DETAILED SYLLABUS
SEMESTER ONE
MARKETING MODULE
BATCH 2008 – 2010
PRINCIPLES OF MANAGEMENT
Evolution of Management
The real development of management thought began with scientific management approach put forward by Frederick Winslow Taylor though some concepts have been developed by early thinkers. However it was only by the end of the nineteenth century that the stage was set for systematic study of management and the beginning was made by Taylor.
Scientific management
In 1911, Frederick Winslow Taylor published his work, The Principles of Scientific Management, in which he described how the application of the scientific method to the management of workers greatly could improve productivity. Scientific management methods called for optimizing the way that tasks were performed and simplifying the jobs enough so that workers could be trained to perform their specialized sequence of motions in the one "best" way.
Prior to scientific management, work was performed by skilled craftsmen who had learned their jobs in lengthy apprenticeships. They made their own decisions about how their job was to be performed. Scientific management took away much of this autonomy and converted skilled crafts into a series of simplified jobs that could be performed by unskilled workers who easily could be trained for the tasks.
Taylor became interested in improving worker productivity early in his career when he observed gross inefficiencies during his contact with steel workers.
He is often called the father of scientific management.
His contribution consists of the features and principles of Scientific Management
Taylor conducted experiments at his work places to find out how human beings could be made more efficient by standardising the work and through better method of working. Taylor argued that even the most basic, mindless tasks could be planned in a way that dramatically would increase productivity, and that scientific management of the work was more effective than the "initiative and incentive" method of motivating workers. The initiative and incentive method offered an incentive to increase productivity but placed the responsibility on the worker to figure out how to do it.
To scientifically determine the optimal way to perform a job, Taylor performed experiments that he called time studies, (also known as time and motion studies). These studies were characterized by the use of a stopwatch to time a worker's sequence of motions, with the goal of determining the one best way to perform a job.
The following are examples of some of the time-and-motion studies that were performed by Taylor and others in the era of scientific management.
Pig Iron
If workers were moving 12 1/2 tons of pig iron per day and they could be incentivized to try to move 47 1/2 tons per day, left to their own wits they probably would become exhausted after a few hours and fail to reach their goal. However, by first conducting experiments to determine the amount of resting that was necessary, the worker's manager could determine the optimal timing of lifting and resting so that the worker could move the 47 1/2 tons per day without tiring.
Not all workers were physically capable of moving 47 1/2 tons per day; perhaps only 1/8 of the pig iron handlers were capable of doing so. While these 1/8 were not extraordinary people who were highly prized by society, their physical capabilities were well-suited to moving pig iron. This example suggests that workers should be selected according to how well they are suited for a particular job.
The Science of Shoveling
In another study of the "science of shoveling", Taylor ran time studies to determine that the optimal weight that a worker should lift in a shovel was 21 pounds. Since there is a wide range of densities of materials, the shovel should be sized so that it would hold 21 pounds of the substance being shoveled. The firm provided the workers with optimal shovels. The result was a three to four fold increase in productivity and workers were rewarded with pay increases. Prior to scientific management, workers used their own shovels and rarely had the optimal one for the job.
These experiments gave rise to the following features of scientific management
1) Separation of planning and doing: Emphasized the importance of this. Planning should be left to the supervisor and the doing to the worker.
2) Functional foremanship
3) Standardisation: Standardisation should be maintained in instruments and tools,period and amount of work, working conditions, cost of production etc as this would enhance efficiency .
4) Scientific Selection and training of workers: Workers should be selected on a scientific basis considering their education, work experience, physical strength etc. Proper training is needed to ensure efficiency and effectiveness.
5) Financial incentives: These act as a motivating factor. Provide higher wages for extra effort.He suggested the differential piece rate system which should be based on individual performance and not on the position occupied by the worker.
6) Mental revolution: Scientific management depends on mutual cooperation between the workers and management.This requires a mental change in both parties from the traditional attitude of conflict to cooperation.
Taylor's 4 Principles of Scientific Management
After years of various experiments to determine optimal work methods, Taylor proposed the following four principles of scientific management:
1. Replace rule-of-thumb work methods with methods based on a scientific study of the tasks.
2. Scientifically select, train, and develop each worker rather than passively leaving them to train themselves.
3. Cooperate with the workers to ensure that the scientifically developed methods are being followed.
4. Divide work nearly equally between managers and workers, so that the managers apply scientific management principles to planning the work and the workers actually perform the tasks.
These principles were implemented in many factories, often increasing productivity by a factor of three or more. Henry Ford applied Taylor's principles in his automobile factories, and families even began to perform their household tasks based on the results of time and motion studies.
Drawbacks of Scientific Management
While scientific management principles improved productivity and had a substantial impact on industry, they also increased the monotony of work. The core job dimensions of skill variety, task identity, task significance, autonomy, and feedback all were missing from the picture of scientific management.this reductionist approach dehumanizes the worker.
The methods of motivation started and finished at monetary incentives only.
Taylor`s attitude towards workers had a negative bias.According to him, in the majority of cases workers plan to do as little as they safely can.
Despite its controversy, scientific management changed the way that work was done, and forms of it continue to be used today.
