 34.5 percent in 1987, when Mr.
Antonini took over as chairman, president, andchief executive officer. Wal-Mart had soared to 41.6
percent from 20.1 percent.
In the end, attitude may have made a bigger difference than strategy. In Bentonville, Mr. Waltonand Mr. Glass asked subordinates what wasn’t
working, and chided them for failing to deliver any
bad news. Executives were expected to spend
much of their week visiting stores, actively soliciting proposals from subordinates. Mr. Walton
always acted as if a fierce competitor was justbehind him and gaining. Even publicly, he and Mr.
Glass were more likely to discuss Wal-Mart’s weaknesses than its strengths.
In Troy, by contrast, Mr. Antonini didn’t thinkothers could tell him much about the business. A
Kmart employee since 1964, when he started as
an assistant manager, he bristled at criticism andwas known as a “Teflon-coated” boss because

Discount Retailing Battlefield: Kmart vs. Wal-Mart

880

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Martsuggestions for change slid right off. Insiders say
he didn’t do much hiring of managers from outside the company who might challenge him, andhe flayed or fired consultants who recommended
everything from management changes to targeting a narrower consumer market.
In fall of 1993, munching a sandwich in a shiny
new Super Kmart store, Mr. Antonini expressed thepossibility of following the lead of Mr. Walton andwriting a book detailing a retail success.
KMART CORPORATION
Company History
A new concept in merchandising, backed by thousands of dedicated men and women, changed theS.S. Kresge Company from a fledgling newcomerin the variety store field to a multi-billion-dollar
chain of general merchandise and specialty retailstores.
In 1899, Sebastian Spering Kresge opened his
first store in downtown Detroit. By 1912, Kresge
had 85 stores with annual sales of more than $10
million. Kresge stores appealed to shoppers withthe stores’ low prices, open displays, and convenient locations. Inflation in the World War I era
forced Kresge to raise prices to 25¢, and in the mid’20s, Kresge opened “green-front stores” to sellitems at a dollar or less, often next to the red-front
dime stores. Kresge went into the first suburban
shopping center—Country Club Plaza in Kansas
City, Missouri—in 1929. By 1930, variety-store
chains had become commonplace because they
provided a wide array of goods at low prices.
Meanwhile, supermarket chains were introducing
the public to self-service shopping. The Kresge
Company launched its newspaper advertising program in the early 1930s. Radio promotions followed 20 years later, and television was added in1968. Today, print ads still dominate Kmart’s advertising program, with 72 million circulars weekly for
insertion in 1,500 newspapers nationwide.
With the opening of America’s first discountstores in 1953, a new era in retailing had dawned.

The Ann and Hope Mill Outlet in Rhode Island,
which manufactured tinsel and corsage ribbons,sold discounted ribbons and greeting cards as well
as women’s house dresses for $2.19 each. Several
other discount houses emerged in the 1950s, leading Kresge President Harry B. Cunningham to
study a similar strategy for his organization. The
result was the opening of the first Kmart discountdepartment store, in Garden City, Michigan, in
1962. In Kmart’s first year of operation, corporate
sales topped $483 million. By 1966, Kresge registered its first billion-dollar year with 162 Kmartstores in operation. The name of the company waschanged to Kmart Corporation in 1977 to reflect
the fact that more than 95 percent of sales weregenerated by Kmart stores. By 1994, Kmart was
the nation’s second-largest general merchandise
retailer with $34 billion in sales. Today, there are
more than 2,400 Kmart stores in the United States,
Puerto Rico, Canada, the Czech Republic, Slovakia,
Mexico, Singapore, and Australia. Kmart employssome 300,000 individuals worldwide. Loyalty andlong service are common; thousands of Kmart associates have worked for the company for 25 years or
longer. Store management teams are responsible
for the profitability of their own units and have theauthority to make certain independent decisions
about their operations.
In the early ‘70s, the company pursued an aggressive expansion plan that included opening 271
stores in 1976. In 1981, the company shifted toward
refurbishing existing stores. For almost 80 percentof the American public, Kmart is the nearly complete one-stop shopping center. Still, the company
is working to prompt customers to think of Kmartfor even more of their shopping needs. In the
1980s, Kmart had the highest shopper traffic in thenation.
Today’s Kmart differs greatly from its forerunner of the ‘60s. Kmart emphasizes top brands and astrong program of private-label products for thevalue-conscious customer. These merchandise lines
include the Jaclyn Smith apparel line, Fuzzy Zoeller
golf apparel, designer jeans for men and women,
name-brand athletic shoes, Martha Stewart

897

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Discount Retailing Battlefield: Kmart vs. Wal-Mart

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Martfashions for the home, prestige cosmetics and fragrances, and many respected names in home
improvement and health and beauty care. The company adheres to a “satisfaction always” policy,
which means that customers receive refunds andexchanges with ease. The Kmart Price Promise
gives each store manager and associate the power
to match competitor’s prices. This policy ensures
Kmart remains America’s price leader. The company has made strides toward more efficient operations. Kmart Information Network (KIN) is anelectronic system that connects all stores, distribution centers, and headquarters and streamlines various office procedures. Point-of-sale equipment isin all 2,400 stores. In 1986, Kmart and GTE established a satellite-based communications network.
Thirteen distribution centers supply stores with asubstantial amount of their basic stock; most storesare less than one day’s drive from a distribution
center.
Diversification and Modernization
The acquisition of the nation’s largest retail bookstore chain, Walden Book Company, Inc., was completed on August 9, 1984. In addition to books,
Waldenbooks stores also carry video and music
selections and computer software. Average storesoccupy 3,000 square feet and are located primarily
in regional shopping malls and strip shopping centers. Kmart Corporation completed the acquisition
of Builders Square, Inc. (formerly Home Centers ofAmerica) on September 27, 1984. A typical Builders
Square store occupies approximately 80,000 square
feet and features name-brand merchandise at discount prices. Assortments include lumber, building
materials, hardware, paint, plumbing and electricalsupplies, and garden and home improvement
goods. In 1987, the company celebrated the 25th
anniversary of Kmart stores and announced a partnership with Bruno’s, Inc., of Birmingham, Alabama to develop American Fare, combination
concept stores, in the United States. The company
also moved to streamline operations, closing its
Central Regional Office in Plymouth, Michigan and881

realigning its five remaining regional offices. The
company also established a marketing department
to strengthen communication to its customers
about the Kmart store.
In 1988, Kmart announced two new retailingconcepts to be developed by its Builders Squaresubsidiary—Sports Giant, a chain of sporting
goods superstores, and Office Square, a warehouse-type office supply store. In February 1990,
Kmart announced an accelerated five-year, $3.5
billion new store opening, enlargement, and modernization program. This aggressive program
involved building approximately 280 new full-size
Kmart stores, enlarging 700 existing stores, relocating 300 others, and refurbishing 670 to bring their
fixturing and layout up to the new store standards.
The early 1990 acquisition of The Sports Authority
allowed the company to move forward in the
sporting goods mega-store arena. The company’sSports Giant stores were converted to The Sports
Authority stores. In September 1990, Kmart acquired
22 percent ownership interest in OfficeMax, anoffice supply superstore chain. OfficeMax agreed
to acquire the Office Square business of Kmart’s
subsidiary Builders Square. Kmart acquired theremaining interest in OfficeMax in November
1991.
A new, bold Kmart logo was unveiled in September 1990, signaling change and innovation for the
chain. The new symbol keeps Kmart in step with thetimes and reflects the dynamism and excitement of
the company’s commitment to renewal. In 1991,
Kmart raised $1 billion in equity through a Preferred
Equity Redemption Cumulative Stock offering(PERCS), ensuring the completion of its modernization program in 1996. At year end 1991, approximately 30 percent of the chain’s Kmart storessported the updated look.
Kmart’s subsidiary operations, which in 1992
included Builders Square, OfficeMax, The Sports
Authority, Waldenbooks, and Borders, were under
the Specialty Retail Group. By year-end 1993,
Kmart had completed more than half of its comprehensive store renewal program. Kmart also
stepped up the roll-out of combination stores called

Discount Retailing Battlefield: Kmart vs. Wal-Mart

882

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-MartSuper Kmart Centers. In 1993, Kmart sold its Pace
Membership Warehouse subsidiary. Kmart alsoannounced the sale of Payless Drugstore Northwest to Thrifty Drugs. By the end of 1994, there
were 67 Super Kmart Centers nationwide. BordersWalden, Inc. announced a corporate restructuring,
renaming the entity Borders Group, Inc. Kmart soldits 21.5 percent interest in Coles Myer Ltd. andannounced plans for Initial Public Offerings (IPOs)
in Sports Authority, OfficeMax, and Borders Group,
Inc.
Kmart initiated a productivity improvement
process to reduce expenses by $600 to $800 million
by the end of 1996. This process included thereview of all aspects of the business to ensure
growth in sales and earnings. A merchandise flowtask force also was formed to focus on inventory
flow, especially high-velocity consumable items.
Financial information on the company is summarized in Exhibit 3.
International Expansion
Kmart made its initial entry into the European
market when it purchased its first store in the
Czech Republic in May 1992. Later that year,
Kmart finalized the purchase of 12 additional
stores in the Czech Republic and Slovakia. Kmartalso announced plans to expand global operations,through joint ventures, in Mexico and Singapore.
In 1994, Kmart opened its thirteenth distribution
center in Brighton, Colorado, and stores in Mexicoand Singapore.
Corporate Culture
The thirtieth anniversary of Kmart in 1992 marked
the celebration of an institution deeply ingrainedin the fabric of American life. Since its beginnings
as Kresge, Kmart has successfully met the challenge of serving the changing needs of theAmerican family.
Three savvy merchants, leaders of their generations, have played significant roles in the history of
Kmart. The first was the founder, Sebastian Spering(S.S.) Kresge, who built not only a successful retailing chain, but more important for its future, a flexible and responsive organization; the second, Harry
Cunningham, emerged from the ranks to transform Kresge into Kmart; and until June 1995, Joe
Antonini, the president and CEO who spearheaded
Kmart’s renewal for today’s customer. Of all thegreat variety stores founded at the time of Kresge,
only Kmart has maintained its leadership ofAmerican retailing.
Kmart was founded by a traveling salesmanfrom Pennsylvania, Sebastian Spering Kresge.
Kresge’s variety stores spread throughout urbanizing America. Later, there were larger stores expanding the product lines and broadening the customer
base. Through all this, S.S. Kresge was a man ofvision deeply in tune with the dynamics of a growing America. Despite his personal frugality—and to
the shock of his colleagues and associates—he borrowed heavily to invest in store expansion to go
where his customers were.
Kresge believed that one should both entice andlisten to the customer; he ran specials in his storeson a weekly basis so that each week there would bea new reason to shop at Kresge. He also left Kresge
employees free to exercise their judgment and dotheir jobs—all who worked for him said that henever looked over their shoulders (in an age ofheavy employee supervision)—an early example ofthe empowerment of employees.
Harry Cunningham, the next great Kresge/
Kmart leader, also was known for listening to his
customers. As a young manager, he asked the sales
clerks to record all customer requests on little blue
cards. Cunningham read the blue cards daily,ordering the merchandise requested. Within a year,
Cunningham increased his store sales by 100 percent. Before he took over as president in 1959,
Cunningham toured the country. He looked at his
and other people’s stores, he listened to the people,
and he thought about the emergence of the new
suburban lifestyle. He saw a sea of young families
needing to furnish their homes, but, like all young
families strapped by cash, they desired high quality
at a low price. This post-war generation, newly