Administrative Theory
Perhaps the real father of modern management theory is the French industrialist Henri Fayol.His contribution is termed as administrative management. His contributions were first published in the book titled “Administration Industrielle at Generale” in French
Fayol found that the activities of an organisation can be divided into
1) Technical(production related)
2) Commercial(buying, selling and exchange)
3) Financial(search for capital and its optimum use)
4) Security(protection of person and property)
5) Accounting
6) Managerial( planning, organising, coordinating, leading and controlling)
Fayol recognized the need for management teaching and developed fourteen principles of management.
These principles according to Fayol are not exhaustive, nor rigid. They are
1) Division of work: this leads to the advantage of specialisation. According to him specialisation belongs to natural order. The workers always work on the same part and a particular manager is concerned with the same matters. This help to acquire an ability, sureness, accuracy and increase in output.
2) Authority and responsibility: Official authority is derived from the mangers position in the organisation. Responsibility arises from the assignment of activities. There should be parity between the two.
3) Discipline: Discipline may be self imposed or command discipline. Self imposed comes from within while command stems from recognised authority and uses rules, regulations and deterrents etc to ensure compliance
4) Unity of Command: A person should get orders from only one boss. This will help to avoid conflict in instructions and will lead to greater personal responsibility of managers and workers.
5) Unity of Direction: Each group of activities with the same objective must have one head and on plan. The different departments must work in tandem towards the common goal.
6) Subordination of individual to general interest: Workers individual interest must bow down before general organisational interest and must be aligned with the interest of the organisation.
7) Remuneration: fair and adequate remuneration is needed to provide satisfaction. Fayol also favoured non financial benefits.
8) Centralisation: The extent of centralisation or decentralisation should be appropropriately determined. In small firms centralisation is natural but in large ones decentralisation of authority and a taller organisation structure is needed.
9) Scalar chain: There should be a scalar chain of authority and of communication ranging from highest to lowest. It suggests that each communication going up or down must flow through each position in the line of authority. It can be short-circuited only in circumstances where following it would be detrimental.
10) Order: This is the principle relating to the arrangement of things and people. In material order there should be a place for everything and everything should be in its right place. In social order the right man should be in the right place.
11) Equity: Equitable, just treatment and behaviour towards employees brings loyalty to the organisation.
12) Stability of tenure: Reasonable job security should be provided. Efforts should be made to ensure that unnecessary turnover does not take place.
13) Initiative: Within the limits of authority and discipline, employees should be encouraged to take initiative.
14) Espirit de Corps: This is the principle that ‘union is strength’, and of establishing team work.
Bureaucratic Management (1864-1920)
A bureaucracy is a highly structured, formalized, and impersonal organisation. It is a formal organisation structure with set of rules and regulations. Max Weber embellished the scientific management theory with his bureaucratic theory. Weber focused on dividing organizations into hierarchies, establishing strong lines of authority and control. He suggested organizations develop comprehensive and detailed standard operating procedures for all routinized tasks.
Bureaucratic organisation emphasizes the need for organisations to function on rational basis.
Features
• A continuous organisation of official functions bound by rules.
• Systematic division of labour rights and power
• Principle of hierarchy
• The rules governing the conduct of an organisation may be technical rules or norms. Specialized training is needed.
• It is a matter of principle that members of the administrative staff should be separated from the ownership of the means of production and administration.
• There should be complete absence of appropriation of official position by the incumbent.
Advantages
• Removes ambiguity and inefficiency owing to clarity of work and processes
• Highly structured
• Very formalized
• Impersonal organisation
Drawbacks
• Overemphasis on rules and procedures, record keeping and paperwork as an end rather than a means to an end
• Dependence on bureaucratic status, symbols and rules
• Lack of initiative due to lack of accountability in many cases
• Position in the organisation often gives rise to officious bureaucratic behaviour
• Impersonal organisation leads to stereotype behaviour and lack of responsiveness to individual incidents and problems
• Red tapism
• The compartmentalisation of work restricts psychological growth of the individual and may cause frustration, feelings of failure and conflict
• Over emphasis on process rather than purpose, fragmented responsibility and hierarchical control means that it is all too easy to neglect the larger purpose for which the smaller effort is being put.
Human Relations School
Behavioural or human relations management emerged in the 1920s and dealt with the human aspects of organizations. It has been referred to as the neoclassical school because it was initially a reaction to the shortcomings of the classical approaches to management. The human relations movement began with the Hawthorne Studies which were conducted from 1924 to 1933 at the Hawthorne Plant of the Western Electric Company in Cicero, Illinois.
The Hawthorne Studies
Harvard Business School researchers, T.N. Whitehead, Elton Mayo, and George Homans, were led by Fritz Roethlisberger. Elton Mayo, known as the Father of the Hawthorne Studies, identified the Hawthorne Effect or the bias that occurs when people know that they are being studied. The Hawthorne Studies are significant because they demonstrated the important influence of human factors on worker productivity.
There were four major phases to the Hawthorne Studies: the illumination experiments, the relay assembly group experiments, the interviewing program, and the bank wiring group studies. The intent of these studies was to determine the effect of working conditions on productivity.