899

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Discount Retailing Battlefield: Kmart vs. Wal-Mart

883

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

EXHIBIT 3
Kmart Corporation Consolidated Statements of Income (Dollars in millions, except per-share data)
Fiscal Year Ended

Sales
Licensee fees and other income

Jan. 25,
1995

Jan. 26,
1994

Jan. 27,
1993$34,025288$36,694296$33,366
292

34,31336,99033,65825,9927,701(168 )–

27,520
8,217
–
1,348

24,516
7,393
–
–

258
236

303
192

243
185

34,01937,58032,33729480
114(590 )
52(191 )

1,321
54
474

260

(347 )

901

20

(77 )

40

16
–
–

(521 )
(10 )
(19 )

–
–
–

Cost of merchandise sold (includes buying and occupancy costs)
Selling, general and administrative expenses
Gain on subsidiary public offerings
Store restructuring and other charges
Interest expense:
Debt—net
Capital lease obligations and other
Income (loss) from continuing retail operations before income taxes
and equity income
Equity in net income of unconsolidated companies
Income taxes
Net income (loss) from continuing retail operations before
extraordinary item and the effect of accounting changes
Discontinued operations including the effect of accounting changes,
net of income taxes of $7, $(61) and $11, respectively
Gain (loss) on disposal of discontinued operations, net of income
taxes of $215 and $(248), respectively
Extraordinary item, net of income taxes of $(6)Effect of accounting changes, net of income taxes of $(37)Net income (loss)
Earnings per common and common equivalent share:
Net income (loss) from continuing retail operations before
extraordinary item and the effect of accounting changes
Discontinued operations including the effect of accounting changes,
net of income taxes
Gain (loss) on disposal of discontinued operations, net of income
taxes
Extraordinary item, net of income taxes
Effect of accounting changes, net of income taxes

$

296

$

(974)

$

941

$

.55

$

(.78)

$

1.97

$
Weighted average shares (millions).04(.17 )

.09

.04
–
–

(1.14 )(.02 )(.04 )–––.63$ (2.15)

456.6

456.7

$

2.06
455.6

Discount Retailing Battlefield: Kmart vs. Wal-Mart

884

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

EXHIBIT 3 (continued)
Kmart Corporation Consolidated Statements (Dollars in millions)

AssetsCurrent assets:
Cash (includes temporary investments of $93 and $32, respectively)
Merchandise inventories
Accounts receivable and other current assets

Jan. 25,
1995

Jan. 26,
1994

$

$

Total current assets
Investments in affiliated retail companies
Property and equipment—net
Other assets and deferred charges
Goodwill—net of accumulated amortization of $45 and $59, respectively
Liabilities and Shareholders’ Equity
Current liabilities:
Long-term debt due within one year
Notes payable
Accounts payable — trade
Accrued payrolls and other liabilities
Taxes other than income taxes
Income taxes

480
7,382
1,325

449
7,252
1,816

9,187
368
6,280
910
284

9,517
606
5,886
799
696

$17,029$ 17,504

$

$

236
638
2,910
1,313
272
257

390
918
2,763
1,347
271
35

Total current liabilities
Capital lease obligations
Long-term debt
Other long-term liabilities (includes store restructuring obligations)Shareholders’ equity:
Preferred stock, 10,000,000 shares authorized;
Series A, 5,750,000 shares authorized and issued at January 26, 1994
Series C, 790,287 shares authorized; shares issued 658,315 and 784,938,
respectively
Common stock 1,500,000,000 shares authorized; shares issued 464,549,561
and 416,546,780, respectively
Capital in excess of par value
Performance restricted stock deferred compensation
Retained earnings
Treasury shares
Foreign currency translation adjustment

5,626
1,777
2,011
1,583

5,724
1,720
2,227
1,740

–

986

132

157

465
1,505
–
4,074
(86)
(58)

417
538
(3)
4,237
(109)
(130)

Total shareholders’ equity

6,032

6,093

$17,029$ 17,504

Source: Kmart Corporation 1994 Annual Report.

901

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Discount Retailing Battlefield: Kmart vs. Wal-Mart

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

affluent, produced the baby boomers and was thefirst generation to make shopping a vocation.
In his travels, Cunningham visited a new kind of
store—the discount store. While the stores themselves were badly managed, he saw the beauty of
the concept and understood how the professional
Kresge organization could do better. Initially, theKresge Board was skeptical because of the unprovensuccess of those initial discounters, but Cunningham was persuasive in his belief that Kresge could
provide value to the customer while maintaining
high quality standards. Investing for the future,they spent more than $80 million. By the time thefirst Kmart opened in March 1962, there were 32
more locations ready to go.
Cunningham’s blue index cards and S.S.
Kresge’s special promotions were transformed intoa unique American experience—the blue light special. Its origins were humble but the blue light special has entered the vernacular and is a registeredtrademark.
In the spirit of Harry Cunningham and S.S.
Kresge, Joe Antonini had the vision to address theneeds of today’s woman, the core Kmart customer.
As head of apparel in 1983, he began the transformation of the Kmart organization and the Kmart
shopping experience. The women’s apparel section
was totally revamped and the Jaclyn Smith
Collection was created. He followed with manylines designed for today’s “busy, budget-consciousmom,” the woman who plays many roles in the lifeof her family and community.
Antonini’s understanding of that special woman,
the Kmart customer, spurred him to examine her
entire shopping experience. Just as other great retailers have entered the psyche of their customers,
Kmart understands theirs—the time pressures andthe multiple roles, the need for convenience, therequirement of value, and the desire to translate the
new fashion and home trends to enrich her life andthat of her family. Respect for the customer and adesire to make the shopping experience both fruitfuland fun were the catalyst for the massive organizational redesign from the stores themselves to relationships with suppliers to the information systems

885

necessary to bring the latest fashion to every shopper. Antonini’s commitment to the Kmart customer
led to an investment of $3.5 billion to refurbish andbuild the right kind of stores.

Super Kmart Center
Ranging in size from 160,000 to 190,000 square feet,
Super Kmart Centers offer customers the ultimate
experience in merchandise selection as well as anarray of sensational groceries. Super Kmart Centersfeature in-house bakeries, USDA fresh meats, fresh
seafood (delivered daily), an array of hot and cold
dishes from delicatessens, cookie kiosks, cappuccino bars, in-store eateries, fresh carry-out saladbars, and “Oriental-to-Go” menu items. To ensure
grocery freshness, Kmart has developed its own
grocery buying and operations division. Trained
grocery personnel work closely with local suppliers
to make regional fresh food available to shoppers.
Cross merchandising offers added convenience at
Super Kmart Centers. For example, toasters areabove the fresh baked breads, kitchen gadgets are
positioned across the aisle from produce, andinfant centers feature everything for baby fromfood to clothing. In many locations, Super Kmart
Centers provide customers with a selection of special services such as video rental, hair salon, florist,
UPS shipping, banking and ATMs, lottery, moneyorders, as well as faxing and copy services with
one-hour photo processing in the up-to-date image
centers.
The first Super Kmart Center opened in Medina,
Ohio on July 25, 1991. Its success and overwhelming
acceptance by customers provided the foundation
for Kmart’s nationwide roll-out of 67 additional
Super Kmart Centers over the last three years. Morethan 25 Super Kmart Centers are planned for 1995,
bringing the total to about 100.
A company report noted:
The Super Kmart supercenter format is a dynamic
new retail channel that builds on our core competencies and has strong potential for profitable growth.
The Super Kmart format is based on a grocery-driven,

Discount Retailing Battlefield: Kmart vs. Wal-Mart

886

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Marthigh-frequency concept that, when executed properly,
yields superior sales productivity and attracts ayounger and more affluent family shopper than our
traditional Kmart discount stores.
We are exploring ways to improve the Super Kmart“big box” concept by increasing the ease of shopping,providing more visual excitement and coherence within
the store, creating better adjacencies of related merchandise, and reducing expenses. We may also develop asmaller Super Kmart format so we can expand into communities that cannot support the “big box.”
The supercenter concept is a natural extension of
our traditional business, which marries the need ofour time-poor customers—who want convenience,value, and one-stop shopping—with our desire forincreased shopper frequency.

WAL-MART STORESSamuel Moore Walton, the billionaire boy scout of
Bentonville, Arkansas, built an empire on a fervid
belief in value, pioneered by ideas like empowerment, and revolutionized retailing in the process.
Dead at 74 after a long fight with cancer, he did notinvent the discount department store, although it
hardly seems possible that he didn’t. He grabbed
hold of the leading edge of retailing in 1962 andnever let go, creating a value-powered merchandising machine that seems certain to outlive hismemory.
In 1994, the still-young company earned $2.3 billion on sales of $67 billion. A $1,650 investment in
100 Wal-Mart shares in 1970, when they began trading, is worth $3 million today. (See Exhibit 4 forfinancial information on the company.) He taught
American business that the vast amount ofAmerican people want value. He saw the future,and he helped make the future. According to aretail executive, while Walton was one of the great
showmen of retailing, if he had been a televisionpreacher he’d have become Pope. As a manager heapplied such concepts as a flat organization,
empowerment, and gain-sharing long before anyone gave them those names. In the 1950s, he shared
information and profits with all employees. He
ingested as much data as he could to get close to

the customer and closer to the competition. He
stressed flexibility and action over deliberation.
Wal-Mart is ultimately a monument to consumers: it has saved them billions. Sam Walton
truly believed that nothing happens until a customer walks into a store with a purpose, buys
something, and walks out. His philosophy was
simple: satisfy the customer. Operating nearly 2,000
stores in 47 states, Wal-Mart remains the leader inthe discount store industry. In addition, with over
400 Sam’s Clubs, Wal-Mart is a major factor in the
Warehouse Club industry. Combining general merchandise and groceries, Supercenters represent thecompany’s fastest growing segment, with 65 to 70
stores planned in fiscal 1995 on a base of 68.
Walton long ago wanted manufacturers to seethemselves, wholesalers, retailers, and consumers
as parts of a single customer-focused process rather
than as participants in a series of transactions. He
personally and permanently altered the relationship between manufacturers and retailers, which
has historically been, to put it politely, antagonistic.
About five years ago he asked Procter & Gamble
executives to view a focus group of Wal-Mart executives talking about their prickly relationship withthe packaged-goods company. It was sobering. His
strategy clearly was that we ought to be able towork together to lower the costs of both the manufacturer and the distributor and get lower costs for
consumers. Walton got both sides to focus on distribution costs and how to cut them. Wal-Mart
linked P&G with its computers to allow automatic
reordering, thus avoiding bulges in order cycles.
With better coordination of buying, P&G could
plan more consistent manufacturing runs, rationalize distribution, and lower its costs, passing onsome of the savings. This systematic approach is
now in broad use throughout the industry. Walton
has been described as a visionary, and he clearly
was that. His vision was apparent in 1956 as a Ben
Franklin variety store owner. To lure one of his first
store managers, Bob Bogle, away from the state
health department, Walton showed him the books
and offered to pay him 25 percent of the store’s net
profit in addition to salary.

903

904

Discount Retailing Battlefield: Kmart vs. Wal-Mart

887

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

EXHIBIT 4
Wal-Mart Stores, Inc. Consolidated Statements of Income(Amounts in thousands except per-share data.)
Fiscal year ended January 31,

1994

1993

1992

$67,344,574
47,422593,548$55,483,771
36,035
464,758$43,886,902
28,659373,862

67,985,544

55,984,564

44,289,423

53,443,743
10,333,218

44,174,685
8,320,842

34,786,119
6,684,304

331,308
185,697

142,649
180,049

113,305
152,558

64,293,966

52,818,225

41,736,286

3,691,578

3,166,339

2,553,137

1,324,777
33,524

1,136,918
34,627906,183
38,4781,358,301

1,171,545

944,661

Net Income$ 2,333,277$ 1,994,794$ 1,608,476

Net Income Per Share

$

$

$

Revenues:
Net sales
Rental from licensed departments
Other income—net
Costs and Expenses:
Cost of sales
Operating, selling, and general and administrative expenses
Interest Costs:
Debt
Capital leases

Income Before Income Taxes
Provision for Income Taxes:
Current
Deferred

Net Income (Millions of Dollars)

Source: Wal-Mart 1994 Annual Report.

1.02

.87

.70

Discount Retailing Battlefield: Kmart vs. Wal-Mart

888

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

EXHIBIT 4 (continued)
Wal-Mart Stores, Inc. Consolidated Balance Sheets(Amounts in thousands.) January 31,
Assets:Current Assets:
Cash and cash equivalents
Receivables
Recoverable costs from sale/leaseback
Inventories:
At replacement costLess LIFO reserve

1994

$

20,115689,987
208,236

1993$

12,363
524,555
312,016

11,483,119
469,413

9,779,981
511,672

11,013,706
182,558

9,268,309
80,347

12,114,602

10,197,590

2,740,883
6,818,479
3,980,674
259,537

1,692,510
4,641,009
3,417,230
111,151

Less accumulated depreciation

13,799,573
2,172,808

9,861,900
1,607,623

Net property, plant, and equipment
Property under capital leases
Less accumulated amortization

11,626,765
2,058,588
509,987

8,254,277
1,986,104
447,500

1,548,601
1,150,796

1,538,604
574,616$26,440,764$ 20,565,087$ 1,575,029
4,103,878
1,473,198
183,031
19,65851,429$ 1,588,825
3,873,331
1,042,108
190,620
13,84945,553

7,406,223
6,155,894
1,804,300
321,9096,754,286
3,072,835
1,772,152
206,634

229,877
535,639
9,986,922

229,964
526,647
8,002,569

10,752,438

8,759,180$26,440,764$ 20,565,087

LIFO
Prepaid expenses and otherTotal current assets
Property, Plant, and Equipment, at Cost:Land
Buildings and improvements
Fixtures and equipment
Transportation equipment

Net property under capital leases
Other Assets and Deferred Charges
Total assets
Liabilities and Shareholders’ Equity
Current Liabilities:
Commercial paper
Accounts payable
Accrued liabilities
Accrued federal and state income taxes
Long-term debt due within one year
Obligations under capital leases due within one year
Total current liabilities
Long-Term Debt
Long-Term Obligations Under Capital Leases
Deferred Income Taxes
Shareholders’ Equity:
Preferred stock ($.10 par value; 100,000 shares authorized, none issued)
Common stock ($.10 par value; 5,500,000 shares authorized, 2,298,769
and 2,299,638 issued and outstanding in 1994 and 1993, respectively)
Capital in excess of par value
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
Source: Wal-Mart 1994 Annual Report.

905

906

Discount Retailing Battlefield: Kmart vs. Wal-Mart

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

STRATEGIC ANALYSIS OF
WAL-MART’S SUCCESS
Wal-Mart’s Competitive Capabilities
What accounts for Wal-Mart’s remarkable success?
Most explanations focus on a few familiar andhighly visible factors: the genius of founder Sam
Walton, who inspires his employees and has
molded a culture of service excellence; the “greeters” who welcome customers at the door; the motivational power of allowing employees to own partof the business; the strategy of “everyday low
prices,” which offers the customer a better deal andsaves on merchandising and advertising costs.
Strategists also point to Wal-Mart’s big stores,
which offer economies of scale and a wider choiceof merchandise.
Such explanations only redefine the question.
Why is Wal-Mart able to justify building bigger
stores? Why does Wal-Mart alone have a cost structure low enough to accommodate everyday low
prices and greeters? What has enabled the company to continue to grow far beyond the directreach of Sam Walton’s magnetic personality? The
real secret of Wal-Mart’s success lies deeper, in a setof strategic business decisions that transformed thecompany into a capabilities-based competitor.
The starting point was a relentless focus on satisfying customer needs. Wal-Mart’s goals were simple
to define but hard to execute: to provide customers
access to quality goods, to make these goods available when and where customers want them, todevelop a cost structure that enables competitive
pricing, and to build and maintain a reputation for
absolute trustworthiness. The key to achieving thesegoals was to make the way the company replenishedinventory the centerpiece of its competitive strategy.
This strategic vision reached its fullest expression in a largely invisible logistics techniqueknown as “cross-docking.” In this system, goods
are continuously delivered to Wal-Mart’s warehouses, where they are selected, repacked, andthen dispatched to stores, often without ever sitting in inventory. Instead of spending valuable

889

time in the warehouse, goods just cross from one
loading dock to another in 48 hours or less. Crossdocking enables Wal-Mart to achieve theeconomies that come from purchasing full truckloads of goods while avoiding the usual inventory
and handling costs. Wal-Mart runs a full 85 percent
of its goods through its warehouse system—as
opposed to only 50 percent for Kmart. This reduces
Wal-Mart’s costs of sales by 2 percent to 3 percent
compared with the industry average. That cost difference makes possible the everyday low prices.
That’s not all. Low prices in turn mean that WalMart can save even more by eliminating theexpense of frequent promotions. Stable prices also
make sales more predictable, thus reducing stockouts and excess inventory. Finally, everyday low
prices bring in the customers, which translates intohigher sales per retail square foot. These advantages in basic economics make the greeters and the
profit sharing easy to afford.
With such obvious benefits, why don’t all retailers use cross-docking? The reason: it is extremely
difficult to manage. To make cross-docking work,
Wal-Mart had to make strategic investments in avariety of interlocking support systems far beyond
what could be justified by conventional ROI criteria. For example, cross-docking requires continuous contact among Wal-Mart’s distribution centers,
suppliers, and every point of sale in every store toensure that orders can flow in and be consolidated
and executed within a matter of hours. Wal-Mart
operates a private satellite-communication systemthat daily sends point-of-sale data directly to WalMart’s 4,000 vendors.
Another key component of Wal-Mart’s logistics
infrastructure is the company’s fast and responsive
transportation system. The company’s 19 distribution centers are serviced by nearly 2,000 companyowned trucks. This dedicated truck fleet permits
Wal-Mart to ship goods from warehouse to store inless than 48 hours and to replenish its store shelves
twice a week on average. By contrast, the industry
norm is once every two weeks.
To gain the full benefits of cross-docking, WalMart has also had to make fundamental changes inDiscount Retailing Battlefield: Kmart vs. Wal-Mart

890

CASE 25 Discount Retailing Battlefield: Kmart vs. Wal-Mart

its approach to managerial control. Traditionally, inthe retail industry, decisions about merchandising,pricing, and promotions have been highly centralized and made at the corporate level. Cross-docking,however, turns this command-and-control logic on
its head. Instead of the retailer pushing products into
the system, customers “pull” products when andwhere they need them. This approach places a premium on frequent, informal cooperation among
stores, distribution centers, and suppliers—with far
less centralized control.
The job of senior management at Wal-Mart, then,is not to tell individual store managers what to do,but to create an environment where they can learn
from the market—and from each other. The company’s information systems, for example, provide
store managers with detailed information about
customer behavior, while a fleet of airplanes regularly ferries store managers to Bentonville, Arkansas headquarters for meetings on market trends
and merchandising.
As the company has grown and its stores havemultiplied, even Wal-Mart’s own private air force
hasn’t been enough to maintain the necessary contacts among store managers. Therefore, Wal-Mart has
installed a video link connecting all its stores to corporate headquarters and to each other. Store managers frequently hold video conferences to exchange
information on what’s happening in the field, such as
which products are selling and which ones aren’t,
which promotions work and which don’t.
The final piece of this capabilities mosaic is WalMart’s human resources system. The company realizes that its frontline employees play a significant
role in satisfying customer needs. Therefore, it
attempts to enhance its organizational capability
with programs such as stock ownership and profit
sharing geared toward making its personnel more
responsive to customers. Even the way Wal-Mart
stores are organized contributes to this goal. Where
Kmart has five separate merchandise departmentsin each store, Wal-Mart has 36. This means thattraining can be more focused and more effective,and employees can be more attuned to customers.

Kmart/Wal-Mart Contrasts
Kmart did not see its business this way. While WalMart was fine-tuning its business processes andorganizational practices, Kmart was following theclassic textbook approach that had accounted for its
original success. Kmart managed its business byfocusing on a few product-centered strategic business units, each a profit center under strong centralized line management. Each SBU made strategy—selecting merchandise, setting prices, and deciding which products to promote. Senior management spent most of its time and resources making
line decisions rather than investing in a support
infrastructure.
Similarly, Kmart evaluated its competitive
advantage at each stage along a value chain andsubcontracted activities that managers concluded
others could do better. While Wal-Mart was building its ground transportation fleet, Kmart wasmoving out of trucking because a subcontracted
fleet was cheaper. While Wal-Mart was building
close relationships with its suppliers, Kmart wasconstantly switching suppliers in search of priceimprovements. While Wal-Mart was controlling all
the departments in its stores, Kmart was leasingout many of its departments to other companies on
the theory that it could make more per square footin rent than through its own efforts.
This is not to say that the Kmart managers do
not care about the business processes. After all,they have quality programs too. Nor is it that WalMart managers ignore the structural dimension ofstrategy: they focus on the same consumer segments as Kmart and still need to make traditional
strategic decisions such as where to open new
stores. The difference is that Wal-Mart emphasizes
behavior—the organizational practices and business processes in which capabilities are rooted—as
the primary object of strategy and, therefore,
focuses its managerial attention on the infrastructure that supports capabilities. This subtle distinction has made all the difference between
exceptional and average performance.