The illumination experiments tried to determine whether better lighting would lead to increased productivity. Both the control group and the experimental group of female employees produced more whether the lights were turned up or down. It was discovered that this increased productivity was a result of the attention received by the group.
In the relay assembly group experiments, six female employees worked in a special, separate area; were given breaks and had the freedom to talk; and were continuously observed by a researcher who served as the supervisor. The supervisor consulted the employees prior to any change.
The bank wiring group studies were analyzed thoroughly by Homans and were included in his now classic book, The Human Group. The bank wiring groups involved fourteen male employees and were similar to the relay assembly group experiments, except that there was no change of supervision. Again, in the relay and bank wiring phases, productivity increased and was attributed to group dynamics.
The conclusion was that there was no cause-and-effect relationship between working conditions and productivity. Worker attitude was found to be important. An extensive employee interviewing program of 21,000 interviews was conducted to determine employee attitudes toward the company and their jobs. As a major outcome of these interviews, supervisors learned that an employee's complaint frequently is a symptom of some underlying problem on the job, at home, or in the person's past.
MANEGERIAL SKILLS
A skill is an individual’s ability to translate knowledge into action. Hence, it is manifested in an individual’s performance. Skill is not necessarily inborn. It can be developed through practice and through relating learning’s to one’s own personal experience and background.
In order to be able to successfully discharge his roles, a manager should possess three major skills. These are:
• Conceptual Skill
• Human Relations Skill
• Technical Skill
Robert L. Katz, a teacher and business executive, popularized the concept of managerial skills, which was developed by Henri Fayol, a famous management theorist.
The skills that managers possess are the most valued resources of the organisation.
Conceptual skill deals with formulation of ideas, technical skill with things and human skill with people. While both conceptual and technical skills are needed for good decision-making, human skill is necessary for a good leader.
Conceptual Skill
The conceptual skill refers to the ability of a manager to take a broad and farsighted view of the organisation and its future, his ability to think in abstract, his ability to analyse the forces working in a situation, his creative and innovative ability and his ability to assess the environment and the changes taking place in it. It involves the ability to see the organisation as a whole, understanding how its parts depend on one another, and anticipating how its parts depend on one another, and anticipating how a change in any of its parts will affect the whole. Also to solve problems in a way that benefits the entire organisation. Analytical, creative and intuitive talents make up the manager’s conceptual skills. These abilities are essential to effective decision making. It is this conceptual requirement that enables an executive to recognize the interrelationships and relative values of the various factors intertwined in a managerial problem. In short, it is his ability to conceptualise the environment, the organisation, and his own job, so that he can set appropriate goals for his organisation, for himself, and for his team. This skill seems to increase in importance as manager moves up to higher positions of responsibility in the organisation. Managers may acquire these skills initially through formal education and then further develop them by training and job experience.
Examples of situations that require conceptual skills include the passage of laws that affect hiring patterns in an organisation, a competitor’s change in marketing strategy, suggesting a new product line for the company, entering the international market, or the reorganisation of one department which ultimately affects the activities of other departments in the organisation.
Technical Skills
The technical skill is the manager’s understanding of the nature of job that people under him have to perform. It refers to a person’s knowledge and proficiency in any type of process or technique. In a production department, this would mean an understanding of the technicalities of the process of production. Technical skills usually consist of specialised knowledge and the ability to perform within that speciality. It enables person to accomplish the mechanics demanded in performing a particular job. Whereas this type of skill and competence seems to be more important at the lower levels of management, its relative importance as a part of the managerial role diminishes as the manager moves to higher positions. Technical skills are usually obtained through training programs that an organisation may offer its managers or employees or maybe obtained by way of college degree.
Examples of technical skills are writing computer programs, completing accounting statements, analysing marketing statistics, writing legal documents, or drafting a design for a new airfoil on an airplane. Accountants, engineers, market researchers, and computer scientists, as examples, possess technical skills.
Human Relations Skill
Human relations skill is the ability to interact effectively with people at all levels. This skill develops in the manager sufficient ability (a) to recognise the feelings and sentiments of others; (b) to judge the possible reactions to, and outcomes of various courses of action he may undertake; and (c) to examine his own concepts and values which may enable him to develop more useful attitudes about himself. Human relations skills are used to build positive interpersonal relationships, solve human relations problems, build acceptance of one’s co-workers, and relate to them in a way that their behaviour is consistent with the needs of the organisation. It involves the ability to work with, motivate, and direct individuals or groups in the organisation whether they are subordinates, peers, or superiors. It is cooperative effort; it is teamwork; it is the creation of an environment in which people feel secure and free to express their opinions. Human relations skills can be developed through an understanding of human and group behaviour. This type of skill remains consistently important for managers at all levels in order to interact and communicate with other people successfully. A manager with good human skills has a high degree of self-awareness and a capacity to understand or empathize with the feelings of others.
Some managers are naturally born with great human skills, while others improve their skills through classes or experience.
The application of human skill may involve persuading a sales force to accept a revised sales presentation, or obtaining support from an office and clerical staff to save money on supplies and energy costs (e.g., reusing old files, turning off lights, setting thermostats lower in the winter).