907

Procter & Gamble—ScopeAs Gwen Hearst looked at the year-end report,
she was pleased to see that Scope held a 32
percent share of the mouthwash market for 1990.
She had been concerned about the inroads that
Plax, a prebrushing rinse, had made in the market.
Since its introduction in 1988, Plax had gained a
10 percent share of the product category andposed a threat to Scope. As brand manager, Hearst
planned, developed, and directed the total marketing effort for Scope, Procter & Gamble’s (P&G)
brand in the mouthwash market. She was responsible for maximizing the market share, volume,and profitability of the brand.
Until the entry of Plax, brands in the mouthwash
market were positioned around two major benefits:
fresh breath and killing germs. Plax was positioned
around a new benefit—as a “plaque fighter”—andindications were that other brands, such as
Listerine, were going to promote this benefit. The
challenge for Hearst was to develop a strategy thatwould ensure the continued profitability of Scopein the face of these competitive threats. Her specifictask was to prepare a marketing plan for P&G’s
mouthwash business for the next three years. It
was early February 1991 and she would be presenting the plan to senior management in March.
COMPANY BACKGROUND
Based on the philosophy of providing products ofsuperior quality and value that best fill the needsof consumers, Procter & Gamble is one of themost successful consumer goods companies in theworld. The company marketed its brands in morethan 140 countries and had net earnings of $1.6 billion in 1990. The Canadian subsidiary contributed$1.4 billion in sales and $100 million in net earnings
in 1990. It is recognized as a leader in the Canadian

44
CASE 26
packaged goods industry, and its consumer brands
lead in most of the categories in which the company competes.
Between 1987 and 1990, worldwide sales of P&G
had increased by $8 billion and net earnings by $1.3
billion. P&G executives attributed the company’s
success to a variety of factors, including the ability
to develop truly innovative products to meet consumers’ needs. Exhibit 1 contains the statement of
purpose and strategy of the Canadian subsidiary.
P&G Canada has five operating divisions, organized by product category. The divisions, and someof the major brands, are:
1. Paper products: Royale, Pampers, Luvs, Attends,
Always
2. Food and beverages: Duncan Hines, Crisco, Pringles,
Sunny Delight
3. Beauty care: Head & Shoulders, Pantene, Pert, Vidal
Sassoon, Clearasil, Clarion, Cover Girl, Max Factor,
Oil of Olay, Noxzema, Secret
4. Health care: Crest, Scope, Vicks, Pepto Bismol,
Metamucil
5. Laundry and cleaning: Tide, Cheer, Bounce, Bold,
Oxydol, Joy, Cascade, Comet, Mr. Clean

Each division has its own brand management,
sales, finance, product development, and operations line management groups and is evaluated asa profit center. Typically, within each division abrand manager is assigned to each brand (e.g.,
Scope). Hearst was in the Health Care Division andreported to the associate advertising manager fororal care, who, in turn, reported to the generalmanager of the division. After completing her business degree (B.B.A.) at a well-known Ontario business school in 1986, Hearst had joined P&G as abrand assistant. In 1987, she became the assistantbrand manager for Scope and in 1988 she wasThis case was written by Professor Gordon H. G. McDougall and Professor Franklin Ramsoomair of Wilfrid Laurier University
as a basis of classroom discussion. Reprinted by permission of the authors.

891

909

910

Procter & Gamble-Scope

892

CASE 26 Procter & Gamble—Scope

EXHIBIT 1
A Statement of Purpose and Strategy
Procter & Gamble, Canada
We will provide products of superior quality and valuethat best fill the needs of consumers.
We will achieve that purpose through an organization
and a working environment which attracts the finest
people; fully develops and challenges our individual
talents; encourages our free and spirited collaboration todrive the business ahead; and maintains the company’s
historic principles of integrity, and doing the rightthing.
We will build a profitable business in Canada. We will
apply P&G worldwide learning and resources to maximize our success rate. We will concentrate our resourceson the most profitable categories and on unique, important Canadian market opportunities. We will also contribute to the development of outstanding people andinnovative business ideas for worldwide company use.
We will reach our business goals and achieve optimum cost efficiencies through continuing innovation,
strategic planning, and the continuous pursuit of excellence in everything we do.
We will continuously stay ahead of competition while
aggressively defending our established profitable business against major competitive challenges despite shortterm profit consequences.
Through the successful pursuit of our commitment,
we expect our brands to achieve leadership share andprofit positions and that, as a result, our business, ourpeople, our shareholders, and the communities in which
we live and work, will prosper.
Source: Company records.

promoted to brand manager. Hearst’s rapid
advancement at P&G reflected the confidence that
her managers had in her abilities.
THE CANADIAN MOUTHWASH MARKET
Until 1987, on a unit basis the mouthwash market
had grown at an average of 3 percent per year forthe previous 12 years. In 1987, it experienced a 26
percent increase with the introduction of new flavors such as peppermint. Since then, the growthrate had declined to a level of 5 percent in 1990
(Exhibit 2).
The mouthwash market was initially developedby Warner-Lambert with its pioneer brand Listerine. Positioned as a therapeutic germ-killing
mouthwash that eliminated bad breath, it dominated the market until the entry of Scope in 1967.
Scope, a green, mint-tasting mouthwash, was positioned as a great tasting, mouth-refreshing brandthat provided bad breath protection. It was the firstbrand that offered both effective protection against
bad breath and a better taste than other mouthwashes. Its advertising focused, in part, on a perceived weakness of Listerine—a medicine breath(e.g., “Scope fights bad breath. Don’t let the good
taste fool you.”)—and in 1976, Scope became themarket leader in Canada.
In 1977, Warner-Lambert launched Listermint
mouthwash as a direct competitor to Scope. Like
Scope, it was a green, mint-tasting mouthwash andwas positioned as a “good tasting mouthwash thatfights bad breath.” Within a year it had achieved a
12 percent market share, primarily at the expense of
Listerine and smaller brands in the market.
In the 1970s, Merrell Dow, a large pharmaceuticalfirm, launched Cepacol, which was positioned very
close to Listerine. It achieved and held approximately 14 percent of the market in the early 1980s.
During the 1980s, the major competitive changes
in the Canadian mouthwash market were:• Listerine, which had been marketed primarily on a“bad breath” strategy, began shifting its position andin 1988 introduced the claim: “Fights plaque andhelps prevent inflamed gums caused by plaque.” In
the U.S., Listerine gained the American Dental
Association seal for fighting plaque but, as yet, did
not have the seal in Canada.
• Listermint added fluoride during the early 1980s andadded the Canadian Dental Association seal for preventing cavities in 1983. More recently, Listermint
had downplayed fluoride and removed the seal.
• In early 1987, flavors were introduced by a numberof brands including Scope, Listermint, and various
store brands. This greatly expanded the market in1987 but did not significantly change the market
shares held by the major brands.

911

Procter & Gamble-Scope

CASE 26 Procter & Gamble—Scope

893

EXHIBIT 2
Mouthwash Market
1986

1987

1988

1989

1990

Total Retail Sales (000,000)

$43.4

$54.6

$60.2

$65.4

$68.6

Total Factory Sales (000,000)

$34.8

$43.5

$48.1

$52.2

$54.4

863

1,088

1,197

1,294

1,358

(% change)

3

26

10

8

5

(% change—“breath only)b

3

26

0

3

5

Penetration (%)c

65

70

75

73

75

Usage (# of times per week)d

2.0

2.2

2.3

2.4

3.0

Total Unit Sales (000)a

Source: Company records.
a One unit or statistical case equals 10 litres or 352 fluid ounces of mouthwash.
b Excludes Plax and other prebrushing rinses.
c Percent of households having at least one brand in home.
d For each adult household member.

• Colgate Fluoride Rinse was launched in 1988. With
the seal from the Canadian Dental Association forpreventing cavities, it claimed that “Colgate’s new
fluoride rinse fights cavities. It has a mild taste thatencourages children to rinse longer and more often.”
Colgate’s share peaked at 2 percent and thendeclined. There were rumors that Colgate was planning to discontinue the brand.
• In 1988, Merrell Dow entered a licensing agreementwith Strategic Brands to market Cepacol in Canada.
Strategic Brands, a Canadian firm that markets avariety of consumer household products, had
focused its efforts on gaining greater distribution for
Cepacol and promoting it on the basis of price.
• In 1988, Plax was launched on a new and different
platform. Its launch and immediate success caught
many in the industry by surprise.

THE INTRODUCTION OF PLAX
Plax was launched in Canada in late 1988 on a platform quite different from the traditional mouthwashes. First, instead of the usual use occasion of“after brushing,” it called itself a “prebrushing”
rinse. The user rinses before brushing, and Plax’s
detergents are supposed to help loosen plaque tomake brushing especially effective. Second, theproduct benefits were not breath focused. Instead it
claimed that “Rinsing with Plax, then brushingnormally, removes up to three times more plaquethan just brushing alone.”
Pfizer Inc., a pharmaceutical firm, launched
Plax in Canada with a promotional campaign
budget that was estimated to be close to $4 million. The campaign, which covered the last threemonths of 1988 and all of 1989, consisted of advertising estimated at $3 million and extensive sales
promotions including: (a) trial-size display inthree drugstore chains ($60,000); (b) co-op mailcouponing to 2.5 million households ($160,000);(c) instantly redeemable coupon offer ($110,000);(d) professional mailer to drug and supermarket
chains ($30,000); and (e) a number of price reductions ($640,000). Plax continued to support thebrand with advertising expenditures of approximately $1.2 million in 1990. In 1990, Plax held a 10
percent share of the total market.
When Plax was launched in the U.S., it claimed
that using Plax “removed up to 300 percent moreplaque than just brushing.” This claim was challenged by mouthwash competitors and led to an
investigation by the Better Business Bureau. The
investigation found that the study on which Plax

912

Procter & Gamble-Scope894

CASE 26 Procter & Gamble—Scope

based its claim had panelists limit their toothbrushing to just 15 seconds—and didn’t let them use
toothpaste. A further study, where people wereallowed to brush in their “usual manner” and withtoothpaste, showed no overall difference in thelevel of plaque buildup between those using Plax
and a control group that did not use Plax. Plax thenrevised its claim to “three times more plaque thanjust brushing alone.” Information on plaque is contained in Appendix A.
THE CURRENT SITUATIONIn preparing for the strategic plan, Gwen Hearst
reviewed the available information for the mouthwash market and Scope. As shown in Exhibit 2, in
1990, 75 percent of Canadian households used one
or more mouthwash brands and on average, usage
was three times per week for each adult household
member. Company market research revealed thatusers could be segmented on frequency of use;“heavy” users (once a day or more) comprised 40
percent of all users, “medium” users (two to six
times a week) comprised 45 percent, and “light”
users (less than once a week) comprised 15 percent.
No information was available on the usage habitsof prebrushing rinse users.
Non-users currently don’t buy mouthwash
because they either: (a) don’t believe they get badbreath; (b) believe that brushing their teeth is adequate; and/or (c) find alternatives such as gums
and mints more convenient.
The most important reasons why consumers use
mouthwash follow:
Most important reason for using mouthwash:%*

It is part of my basic oral hygiene

40

It gets rid of bad breath40

It kills germs

30

It makes me feel more confident

20

To avoid offending others

25

on the market (Exhibit 3). Respondents were asked
to rate the brands on a number of attributes and theresults showed that Plax had achieved a strong
image on the “removes plaque/healthier teeth andgums” attributes.
Market share data revealed there was a substantial difference in the share held by Scope in foodstores (e.g., supermarkets), 42 percent, versus drugstores, 27 percent (Exhibit 4). Approximately 65
percent of all mouthwash sales went through drugstores while 35 percent went through food stores.
Recently, wholesale clubs, such as Price Club andCostco, had accounted for a greater share ofmouthwash sales.1 Typically, these clubs carried
Cepacol, Scope, Listerine, and Plax.
Competitive data was also collected for advertising expenditures and retail prices. As shown in
Exhibit 5, total media spending of all brands in1990 was $5 million, with Scope, Listerine, and Plax
accounting for 90 percent of all advertising. Retailprices were calculated based on a 750 mL bottle:
both Listerine and Plax were priced at a higher
level in food stores and Plax was priced at a premium in drugstores.
Information on the U.S. market for 1989 was alsoavailable (Exhibit 6). In contrast to Canada, Listerine held the dominant share in the U.S. market.
Since early 1989, Listerine had been advertisedheavily in the U.S. as “the only nonprescription
mouthwash accepted by the American Dental
Association for its significant help in preventing
and reducing plaque and gingivitis.” In clinicaltests in the United States, Listerine significantly
reduced plaque scores by roughly 20 to 35 percent,with a similar reduction in gingivitis. In Canada,
the 1990 advertising campaign included the claimthat Listerine has been clinically proven to “helpprevent inflamed and irritated gums caused byplaque build-up.” Listerine’s formula relied onfour essential oils—menthol, eucalyptol, thymol,
and methyl salicylate—all derivatives of phenol, apowerful antiseptic.

*Multiple reasons allowed.

During 1990, a survey was conducted on theimage mouthwash users had of the major brands

1 Wholesale clubs were included in food store sales.

913

Procter & Gamble-Scope

895

CASE 26 Procter & Gamble—Scope

EXHIBIT 3
Consumer Perceptions of Brand Images
All Users a
Attributes

Cepacol

ColgateListerine

Listermint

Plax

Scope

…
+
…
…
…
…
…

…
…
…
…
—
…
…

…
+
…
…
+
…
…

…
…
…
…
…
…
…

—
…
+
+
…
+
…

…
—
—
—
…
…
…

Cepacol

ColgateListerine

Listermint

Plax

Scope

+
+
—
…
+
+

—
…
+
+
—
+

+
+
+
+
+
+

+
—
—
—
—
—

—
—
+
+
—
+

+
…
—
—
—
—

Reduces Bad Breath
Kills Germs
Removes PlaqueHealthier Teeth and Gums
Good for Preventing Colds
Recommended by Doctors/Dentists
Cleans Your Mouth Well
Brand Users b
Attributes
Reduces Bad Breath
Kills Germs
Removes PlaqueHealthier Teeth and Gums
Good for Preventing Colds
Recommended by Doctors/Dentists

Source: Company records.
a Includes anyone who uses mouthwash. Respondents were asked to rate all brands (even those they hadn’t used) on the attributes. A “+” means this brand scores higher than average. A “…” means this brand scored about average. A “—“ means this brandscored below average. For example, Cepacol is perceived by those who use mouthwash as a brand that is good/better than most at“preventing germs.”
b Includes only the users of that brand. For example, Cepacol is perceived by those whose “usual brand” is Cepacol as a brandthat is good/better than most at “reducing bad breath.”

Listerine had not received the consumer productseal given by the Canadian Dental Association(CDA) because the association was not convinced amouthrinse could be of therapeutic value. The
CDA was currently reviewing American tests forseveral products sold in Canada. In fact, any proposed changes to the formulation of mouthwashes
or advertising claims could require approval fromvarious regulatory agencies.
THE REGULATORY ENVIRONMENT
1. Health Protection Branch (HPB): This government
body classifies products into “drug status” or “cosmetic status” based on both the product’s action on
bodily functions and its advertising claims. Drugproducts are those that affect a bodily function (e.g.,prevent cavities or prevent plaque build-up). For“drug status” products, all product formulations,packaging, copy, and advertising must be preclearedby the Health Protection Branch (HPB), with guidelines that are very stringent. Mouthwashes such as
Scope that claim to only prevent bad breath are considered as “cosmetic status.” However, if any claims
regarding inhibition of plaque formation are made,the product reverts to “drug status” and all advertising is scrutinized.
2. The Canadian Dental Association (CDA): The CDA
will, upon request of the manufacturer, place its sealof recognition on products that have demonstrated
efficacy against cavities or against plaque/gingivitis.
However, those products with the seal of recognition
must submit their packaging and advertising to the
CDA for approval. The CDA and the American
Dental Association (ADA) are two separate bodies
and are independent of one another, and don’t
always agree on issues. The CDA, for example,

914

Procter & Gamble-Scope

896

CASE 26 Procter & Gamble—Scope

EXHIBIT 4
Canadian Mouthwash Market Shares (%)
Units1990 Average
1988

1989

1990

Food

Drug

33.0

33.0

32.3

42.0

27.0

Listerine

15.2

16.1

16.6

12.0

19.0

Listermint

15.2

9.8

10.6

8.0

12.0

Cepacol

13.6

10.6

10.3

9.0

11.0

Colgate Oral Rinse

1.4

1.2

0.5

0.4

0.5

Scope

Plax

1.0

10.0

10.0

8.0

11.0

Store Brands

16.0

15.4

16.0

18.0

15.0

Miscellaneous Other

4.6

3.9

3.7

2.6

4.5

Total

100.0

100.0

100.0

100.0

100.0

Retail Sales (000,000)

$60.2

$65.4

$68.6

$24.0

$44.6

Source: Company records.

would not provide a “plaque/gingivitis” seal unlessclinical studies demonstrating actual gum healthimprovements were done.
3. Saccharin/Cyclamate Sweeteners: All mouthwashes
contain an artificial sweetener. In Canada, cyclamate
is used as the sweetener as saccharin is considered abanned substance. In contrast, the U.S. uses saccharin because cyclamate is prohibited. Thus, despite
the fact that many of the same brands competed inboth Canada and the U.S., the formulas in each country were different.

THE THREE-YEAR PLAN
In preparing the three-year plan for Scope, a team
had been formed within P&G to examine various
options. The team included individuals from product development (PDD), manufacturing, sales,
market research, finance, advertising, and operations. Over the past year, the team had completed avariety of activities relating to Scope.
The key issue, in Hearst’s mind, was how P&G
should capitalize on the emerging market segment
within the rinse category that focused more on“health-related benefits” than the traditional breath

strategy of Scope. Specifically with the launch ofPlax, the mouthwash market had segmented itself
along the “breath-only” brands (like Scope) andthose promising other benefits. Plax, in positioning
itself as a prebrushing rinse, was not seen as, nor
did it taste like, a “breath refreshment” mouthwash
like Scope.
Gwen Hearst believed that a line extension positioned against Plax, a recent entry into the market,
made the most sense. If the mouthwash market
became more segmented, and if these other brands
grew, her fear was that P&G would be left with alarge share of a segment that focused only on“breath” and hence might decline. However, shealso knew that there were questions regarding
both the strategic and financial implications ofsuch a proposal. Exhibit 7 provides historicalfinancials for Scope. In recent meetings, otherideas had been proposed, including “doing nothing” and looking at claims other than “breath”
that might be used by Scope instead of adding a
new product. Several team members questioned
whether there was any real threat, as Plax was
positioned very differently from Scope. As she915

Procter & Gamble-Scope

897

CASE 26 Procter & Gamble—Scope

EXHIBIT 5
Competitive Market Data—1990

EXHIBIT 6
Canada–U.S. Market Share
Comparison (1989) (% units)

Advertising Expenditures (000)
Scope
Listerine
Plax
Listermint
Cepacol$1,700
1,600
1,200
330
170

Media Plans
Scope
Listerine
Plax

No. of Weeks on Air

GRPs a

35
25
20

325
450
325

Food Stores

Drugstores

98
129
103
123
170
58
84
100

84
97
84
119
141
58
81
100

Retail Price Indices
Scope
Listerine
Listermint
ColgatePlax
Store Brand
Cepacol
Total Market b

Source: Company records.
a GRP (Gross Rating Points) is a measurement of advertising
impact derived by multiplying the number of persons exposed
to an advertisement by the average number of exposures perperson. The GRPs reported are monthly.
b An average weighted index of the retail prices of allmouthwash brands is calculated and indexed at 100 for bothfood stores and drugstores. Scope is priced slightly below thisindex in food stores and about 16% below in drugstores.

considered the alternatives, Hearst reviewed theactivities of the team and the issues that had beenraised by various team members.
PRODUCT DEVELOPMENT (PDD)
In product tests on Scope, PDD had demonstrated
that Scope reduced plaque better than brushingalone because of antibacterial ingredients contained in Scope. However, as yet P&G did not havea clinical database to convince the HPB to allow

BrandsCanadaUnited States

Scope

33.0

21.6

Listerine

16.1

28.7

Listermint

9.8

4.5

Cepacol

10.6

3.6

Plax

10.0

9.6

Source: Company records.

Scope to extend these claims into the prevention of
inflamed gums (as Listerine does).
PDD had recently developed a new prebrushingrinse product that performed as well as Plax but
did not work any better than Plax against plaquereduction. In fact, in their testing of Plax itself, PDD
were actually unable to replicate the plaque reduction claim made by Pfizer that “rinsing with Plax,
then brushing normally removes up to three times
more plaque than brushing alone.” The key benefitof P&G’s prebrushing rinse was that it did taste
better than Plax. Other than that, it had similar aesthetic qualities to Plax—qualities that made its “inmouth” experience quite different from that of
Scope.
The product development people in particularwere concerned about Hearst’s idea of launching aline extension because it was a product that was
only equal in efficacy to Plax for plaque reduction.
Traditionally, P&G had only launched productsthat focused on unmet consumer needs—typicallysuperior performing products. However, Hearst
had pointed out, because the new product offeredsimilar efficacy at a better taste, this was similar tothe situation when Scope was originally launched.
Some PDD members were also concerned that if
they couldn’t replicate Plax’s clinical results with
P&G’s stringent test methodology, and if the product possibly didn’t provide any greater benefit
than rinsing with liquid, that P&G’s image andcredibility with dental professionals might be
impacted. There was debate on this issue as others

916

Procter & Gamble-Scope

898

CASE 26 Procter & Gamble—Scope

EXHIBIT 7
Scope Historical Financials
Year

1988

1989

1990

Total Market Size (units) (000)

1,197

1,294

1,358

Scope Market Share

33.0%

33.0%

32.4%

Scope Volume (units) (000)

395

427

440

$(000)$/Unit$(000)$(Unit)$(000)$(Unit)Sales

16,76742.45

17,84741.80

18,150

41.25

COGS

10,73827.18

11,31626.50

11,40925.93

Gross Margin

6,029

15.27

7,299

15.30

6,741

15.32

Scope Marketing Plan Inputs
Scope “Going” Marketing Spending
Year

1990

1989

1988

Advertising (000)$1,700––

Promotion (000)

1,460

–

–

Total (000)

3,160

3,733

2,697

Marketing Input Costs
Advertising:
Promotion:(See above.)
Samples(Including Distribution): $0.45/piece

Mailed Couponing$10.00 per 1,000 for printing distribution$0.17 handling per redeemed coupon (beyond face value)
redemption rates: 10% to 15%

In-store Promotion$200/store (fixed)$0.17 handling per redeemed coupon (beyond face value)
redemption rates: 85% +Source: Company records.

felt that as long as the product did encourage better oral hygiene, it did provide a benefit. As further support, they noted that many professionals
did recommend Plax. Overall, PDD’s preference
was to not launch a new product but, instead, to
add plaque reduction claims to Scope. The basic
argument was that it was better to protect thebusiness that P&G was already in than to launch acompletely new entity. If a line extension was pursued, a product test costing $20,000 would be
required.