A manager's level in the organization determines the relative importance of possessing technical, human, and conceptual skills. The figure below gives an idea about the required change in the skill-mix of a manager with the change in his level.
The relative importance of conceptual, human and technical skills changes as a person progresses from lower, to middle, to top management. Although all three management skills are important at all three levels of management, technical skills become least important at the top level of the management hierarchy. That is why, people at the top shift with great ease from one industry to another without an apparent fall in their efficiency. This skill is replaced with a greater emphasis on conceptual skills. Technical skills are most pronounced at lower levels or supervisory levels of management because first-line managers are closer to the production process, where technical expertise is in greatest demand. Human skills are equally necessary at each level of the management hierarchy. Conceptual skills are critical for top managers because the plans, policies, and decisions developed at this level require the ability to understand how a change in one activity will affect changes in other activities.
References
Principles of Management, Second Edition, P C Tripathi and P N Reddy, Tata McGraw-Hill publishing Company, New Delhi. (Pg No. 7 and 8)
Management, Sixth Edition, James A.F. Stoner, R. Edward Freeman, Daniel R. Gilbert, Jr., Patience Hall of India Private Limited, New Delhi. Part One, Chapter 1, Pg No. 17
Principles of Management, Eighth Edition, George R. Terry and Stephen G. Franklin, A.I.T.B.S Publishers & Distributors, Delhi.Part 1, Chapter 1, Pg No. 7 & 8
Principles of Management, Theories, Practices, Techniques. Prof. Nirmal Singh. Deep & Deep Publications Pvt. Ltd., New Delhi. Part 1, Chapter 1, Pg No. 51
Ollie.dcccd. edu/MGMT1374/ book_contents/1 overview/management_skills/mgmt_skills.htm
Ohioonline.osu.edu/~mgtexcel/Function.html
En.articlesgratuits.com/management-skills-id1586.php
Cliffnotes.com/WileyCDA/CliffsReviewTopic/Functions-of-Managers.topicArticleId-8944,article-8848.html
INDIAN BUSINESS ENVIRONMENT
Accelerator effect
The accelerator effect in economics refers to a positive effect on private fixed investment of the growth of the market economy (measured e.g. by Gross Domestic Product). Rising GDP (an economic boom or prosperity) implies that businesses in general see rising profits, increased sales and cash flow, and greater use of existing capacity. This usually implies that profit expectations and business confidence rise, encouraging businesses to build more factories and other buildings and to install more machinery. (This expenditure is called fixed investment.) This may lead to further growth of the economy through the stimulation of consumer incomes and purchases, i.e., via the multiplier effect.
The accelerator effect also goes the other way: falling GDP (a recession) hurts business profits, sales, cash flow, use of capacity and expectations. This in turn discourages fixed investment, worsening a recession by the multiplier effect.
The accelerator effect fits the behavior of an economy best when either the economy is moving away from full employment or when it is already below that level of production. This is because high levels of aggregate demand hit against the limits set by the existing labor force, the existing stock of capital goods, the availability of natural resources, and the technical ability of an economy to convert inputs into products.
Accelerator models
The accelerator effect is shown in the simple accelerator model. This model assumes that the stock of capital goods (K) is proportional to the level of production (Y):
K = k×Y
This implies that if k (the capital-output ratio) is constant, an increase in Y requires an increase in K. That is, net investment, In equals:
In = k×ΔY
Suppose that k = 2. This equation implies that if Y rises by 10, then net investment will equal 10×2 = 20, as suggested by the accelerator effect. If Y then rises by only 5, the equation implies that the level of investment will be 5×2 = 10. This means that the simple accelerator model implies that fixed investment will fall if the growth of production slows. An actual fall in production is not needed to cause investment to fall. However, such a fall in output will result if slowing growth of production causes investment to fall, since that reduces aggregate demand. Thus, the simple accelerator model implies an endogenous explanation of the business-cycle downturn, the transition to a recession.
Modern economists have described the accelerator effect in terms of the more sophisticated flexible accelerator model of investment. Businesses are described as engaging in net investment in fixed capital goods in order to close the gap between the desired stock of capital goods (Kd) and the existing stock of capital goods left over from the past (K-1):
In = x(Kd - K-1)
where x is a coefficient representing the speed of adjustment (1 ≥ x ≥ 0).
The desired stock of capital goods is determined by such variables as the expected profit rate, the expected level of output, the interest rate (the cost of finance), and technology. Because the expected level of output plays a role, this model exhibits behaviour described by the accelerator effect but less extreme than that of the simple accelerator. Because the existing capital stock grows over time due to past net investment, a slowing of the growth of output (GDP) can cause the gap between the desired K and the existing K to narrow, close, or even become negative, causing current net investment to fall.
Obviously, ceteris paribus, an actual fall in output depresses the desired stock of capital goods and thus net investment. Similarly, a rise in output causes a rise in investment. Finally, if the desired capital stock is less than the actual stock, then net investment may be depressed for a long time.
In the Neoclassical accelerator model of Dale Jorgenson, the desired capital stock is derived from the aggregate production function assuming profit maximization and perfect competition.
Business Cycle
The business cycle or economic cycle refers to the fluctuations of economic activity about its long term growth trend. The cycle involves shifts over time between periods of relatively rapid growth of output (recovery and prosperity), and periods of relative stagnation or decline (contraction or recession). These fluctuations are often measured using the real gross domestic product. Despite being named cycles, these fluctuations in economic growth and decline do not follow a purely mechanical or predictable periodic pattern.
Types of business cycle
Traditional business cycle models
The main types of business cycles enumerated by Joseph Schumpeter, and others in this field, have been named after their discoverers or proposers:
the Kitchin inventory cycle (3–5 years) — after Joseph Kitchin,
the Juglar fixed investment cycle (7–11 years) — after Clement Juglar,
the Kuznets infrastructural investment cycle (15–25 years) — after Simon Kuznets, Nobel Laureate,
the Kondratieff wave or cycle (45–60 years) — after Nikolai Kondratieff.
the Forrester cycles (200 years) - after Jay Wright Forrester.
the Toffler civilisation cycles (1000-2000 years) - after Alvin Toffler.
Even longer cycles are occasionally proposed, often as multiples of the Kondratieff cycle.
Juglar cycle
In the Juglar cycle, which is sometimes called "the" business cycle, recovery and prosperity are associated with increases in productivity, consumer confidence, aggregate demand, and prices. In the cycles before World War II or that of the late 1990s in the United States, the growth periods usually ended with the failure of speculative investments built on a bubble of confidence that bursts or deflates. In these cycles, the periods of contraction and stagnation reflect a purging of unsuccessful enterprises as resources are transferred by market forces from less productive uses to more productive uses. Cycles between 1945 and the 1990s in the United States were generally more restrained and followed political factors, such as fiscal policy and monetary policy. Automatic stabilisation due to the government's budget helped defeat the cycle even without conscious action done by policy-makers;
A colloquial term for a crisis of this time scale is a "decennial crisis" (meaning one that occurs after about ten years). The phrase was noted during the Great Depression due to the similarity of the coming of the Panic of 1825 in London ten years after the end of the Napoleonic Wars, which had been bankrolled by Britain, with that of Black Monday in New York eleven years after the First World War, which had been similarly paid for by the United States. After the Second World War, however, the nearest equivalent in time and intensity was the recession of 1958.
Politically-based business cycle models
Another set of models tries to derive the business cycle from political decisions.
The partisan business cycle suggests that cycles result from the successive elections of administrations with different policy regimes. Regime A adopts expansionary policies, resulting in growth and inflation, but is voted out of office when inflation becomes unacceptably high. The replacement, Regime B, adopts contractionary policies reducing inflation and growth, and the downwards swing of the cycle. It is voted out of office when unemployment is too high, being replaced by Party A.
The political business cycle is an alternative theory stating that when an administration of any hue is elected, it initially adopts a contractionary policy to reduce inflation and gain a reputation for economic competence. It then adopts an expansionary policy in the lead up to the next election, hoping to achieve simultaneously low inflation and unemployment on election day.
Preventing business cycles
Because the periods of stagnation are painful for many who lose their jobs, pressure arises for politicians to try to smooth out the oscillations. An important goal of all Western nations since the Great Depression has been to limit the dips. Government intervention in the economy can be risky, however. For instance, some of Herbert Hoover's efforts (including tax increases) are widely, though not universally, believed to have deepened the depression.
Managing economic policy to even out the cycle is a difficult task in a society with a complex economy, even when Keynesian theory is applied. According to some theorists, notably nineteenth-century advocates of communism, this difficulty is insurmountable. Karl Marx in particular claimed that the recurrent business cycle crises of capitalism were inevitable results of the system's operations. In this view, all that the government can do is to change the timing of economic crises. The crisis could also show up in a different form, for example as severe inflation or a steadily increasing government deficit. Worse, by delaying a crisis, government policy is seen as making it more dramatic and thus more painful.
Additionally, Neoclassical economics plays down the ability of Keynesian policies to manage an economy. Challenging the Phillips Curve since the 1960s, economists like Nobel Laureate Milton Friedman or 2006 Nobel Laureate Edmund Phelps have made ground in their arguments that inflationary expectations negate the Phillips Curve in the long run. The stagflation of the 70's supported their theory by flying in the face of Keynesian predictions. Friedman has gone so far as to argue, that all the Federal Reserve System can do is to avoid making large mistakes, as he believes they did by contracting the money supply very rapidly in the face of the Stock Market Crash of 1929, in which they made what would have been a recession into a great depression. (Friedman calls the Great Depression the "Great Contraction" because of this).
Alternative interpretations of business cycles
Marxist
Michal Kalecki's Marxian-influenced "political business cycle" theory blames the government.[1] He argued that no democratic government under capitalism would allow the persistence of full employment, so that recessions would be caused by political decisions: persistent full employment would mean increasing workers' bargaining power to raise wages and to avoid doing unpaid labour, potentially hurting profitability. (He did not see this theory as applying under fascism, which would use direct force to destroy labour’s power.) In recent years, proponents of the "electoral business cycle" theory have argued that incumbent politicians encourage prosperity before elections in order to ensure re-election -- and make the citizens pay for it with recessions afterwards.