SALES
The sales people, who had seen the inroads Plax
had been making in the marketplace, believed that
Scope should respond quickly. They had one key
concern—as stock-keeping units (SKUs) had
begun to proliferate in many categories, the retailindustry had become much more stringent regarding what it would accept. Now, to be listed on
store shelves, a brand must be seen as uniqueenough from the competition to build incremental

917

Procter & Gamble-Scope

CASE 26 Procter & Gamble—Scopepurchases—otherwise retailers argued that category sales volume would simply be spread overmore units. When this happened, a retail outlet’s
profitability was reduced because inventory costs
were higher, but no additional sales revenue was
generated. When a new brand was viewed as not
generating more sales, retailers might still list thebrand by replacing units within the existing line
(e.g., drop shelf facings of Scope), or the manufacturer would pay approximately $50,000 per SKU
in listing fees to add the new brand. This fee of$50,000 per SKU would enable a manufacturer to
get national distribution with a retail chain suchas Shopper’s Drug Mart or Loblaws.
MARKET RESEARCH (MR)Market research had worked extensively withHearst to test the options with consumers. Theirwork to date had shown:
1. A plaque reassurance on current Scope (i.e., “Now
Scope fights plaque”) did not seem to increase competitive users’ desire to purchase Scope. This meantthat it was unlikely to generate additional volume
but it could prevent current users from switching.
MR also cautioned that in adding “reassurances” toa product, it often takes time before the consumer
accepts the idea and then acts on it. The issue inHearst’s mind was whether the reassurance would
ever be enough. At best it might stabilize the business,
she thought, but would it grow behind such a claim?
2. A “Better Tasting Prebrushing Dental Rinse” productdid research well among Plax users, but did notincrease purchase intent among people not currently
using a dental rinse. MR’s estimate was that a brandlaunched on this positioning, using the Scope name,would likely result in approximately a 6.5 percent
share of the total mouthwash and “rinse” market on
an ongoing basis. Historically, it has taken approximately two years to get to the ongoing level. However, there was no way for MR to accurately assess
potential Scope cannibalization. “Use your judgment,” MR had said. However, MR cautioned that
although it was a product for a different usage occasion, it was unlikely to be 100 percent incremental
business. Hearst’s best rough guess was that thisproduct might cannibalize somewhere between 2899

to 9 percent of Scope’s sales. An unresolved issue
was the product’s name—if it were launched, should
it be under the Scope name or not? One fear was that
if the Scope name was used it would either “turnoff” loyal users who saw Scope as a breath refreshment product or confuse them.

MR had questioned Hearst as to whether she
had really looked at all angles to meet her objective.
Because much of this work had been done quickly,
they wondered whether there weren’t some otherbenefits Scope could talk about that would interest
consumers and hence achieve the same objective.
They suggested that Hearst look at other alternatives beyond just “a plaque reassurance on Scope”
or a “line extension positioned as a ‘Better Tasting
Prebrushing Dental Rinse’.”

FINANCEThe point of view from finance was mixed. On the
one hand, Plax commanded a higher price/litre
and so it made sense that a new rinse might be a
profitable option. On the other hand, they wereconcerned about the capital costs and the marketing costs that might be involved to launch a line
extension. One option would be to source the product from a U.S. plant where the necessary equipment already existed. If the product was obtained
from the U.S., delivery costs would increase by$1.00 per unit. Scope’s current financial picture andan estimate of Plax’s financial picture are provided
in Exhibits 8 and 9.

PURCHASING
The purchasing manager had received the formulafor the line extension and estimated that the ingredients cost would increase by $2.55 per unit due tothe addition of new ingredients. However, because
one of the ingredients was very new, finance feltthat the actual ingredient change might vary by ±50 percent. Packaging costs would be $0.30 per unit
higher owing to the fact that the set-up charges
would be spread over a smaller base.

918

Procter & Gamble-Scope

900

CASE 26 Procter & Gamble—Scope

EXHIBIT 8
Scope 1990 Financials

EXHIBIT 9
Plax Financial Estimates (per unit)$(000)$/Units

Net sales

Net sales

18,150

41.25

COGS

Ingredients

3,590

8.16

Ingredients

6.50

Packaging

2,244

5.10

Packaging

8.30

65.09

Manufacturing

3,080

7.00

Manufacturing

6.50

Delivery

1,373

3.12

Delivery

3.00

Miscellaneous

1,122

2.55

Miscellaneous

1.06

11,409

25.93

Total

25.36

15.32

Source: P&G estimates.
Notes: General overhead costs estimated at $5.88/unit.

Cost of Goods Sold
Gross Margin

6,741

Source: Company records.

• Notes:• Net Sales = P&G revenues.
• Manufacturing: 50% of manufacturing cost is fixed,of which $200M is depreciation.
20% of manufacturing cost is labor.
• Miscellaneous: 75% of miscellaneous cost is fixed.
• General office overheads are $1,366M.
• Taxes are 40%.
• Currently the plant operates on a five-day, one-shiftoperation.
• P&G’s weighted average cost of capital is 12%.
• Total units sold in 1990 were 440,000.

ADVERTISING AGENCY
The advertising agency felt that making any new
claims for Scope was a huge strategic shift for thebrand. They favored a line extension. Scope’s strategy had always been “breath refreshment andgood tasting” focused, and they saw the plaqueclaims as very different, with potentially significant strategic implications. The one time they had
focused advertising only on taste and didn’t reinforce breath efficacy, market share fell. They wereconcerned that the current Scope consumer could
be confused if plaque or any “nonbreath” claims
were added and that Scope could actually lose
market share if this occurred. They also pointed

out that trying to communicate two different ideas
in one commercial was very difficult. They believed
the line extension was a completely different product than Scope with a different benefit and use
occasion. In their minds, a line extension would
need to be supported on an ongoing basis separately from Scope.
WHAT TO RECOMMEND?
Hearst knew the business team had thought longand hard about the issue. She knew that management was depending on the Scope business team tocome up with the right long-term plan for P&G—
even if that meant not introducing the new product. However, she felt there was too much risk
associated with P&G’s long-term position in oral
rinses if nothing was done. There was no easyanswer—and compounding the exigencies of thesituation was the fact that the business team had
differing points of view. She was faced with thedilemma of providing recommendations about
Scope, but also needed to ensure that there wasalignment and commitment from the business
team, or senior management would be unlikely toagree to the proposal.

919

Procter & Gamble-Scope

CASE 26 Procter & Gamble—Scope

901

APPENDIX A
PlaquePlaque is a soft, sticky film that coats teeth within hours
of brushing and may eventually harden into tartar. To
curb gum disease—from which over 90 percent of
Canadians suffer at some time—plaque must be curbed.
Research has shown that, without brushing, within 24
hours a film (plaque) starts to spread over teeth andgums and, over days, becomes a sticky, gelatinous mat,which the plaque bacteria spin from sugars andstarches. As the plaque grows, it becomes a home to yet
more bacteria—dozens of strains. A mature plaque isabout 75 percent bacteria; the remainder consists oforganic solids from saliva, water, and other cells shedfrom soft oral tissues.
As plaque bacteria digest food, they also manufacture
irritating malodorous by-products, all of which canharm a tooth’s supporting tissues as they seep into thecrevice below the gum line. Within 10 to 21 days,
depending on the person, signs of gingivitis—themildest gum disease—first appear; gums deepen incolor, swell, and lose their normally tight, arching contour around teeth. Such gingivitis is entirely reversible.
It can disappear within a week after regular brushingand flossing are resumed. When plaque isn’t kept undercontrol, gingivitis can be the first step down toward
periodontitis, the more advanced gum disease in whichbone and other structures that support the teeth become
damaged. Teeth can loosen and fall out, or require
extraction.
The traditional and still best approach to plaque control is careful and thorough brushing and flossing toscrub teeth clean of plaque. Indeed, the anti-plaqueclaims that toothpastes carry are usually based on the
product’s ability to clean teeth mechanically, withbrushing. Toothpastes contain abrasives, detergent, andfoaming agents, all of which help the brush do its
work.
Source: “The Plaque Debate,” Canadian Consumer, 1990. No. 9,
pp. 17–23.

C A S E 2 7 FedEx and UPS in China—
Competing with Contrasting
StrategiesJ

ust how “American” should you be when doing
business many cultures away from home?
Rarely have two rivals offering similar services
answered that question so differently as Federal
Express Corp. and United Parcel Service ofAmerica, Inc.
FedEx was trying to paint China red, white andblue, following the same frontal-assault strategy it
employed in the U.S. in the 1970s and in Europe in
the 1980s. While promoting itself with jarring,Western-style advertising, FedEx was pouring out
money to acquire its own air routes, fly its own
aircraft into and out of China and, in partnershipwith an aggressive local company, built a huge
network of purple and orange trucks and distribution centers.
“We’re the largest all-cargo carrier in the world
and, as a result, we’ve got a pretty good formulafor attacking any market,” noted T. Michael Glenn,
executive vice president for marketing at FedEx’s
parent, FDX Corp. “Whether it’s China or Japan orGermany, it really doesn’t make any difference.”
UPS, by contrast, hopes that Chinese customers
won’t even notice that it was made in America. Its
advertising was understated and old-fashioned
even by Chinese standards. Its freight lands in
China packed into leased space in the underbelliesof planes operated by a Hong Kong airline,
Dragonair, or other regional carriers. To deliver
packages on the ground, UPS followed the traditional approach for foreign freight companies in
China, piggybacking on the operations ofSinotrans, a vast, labyrinthine, government-owned
transportation company.

45“We’re a quiet company,” remarked Charles
Adams, UPS’s top executive in Asia. “Sometimes
we’re the student, and sometimes we’re theteacher.”
How the giants of the U.S. delivery businesswere forging ahead in China was more than a casestudy on differing corporate styles. Their strategies,
which tracked what they did all across Asia, vividly
illustrated two radically different approaches toquestions faced by almost any U.S. company striving to expand overseas. Do we partner withentrenched competitors or tackle them head-on? Do
we risk the capital to build our own manufacturing
and distribution systems or lease someone else’s?
Who are our customers, the locals or our multinational accounts? How much do we risk to build
future market share?
IS THERE A WINNING STRATEGY?
The jury was still out for both FedEx and UPS.
Neither was discussing market share or disclosing
specific financial results in China. However, eachsaid its operations were growing and profitable,
and each contended that its approach was better.
In the Spring of 1998, UPS executives, bufferedby their lower spending from much of the turmoil
in Asia, had been quietly congratulating themselves on the apparent wisdom of their low-risk
approach. As freight traffic slowed in the region,
UPS had simply reduced the space it leased onother companies’ planes.
“Because of the investment (FedEx) made,they’re almost stuck in that market,” remarked

This case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

902

921

922

FedEx and UPS in China-Competing with Contrasting Strategies

CASE 27 FedEx and UPS in China—Competing with Contrasting Strategies

Joseph M. Pyne, UPS’s vice president for marketing. “That’s the plan they have to live with. We’relooking at the market and moving with it inChina.”
Meanwhile, at FedEx, currency devaluations
elsewhere in Asia had cut profits by more than $20
million during the first six months of 1998. On
March 25, 1998, the company posted its first quarterly loss on international operations since 1996,
largely because of the high costs attributable to its
extensive air network in Asia, coupled with declining cargo volume and revenue in the region.
Nevertheless, FedEx noted China remained “abright spot.” Air-freight volumes from troubled
Asian nations to China declined, but China’s
exports were still strong, remarked Michael L.
Drucker, FedEx’s top executive in Asia.
FedEx added that, despite the expense, its “build
it and they will come” strategy was paying off in
the market share. Estimates vary, but according to
Air Cargo Management Group, a Seattle consultancy, FedEx had captured 13 percent of the express
market in China, excluding Hong Kong, while UPS
trailed with less than 5 percent. “We knew it wasrisky when we built so much capacity, but we’restaying. And that has just got to have a long-term
payoff,” noted the FDX’s chief financial officer.
The payoff was critical for both companies.
Although both were still small players in China,
each with less than half the express-freight market
share of at least 30 percent held by DHL International Ltd., a long-established Brussels-based company,
both viewed China as the industry’s most important
emerging market. China’s demand for time-definite
express freight—the high-profit sector they crave—
was projected to grow as much as 20 percent a year
through 2002, far faster than the world-wide airfreight market. Currently, China’s air-cargo market
was the world’s fifth largest, and its embryonicexpress sector was valued at $400 million a year.
“It’s hard to be unmindful of a 1.2 billion-person
country that arguably has the most entrepreneurial,
merchant-oriented people in the world,” said
Frederick W. Smith, FDX’s founder, chairman andchief executive officer.