Problems of measurement
Some argue that modern business cycle theory often measures growth by using the flawed measure of the economy's aggregate production, i.e., real gross domestic product, which is not useful for measuring well-being and also generates distortions in the perception of economic growth because the price changes of the various products are disproportional. Accordingly, there is a mismatch between the state of economic health as perceived by many individuals and that perceived by the bankers and economists, which most likely drives them further apart politically. However, unlike with issues of long-term economic growth, the economists and bankers may be right to use real GDP when studying business cycles. After all, it is fluctuations in real GDP, not those of measures of well-being, that cause changes in employment, unemployment, interest rates, and inflation, i.e. economic issues which are their main concern of business cycle experts.
Business cycle theory has been most effective in microeconomics where it aids in the preparation of risk management scenarios and timing investment, especially in infrastructural capital that must pay for itself over a long period, and which must fund itself by cashflow in late years. When planning such large investments, it is often useful to use the anticipated business cycle as a baseline, so that unreasonable assumptions, e.g. constant exponential growth, are more easily eliminated.
Circular flow of income
In economics, the term circular flow of income or circular flow refers to a simple economic model which describes the reciprocal circulation of income between producers and consumers. In the circular flow model, the inter-dependent entities of producer and consumer are referred to as "firms" and "households" respectively (In some models, these are referred to as the residential and business sectors) and provide each other with factors in order to facilitate the flow of income. Firms provide consumers with goods and services in exchange for consumer expenditure and "factors of production" from households.
The circle of money flowing through the economy is as follows: total income is spent (with the exception of "leakages" such as consumer saving), while that expenditure allows the sale of goods and services, which in turn allows the payment of income (such as wages and salaries). Expenditure based on borrowings and existing wealth – i.e., "injections" such as fixed investment – can add to total spending.
Or
Simplified Diagram
More complete and realistic circular flow models are more complex. They would explicitly include the roles of government and financial markets, along with imports and exports.
Labor and other "factors of production" are sold on resource markets. These resources, purchased by firms, are then used to produce goods and services. The latter are sold on product markets, ending up in the hands of the households, helping them to supply resources.
Assumptions
The basic circular flow of income model consists of six assumptions:
The economy consists of two sectors: households and firms.
Households spend all of their income (Y) on goods and services or consumption (C). There is no saving (S).
All output (O) produced by firms is purchased by households through their expenditure (E).
There is no financial sector.
There is no government sector.
There is no overseas sector.
Two Sector Model
In the simple two sector circular flow of income model the state of equilibrium is defined as a situation in which there is no tendency for the levels of income (Y), expenditure (E) and output (O) to change, that is:
Y = E = O
This means that the expenditure of buyers (households) becomes income for sellers (firms). The firms then spend this income on factors of production such as labour, capital and raw materials, "transferring" their income to the factor owners. The factor owners spend this income on goods which leads to a circular flow of income.
Drawbacks: While the exercise of calculating a circular flow of income can be helpful in demonstrating the strength or weakness of domestic goods to meet the needs of domestic customers, the model is very limited. This is due to the factors that are not considered as part of the model. For example, the flow of income from the household is assumed to be complete. There are no provisions for households choosing to save part of the income in some form. The model also assumes that all products produced by the firms are actually consumed by domestic households. A typical model for a circular flow of income also does not account for taxes and similar expenses that do absorb a portion of the income flow of any household.
Five sector model
All leakages and injections in five sector model
Leakages Injections
Saving (S) Investment (I)
Taxes (T) Government Spending (G)
Imports (M) Exports (X)
The five sector model of the circular flow of income is a more realistic representation of the economy. Unlike the two sector model where there are six assumptions the five sector circular flow relaxes all six assumptions. Since the first assumption is relaxed there are three more sectors introduced. The first is the Financial Sector that consists of banks and non-bank intermediaries who engage in the borrowing (savings from households) and lending of money. In terms of the circular flow of income model the leakage that financial institutions provide in the economy is the option for households to save their money. This is a leakage because the saved money can not be spent in the economy and thus is an idle asset that means not all output will be purchased. The injection that the financial sector provides into the economy is investment (I) into the business/firms sector.
The next sector introduced into the circular flow of income is the Government Sector that consists of the economic activities of local, state and federal governments. The leakage that the Government sector provides is through the collection of revenue through Taxes (T) that is provided by households and firms to the government. For this reason they are a leakage because it is a leakage out of the current income thus reducing the expenditure on current goods and services. The injection provided by the government sector is Government spending (G) that provides collective services and welfare payments to the community. An example of a tax collected by the government as a leakage is income tax and an injection into the economy can be when the government redistributes this income in the form of welfare payments, which is a form of government spending back into the economy.
The final sector in the circular flow of income model is the overseas sector which transforms the model from a closed economy to an open economy. The main leakage from this sector are imports (M), which represent spending by residents into the rest of the world. The main injection provided by this sector is the exports of goods and services which generate income for the exporters from overseas residents.
An example of the use of the overseas sector is Australia exporting wool to China, China pays the exporter of the wool (the farmer) therefore more money enters the economy thus making it an injection. Another example is China processing the wool into items such as coats and Australia importing the product by paying the Chinese exporter; since the money paying for the coat leaves the economy it is a leakage.
In terms of the five-sector circular flow of income model the state of equilibrium occurs when the total leakages are equal to the total injections that occur in the economy. This can be shown as:
Savings + Taxes + Imports = Investment + Government Spending + Exports
OR
S + T + M = I + G + X.
Therefore since the leakages are equal to the injections the economy is in a stable state of equilibrium. This state can be contrasted to the state of disequilibrium where unlike that of equilibrium the sum of total leakages does not equal the sum of total injections. By giving values to the leakages and injections the circular flow of income can be used to show the state of disequilibrium. Disequilibrium can be shown as:
S + T + M ≠ I + G + X
Therefore it can be shown as one of the below equations where:
Total leakages > Total injections
Or
Total Leakages < Total injections
The effects of disequilibrium vary according to which of the above equations they belong to.
If S + T + M > I + G + X the levels of income, output, expenditure and employment will fall causing a recession or contraction in the overall economic activity. But if S + T + M < I + G + X the levels of income, output, expenditure and employment will rise causing a boom or expansion in economic activity.
To manage this problem, if disequilibrium were to occur in the five sector circular flow of income model, changes in expenditure and output will lead to equilibrium being regained. An example of this is if:
S + T + M > I + G + X the levels of income, expenditure and output will fall causing a contraction or recession in the overall economic activity. As the income falls households will cut down on all leakages such as saving, they will also pay less in taxation and with a lower income they will spend less on imports. This will lead to a fall in the leakages until they equal the injections and a lower level of equilibrium will be the result.
The other equation of disequilibrium, if S + T + M < I + G + X in the five sector model the levels of income, expenditure and output will greatly rise causing a boom in economic activity. As the households income increases there will be a higher opportunity to save therefore saving in the financial sector will increase, taxation for the higher threshold will increase and they will be able to spend more on imports. In this case when the leakages increase they will continue to rise until they are equal to the level injections. The end result of this disequilibrium situation will be a higher level of equilibrium.
Consumption
In economics consumption is primary motivating force in the wealth or utility maximizing paradigm. Consumers choose the group of goods and services that make them happiest. All activities are directed towards consumption, either of traditional goods and services, or of personal and perhaps unique activities.
In a one-person world, production is directed towards those goods and services that the individual prefers. With the advent of exchange, consumption is altered by the ability of individuals to take advantage of the gains from trade to adjust their consumption activities with others in the economy.
In Keynesian economics, consumption is the total personal consumption expenditure, or the purchase of currently produced goods and services out of income, out of savings (net worth), or from borrowed funds. It refers to that part of disposable income (income after taxes paid and payments received) that does not go to saving. Analyzing human consumption of available resources play an important role in economics, environmentalism, and geographical analysis. Consumption is generally measured by household consumption expenditures (known as personal consumption expenditures in the United States) and is determined by the consumption function, especially by the marginal propensity to consume. It is part of aggregate demand or effective demand. It can also be defined as "the selection, adoption, use, disposal and recycling of goods and services", as opposed to their design, production and marketing.
History
John Maynard Keynes developed the idea of the consumption function, which sees a consumption as consisting of two main parts:
Induced consumption refers to increases in consumer spending occurring as disposable income rises. Increases in consumption follow the famous marginal propensity to consume. An increase in disposable income leads to an increase in consumption, moving along the consumption function in a graph.
Autonomous consumption refers to consumption spending done as part of long-term plans for the future (smoothing out income fluctuations, providing for retirement and other expected future events, etc.) and as a result of habits and contractual commitments. Changes in plans, expectations, habits, etc. leads to shifts of the consumption function in a graph.
Often, as in the permanent income hypothesis, the word "consumption" refers instead to the benefit received from consumer goods and services (as opposed to the amount spent on such products).
Additional Reading Material on Consumption
Sociological Studies of Consumption
Studies of consumption investigate how and why society and individuals consume goods and services, and how this affects society and human relationships. Contemporary studies focus on meanings of goods, role of consumption in identity making, and the 'consumer' society (e.g. Douglas et al). Traditionally, consumption was seen as rather unimportant compared to production, and the political and economic issues surrounding it. With the development of a consumer society, increasing consumer power in the market place, the growth in marketing, advertising, sophisticated consumers, ethical consumption etc, it is recognised as central to modern life. Sociology of consumption has moved well beyond Veblen's early work on 'conspicuous' consumption. Current theories investigate the role of economic and cultural factors in constraining consumption (Bourdieu), as development of an approach that sees consumers as 'victims' of producers and their social situation. A counter theory highlights the subversive aspects of consumption, with consumers buying and using goods, places etc in ways unintended by the producers. Examples include city squares turned to skateboard parks, and music sharing on the internet.