903

FEDEX’S CULTURE
FedEx’s approach to that market reflected its personality at home. The company, and Mr. Smith, liked sizzle. With $12 billion in annual revenue, FedEx prided
itself on having blitzkrieged the U.S. freight businessby inventing overnight delivery in the 1970s. It called
itself a “global evangelist” for high-tech, just-in-time
deliveries. Its U.S. ad campaigns had long poked fun
at competitors and warned business executives ofcertain humiliation if they used any other delivery
company. FedEx pursued that strategy in China,
even at the risk of seeming cheeky. Last year, it ran aubiquitous print ad in Asia showing the tail of a
FedEx plane parked in front of the Forbidden City—a cherished array of imperial buildings that was off
limits to the public for 500 years. “Call FedEx,” thead said. “It’s almost forbidden not to.”“I don’t know that I agree that there’s a sort ofChinese way and an American way,” Mr. Smith
noted. “I think there is an establishment way . . .
and China at the moment is a country that is very
entrepreneurial in nature. We are more consonantwith the new China.”
Nonetheless, the FedEx style seemed to annoy
some companies that expected a certain tone in theformal face-to-face sales pitches traditional in
China. “I know they’re one of the biggest companies in the U.S.A., but that doesn’t matter here,”
said Li Ping, an executive at Chinatex Cotton Yarns& Fabrics Import & Export Corp. in Beijing. “Thepersonal relationship matters most here. You haveto talk to customers and make them feel good. . . .
They haven’t sent anyone here; so we don’t dobusiness with them.”
FedEx was not worried. Instead of chasing theestablished Chinese business clique, it was focusing first on multinational corporations with
Chinese operations that already used FedEx elsewhere. It also was targeting expanding Chinese
entrepreneurs whom FedEx believed would readily
adopt its mantra about cutting-edge manufacturing
and delivery techniques.
For those customers, who valued a highly
controlled distribution system and constant

FedEx and UPS in China-Competing with Contrasting Strategies

904

CASE 27 FedEx and UPS in China—Competing with Contrasting Strategies

information about the status of shipments, FedEx’s
philosophy was appealing. Wang Fazhang, a manager at Siemens Technology Development Corp. of
Beijing, a unit of Siemens AG of Germany, noted
using FedEx cut the delivery time for medicalequipment spare parts from Europe to three days
from 28.
To achieve such results, FedEx was trying toleapfrog rivals in China and all across Asia byspending millions to build a network much like theone it operated in the U.S. That investment started
in 1988 with its $880 million acquisition of Flying
Tiger Line Inc.; FedEx mostly wanted the cargo carrier’s Asian routes, including a coveted but longunused link between Japan and China. In 1995,
FedEx paid Evergreen International Aviation Inc.
$67.5 million according to Evergreens’ regulatory
filings, to buy the only operating authority currently permitting a U.S. cargo carrier to fly directly
into China.
MUCH CHEAP CARGO
Using that authority, FedEx flew an MD-11, ladenwith up to 170,000 pounds of freight, into Beijing
and Shanghai four times a week. For now, FedEx
filled much of the plane with cheap air cargo, forwhich it charged as little as $2 a pound and made,at best, a slim profit. As more manufacturing operations in China adopted just-in-time manufacturing systems, however, FedEx believed that the bulk
freight would shift to highly profitable smallpackage services, for which the company charged
up to $30 a pound. FedEx promised delivery of
packages from the U.S. to China in three days, but
often they arrived in just two days. Deliveries from
China to the U.S. frequently arrived overnight.
In more than a dozen major cities in China,
FedEx’s operations, trucks and employees looked
identical to those in the U.S. In scores of other cities,
FedEx packages were delivered in aqua-blue trucks
and painted with the logos of both FedEx and its
Chinese affiliate.

UPS STYLE
The 91-year-old UPS, with its giant, mostly groundbased U.S. delivery network and annual revenue ofabout $22.46 billion, was adhering to its long history of keeping a low profile. Until recent years, thecompany, owned mostly by its managers andretirees, eschewed any marketing at all, even at
home. Its boldest advertising moves had beensponsorship of the Olympic games in 1996 and1998.
Therefore, in China, UPS was doing as the
Chinese do. Its marketing sought to build relationships discreetly, on Chinese terms—even though it,
too felt multinationals were the core of its initial
customer base here.
Monica Yan, an ad executive at China Guoxin
Information Corp., switched to UPS from the staterun express-mail service after a UPS account executive came calling at her office in Beijing. “Shecame here and explained to me how UPS could be
more convenient and not cost so much money, so I
decided to use her company,” Ms. Yan noted.
In promoting itself, UPS emphasized its global
network and stability, virtues that ring true formany Chinese. It also nurtured a Chinese customer
base outside China, sponsoring Chinese New Yearcelebrations in Toronto and Vancouver, where
many recent immigrants lived. A six-week UPS
television campaign in China showed a motorized
three-wheeler moving down a runway, followed bya larger van, a truck, and then a 747. “Their ads
show lots of planes and trucks, with a very big
world-wide network,” said Chen Bin, a manager ofa state-owned logistics company in Beijing. “Theimage is not American” but “more world-wide.”
Investing just a fraction of what FedEx had put
into Asia, UPS had gradually expanded withdemand, trading some market share for morelimited risk. Meanwhile, it felt it could catch up
whenever the market was ripe.
Thus, Big Brown operated without a single aircraft in China. It offered “total brown” service—

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FedEx and UPS in China-Competing with Contrasting Strategies

CASE 27 FedEx and UPS in China—Competing with Contrasting Strategies

packages were picked up by workers in brown UPS
uniforms, driving brown trucks—in Beijing,
Shanghai, and only one other Chinese city,
Guangzhou.
Lacking its own air service, UPS could not offer
customers in China the range of logistical services
that FedEx could. However, UPS, while avoiding
the cheap air cargo that FedEx depended upon tofill out its aircraft, could still skim from the cream905

of the business, the lucrative document and smallpackage sector. The upshot: UPS could deliver a
one-pound package or document from the U.S. tomajor Chinese cities in the same time FedEx
promised, three days, at a price of about $47. For
now, UPS executives felt that was plenty.
“If the situation changes in five to 10 years, thenmaybe we’ll want our own planes in China,” UPS’s
Mr. Adams noted. “But that’s not a priority now.”C A S E 2 8 Playboy Enterprises,Inc.(A)In early 1986, Christie Hefner, president and chief
operating officer, Playboy Enterprises, Inc., hadbeen reviewing the company’s strategies to face thechanging world. Once considered a trendsetter for
urban sophisticates, the adult leisure company inrecent years has increasingly found its offerings outof step with the times.
As a writer on social issues put it, “The image ofthe playboy in a smoking jacket is obsolete. People
today are more interested in their cars and theircareers than they are in sex.” Although that claim
may be open to dispute, Playboy has reason to bealarmed. The circulation of its flagship magazine
has dwindled to just over four million a monthfrom more than seven million in 1972. The numberof Playboy Club key holders has fallen steadily. The
cable television Playboy Channel, once seen as crucial to the company’s future, loses money and has
yet to prove that it can survive in its highly competitive field.
Between 1983 and 1985, Playboy’s revenue fell bynearly 50 percent. It earned a profit on operations
in only one of four years between 1982 and 1985,
when it was forced by old legal problems to giveup its lucrative casinos. The company was in theblack (by $6.7 million) in its 1985 fiscal year only
because of returns on $60 million in investments.
Its auditors qualified their opinion on the financial
statement for that year because of uncertainty overwhether Playboy could collect all it is owed on one
casino sale.
COMPANY HISTORY
Initially, Playboy Enterprises, Inc. was establishedas HMH Publishing Company in 1953 to publish
Playboy. The present name was adopted in 1971.
Today, the company’s businesses, in addition
to Playboy and Games magazines, include the46

development and production of programming
principally for pay television and videocassettes
and products for direct sale and licensing that feature the Playboy name and trademarks for worldwide distribution. In addition, the company owns
and franchises Playboy Clubs. In the 1970s, thecompany entered the resort hotel and casino business in different places, including London, Miami,
the Bahamas, and Atlantic City. However, in 1982
the company discontinued its resort hotel andcasino operations.
ENVIRONMENTAL CHANGESPlayboy is a victim of the social changes it helped
promote. Attitudes toward sex have evolved
rapidly since the days when the magazine could
shock millions by publishing two photographs ofan undraped Marilyn Monroe. Today, Playboy
must compete, not only with countless far morelurid “skin books,” but also against the popular
media. Rock songs may have X-rated lyrics and an
episode of “Dynasty” may be nearly as titillating
as a centerfold.
As Ms. Hefner puts it, “We no longer can contrast ourselves to a gray-flannel Eisenhower society. It’s now a lot more difficult for us to offer
something unique.”Yet Playboy also finds itself considerably vexed
these days by those who consider its business
immoral or sexist or both. Although its cable television fare isn’t hard-core, for instance, it hasrepeatedly been challenged in court (so far unsuccessfully) by communities that want it banned.
After ABC recently broadcast a film based on
Gloria Steinem’s critical account of her 1963 stint as
a bunny, Playboy President Christie Hefner fired
off a memo asking her staff to “ponder what it isPlayboy and all of its resources can and should beThis case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

906

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Playboy Enterprises, Inc. (A)CASE 28 Playboy Enterprises, Inc. (A)doing to counter the . . . misimpression out therethat we are not good guys.”
Perhaps a tougher problem for Hefner, though,is finding a clear mission for Playboy in the 1990s,
one as potent as her father’s former vision for thecompany. In an era of aggressive careerism among
both sexes, the company no longer gets much
mileage out of the so-called Playboy philosophy,
Mr. Hefner’s concept of the lifestyle of a man ofleisure.
THE REAL PROBLEM
Some company officials believe that one ofPlayboy’s biggest handicaps may be its association
with the public image of its founder, now 59 years
old. As a Playboy executive put it, “Pajamas justaren’t as fashionable as they used to be.”Though still the best-selling magazine for men,
Playboy has fallen far behind arch-rival Penthouse inlucrative newsstand sales. According to Penthouse
publisher Bob Guccione, “Playboy’s market is older
and its readers are passing into oblivion.” Playboy
executives say that the readership age difference isminimal. However, there are other worrisome
signs. A Chicago newsstand operator who has soldmany copies of Playboy speaks of the typical buyer
as “a guy who thinks he’s up-to-date but isn’t.”
One woman who posed for a pictorial was surprised when she saw the letters the feature generated: “A whole bunch of them were from guys inprison.” A former public relations executive for
Playboy contends that the company “doesn’t wantto face reality—that time has passed it by.”NEW STRATEGY
Against this background, Playboy Enterprises isundertaking what Hefner calls a “repositioning.”
The strategy, she says, is to go after a more upscaleaudience by being more in tune with current tastes
and values. “I think we should be on the cuttingedge of how people who have changed their behavior to reflect a more liberal lifestyle are going tolive.”

907

The October 1985 issue of Playboy, marked“Collector’s Edition,” began what the company
calls the magazine’s next generation. This included
greater coverage of such “life style” subjects as personal finance and home electronics. An ad in thatissue asked, “What sort of man reads Playboy?” andoffered as an example race car driver Danny
Sullivan. Posing in a black silk evening jacket, he
explained that he “grew with the magazine,” learning, for instance, to care about clothes. Curiously,
elsewhere in the issue was a piece satirizing theconsumer society.
Sensitive to criticism that it portrays women assex objects, Playboy intends to feature some who are
more mature or more accomplished. The lead feature in the November 1985 issue was a nod in thisdirection, but it hardly seemed likely to defuse themoral issue. Picturing members of Mensa, the club
people can join only if they have high IQs, the feature was entitled “America’s Smartest Girls Pose
Nude.”
Nevertheless, Hefner says Playboy’s effort tomove upscale is working. As evidence, she notesthat the October 1985 issue carried advertising forCampbell Soup’s Le Menu frozen dinners.
Covers of the new generation Playboy are to havea glitzier look. They are planned in long meetings
by a committee of fashion and art experts who try
to base their designs as much on the latest fashions
as on erotic content.
The graphics also are slicker and a different
printing process binds pages with glue instead ofstaples, giving a more finished look. According toPlayboy’s art director, “The magazine is supposed
to look a lot more like the kind of thing you’d put
on a coffee table.” That goal may be a bit optimistic, however; newsstands say that half of thebuyers of Playboy still ask for a paper bag to carry
it home.
The new magazine retains many standard features, like the Playboy Advisor, which intersperses
advice about sex with answers to questions about
stereos or turbochargers. Some editors complain
about the uneven quality and occasionally questionable taste of color cartoons. Mr. Hefner himself

Playboy Enterprises, Inc. (A)908

CASE 28 Playboy Enterprises, Inc. (A)is said to have rejected an editor’s plea to eliminate
the Party Jokes feature, which in the October 1985
issue regaled readers with one-liners like, “What’sboffo box office among milkmaids? Pail Rider.”The “repositioning” also applies to the Playboy
Clubs, which haven’t had a major updating since
they were started a quarter-century ago. Even witha recent redecorating, the club in Chicago, with its
plush red carpeting and black leather bar stools,
looks a little like a museum for the jazz age. A gift
shop upfront peddling Playboy T-shirts, cigarette
lighters, and golf putters lends a touristy atmosphere to the place.
Rather than confront the deteriorating image ofits big-city clubs, Playboy several years ago headed
for the hinterlands, franchising clubs in places like
Lansing, Michigan, and Des Moines, Iowa, where
they might still have novelty value. However, without a strong big-city base, the whole chain lost its
urban gleam. The Lansing club began resorting tosuch decidedly unglamorous promotions as lipsync contests and valet parking for farm tractors.

THE NEW YORK EXPERIMENTIn the fall of 1985, the company reopened its newly
done New York club. It was a bold experiment. The
cottontailed bunnies were replaced by hostesses
greeting guests wearing long, glittering Jean
Harlow-style gowns. Some of the waiters weremen. Absent were the traditional pool table, party
balloons, and Leroy Neiman paintings. Instead,
video effects, stage acts, and music by a 10-piecehouse orchestra were offered.
The New York club’s new look was sculpted by
Richard Melman, who is noted for elaborate concept restaurants that are as much show-biz productions as eateries. He selected bunnies with talent asbodybuilders, astrologists, and jugglers. Costumes
ranged from a sequined one called the MichaelJackson outfit, to sweater dresses, to a take-off ofthe current cottontail suit. The idea of male waiters(called rabbits) was to help women feel more comfortable in the club.

It remains to be seen if the company will convert
other clubs to the New York style. The company
has 12 other Playboy Clubs, 10 of which are franchised rather than company owned. A section of
the club called Cafe Playboy may be tested as a prototype for a chain of franchised bars open to the
public. (A Playboy key still is needed for admittance to the clubs, though temporary memberships
are readily available.)

STRATEGY FOR OTHER BUSINESSES
Playboy’s products division, too, is working to bolster the company’s image—or at least to stop
endangering it. The division has sold countless key
chains, air fresheners, and the like, even though
doing so risked cheapening the company’s trademark. Now Playboy is moving away from novelty
items and into fashion apparel and branded consumer products. One success is Playboy’s men’s
underwear, the second-best-selling brand.
Playboy still has some hard thinking to do about
its video operation. The division, which launched
the first sex-oriented cable channel for a mass audience five years ago, had identity problems from thestart. Unable to decide how racy to be, the channel
wound up alienating viewers at both ends of thespectrum.
Earlier in 1985, for instance, the channel stopped
offering erotic programming during prime timeand switched to mainstream movies and quasijournalistic specials such as “Omar Sharif Hosts theProstitutes of Paris.” Viewership dropped andPlayboy soon reverted to prime-time prurience.
Partly because of its turnabouts, the Playboy
Channel has had the highest disconnect rate in theindustry, 13 percent of viewers each month. Its current level of about 762,000 subscribers isn’t enoughto pay for the quality programming that might
attract a larger audience. At $20 million, the channel’s yearly budget is less than a network might
spend during a season on a single series.
As a result, Playboy is de-emphasizing the channel as its main outlet for programming and will

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Playboy Enterprises, Inc. (A)CASE 28 Playboy Enterprises, Inc. (A)focus more on cassette sales and a recently
launched pay-per-view service. It is also weighinga return to producing a late-night variety show orhour-long specials, either of which it would try tosell to one of the networks.

909

Still, Playboy’s video operations, like the rest of
its empire, is continuing to grope for the right formula for today’s audience. As Ms. Hefner sums up,“We have to reflect a modern, sophisticatedimage.”

CASE 29

Playboy Enterprises, Inc. (B)In Fall 1998, Christie Hefner, chairman and chief
executive officer of Playboy Enterprises was contemplating a new strategy for the company thatwould most likely put the company on a growthpath. The strategy called for offering a range of
products and services to lure female customers.
CURRENT SITUATION
Back in the 1980s, Playboy Enterprises faces suchsevere financial problems that it considered going
private. Ms. Hefner, who was named CEO in 1988,
has put the company back on solid ground. She
shuttered Playboy’s faded nightclubs, with theirscantily-clad Playboy bunny hostesses, and she got
the company out of the profitable, but troublesome,casino business following scrutiny by U.K. and
U.S. regulators over licensing requirements.
1997 was Playboy’s most profitable fiscal year ina decade. The company reported net income(including a sizable tax benefit) of $21.4 million, or$1.05 a share, on revenue of about $300 million. The
price of the company’s Class-B nonvoting shares
had climbed to around $16 a share from about $4 ashare in 1990.
However, Playboy still desperately needs ayounger and bigger audience, and now the searchis on for ways to create new cachet for the brand.
Ms. Hefner would like to reorient the company
toward the 18–34-year-old females. According toher, these consumers are “pro-sex feminists,” andtheir age mirrors that of their target male demographic. They grew up with the sexual revolution
and the womens’ movement behind them. They are
pro-sex and pro-responsible sex, which is what
Playboy stands for in a unique way.

47

THE NEW STRATEGY
In 1999, the company planned to launch an apparelline for women and men, produced by California
Sunshine Activewear Inc., which also manufactured for GUESS? Inc. The Line would be sold via
the Playboy catalog, Web site, and in collegecampus and specialty gift stores. It included dainty,
spaghetti-strap tank tops and shorts with the
rabbit-head logo. Future plans called for sleepwear,
sunglasses, and even home furnishings that evoke“Hef’s” Los Angeles mansion.
Recently, Playboy began handing out rabbithead stickers in nightclubs. The famed mansion
was seeing a resurgence of young celebrity guests,
including heartthrob Leonardo DiCaprio andsinger Fiona Apple.
Playboy believed its timing was ripe. The last
two years had brought kitsch back in style, fromdark denim Sergio Valente jeans to Kiss to “Austin
Powers,” the hit movie about a groovy womanizer.
The craze wasn’t over yet. The new movie “Velvet
Goldmine” was dredging up David Bowie’s 1970
rock look.
Given all that, a comeback for the Playboy logo
might not be far-fetched. The clothes seemed “fun,and sort of antifashion fashion.” An industry
observer notes, “They’ve got world-wide recognition with the bunny head. There will be some
women who find it degrading, but it’s not like 20
years ago. I think it’s going to fly on the 18-year old
girls.”The resurgence depended in part on Playboy’s
assumptions that young men and women today
were more open about sexuality, whether discussing Monica Lewinsky at work or sharing unisex fragrances. “It’s true that there just aren’t asThis case was prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.

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Playboy Enterprises, Inc. (B)CASE 29 Playboy Enterprises, Inc. (B)many boundaries anymore,” says Heidi Willis, a 26
year-old freelance publicist in New York. She says
she’d wear the Playboy tops jogging or to clubs,“probably with black cigarette pants.”
However, retailers may be a tougher sell. Somemay question the viability of targeting somethingthat was so blatantly sexist historically to the modern woman.
Making the magazine appeal more to womenmight be even trickier. Playboy opined it can be
done. Just look at he success of the October issue,
which featured fashion model Cindy Crawford on
the cover and in the nude pictorial inside reminiscent of an artsy fashion spread. Playboy says theissue was one of its best-sellers, and female readers
were a big reason.
Over the long haul, Playboy was banking on its
entertainment division—including cable and pay-911

per-view channels—and its online operations to
tap the female market. The company noted couples make up about 70 percent of the audience forits videos and TV programs, including such fareas “Erotic Escapades,” about couples acting out
fantasies. Several ads for the Playboy TV channel
featured women confiding, “I watch it too.” Theentertainment unit made twice the profits on halfof the revenues of the publishing division lastyear.
The company believed the pitch to womenmight work best online. Already on its Web site,
Playboy had celebrity chat sessions and personalads, and sold products like martini shakers andjazz guides. According to company sources, it was
in talks with some women’s Web sites and print
publications about possible partnerships, including
sites for chatting and perhaps dating.