Studies of consumption come from a variety of backgrounds. Consumer studies attempt to help marketing. User research aims to improve product design. Feminist studies highlight the importance of women as consumers, and particularly the role of the domestic arena in consumption. Media studies try to understand the consumption of media products such as television and video games. Cultural Studies is interested in the role of material goods in culture (e.g. Mackay) Critical Theory is an important influence on contemporary studies, as consumption is central to contemporary culture. Domestication theory focuses on mass market technologies.
Studying consumption can be done through traditional survey methods, or various ethnographic techniques. Consumption studies are difficult because they involve investigating everyday life situations, bringing research into the private domain, rather than formalised settings such as the workplace.
Marginal propensity to consume
The marginal propensity to consume (MPC) refers to the increase in personal consumer spending (consumption) that occurs with an increase in disposable income (income after taxes and transfers). For example, if a household earns one extra dollar of disposable income, and the marginal propensity to consume is 0.65, then of that dollar, the family will spend 65 cents and save 35 cents.
Mathematically, the marginal propensity to consume (MPC) function is expressed as the derivative of the consumption (C) function with respect to disposable income (Y).
, where a is the change in consumption, and b is the change in disposable income that produced the consumption.
Let's give an example. Suppose you receive a bonus with your paycheck, and it's $500 on top of your normal annual earnings. You suddenly have $500 more in income than you did before. If you decide to spend $400 of this marginal increase in income on a new business suit, your marginal propensity to consume will be 0.8 ($400 / $500).
The marginal propensity to consume is measured as the ratio of the change in consumption to the change in income, thus giving us a figure between 0 and 1. The MPC can be more than one if the subject borrowed money to finance expenditures higher than their income. One minus the MPC equals the marginal propensity to save (in a two sector closed economy), both of which are crucial to Keynesian economics and are key variables in determining the value of the multiplier.
The MPC relies heavily upon the real (inflation-adjusted) rate of interest. A high rate of interest causes spending in the future to become increasingly attractive due to the intertemporal substitution effect on consumption. Because a rate increase primarily decreases the present value of lifetime wealth, the consumer relies on becoming a lender to offset this effect. In a two period model, as S(1+r) increases with the interest rate, so does future income[C= -(1+r)c +we(1+r)]. Therefore, every dollar of current income spent by the consumer is 1(1+r) dollars the consumer will not be able to spend in the second period.
Economists often distinguish between the marginal propensity to consume out of permanent income, and the marginal propensity to consume out of temporary income, because if a consumer expects a change in income to be permanent, then they have a greater incentive to increase their consumption (Barro and Grilli, p. 417-8). This implies that the Keynesian multiplier should be smaller in response to permanent changes in income than it is in response to temporary changes in income (though the earliest Keynesian analyses ignored these subtleties). However, the distinction between permanent and temporary changes in income is often subtle in practice, and there is in some cases hardly any way to assign to income data a so-called permanent or temporary character. What is more, the marginal propensity to consume should also be affected by factors such as the prevailing interest rate and the general level of consumer surplus that can be derived from purchasing.
Multiplier
In economics, the multiplier effect refers to the idea that an initial spending rise can lead to an even greater increase in national income. In other words, an initial change in aggregate demand can cause a further change in aggregate output for the economy.
The multiplier effect is a tool used by governments to restimulate aggregate demand. This can be done in a period of recession or economic uncertainty. The money invested by a government creates more jobs, which in turn will mean more spending and so on.
For example: a company spends $1 million to build a factory. The money does not disappear, but rather becomes wages to builders, revenue to suppliers etc. The builders will have higher disposable income as a result, so consumption, hence aggregate demand will rise as well. Say that all of these workers combined spend $2 million dollars in total, since there was an initial $1 million input which created a $2 million output, the multiplier is 2.
Another example is when a tourist visits somewhere they need to buy the plane ticket, catch a taxi from the airport to the hotel, book in at the hotel, eat at the restaurant and go to the movies or tourist destination. The taxi driver needs petrol (gasoline) for his cab, the hotel needs to hire the staff, the restaurant needs attendants and chefs, and the movies and tourist destinations need staff and cleaners.
It must be noted that the extent of the multiplier effect is dependent upon the marginal propensity to consume and marginal propensity to import. Also that the multiplier can work in reverse as well, so an initial fall in spending can trigger further falls in aggregate output.
The basic formula for the economic multiplier, in macroeconomics, is the change in equilibrium GDP divided by the change in investment (i.e. the initial increase in spending).
It is particularly associated with Keynesian economics; some other schools of economic thought reject, or downplay the importance of multiplier effects, particularly in the long run. The multiplier has been used as an argument for government spending or taxation relief to stimulate aggregate demand.
The concept of the economic multiplier on a macroeconomic scale can be extended to any economic region. For example, building a new factory may lead to new employment for locals, which may have knock-on economic effects for the city or region.
MEC, Motives to hold money, Liquidity Trap and Unemployment
MEC – Marginal Efficiency of Capital
Investment levels depend on two factors: rate of interest and marginal efficiency of capital.
The word “marginal” in economics means “on the borderline”. For example, marginal utility is the utility added to the total utility of a stock of goods by the addition of one unit of the good. Therefore, MEC is defined as the percentage yield earned on an additional unit of capital.
In other words, it is profit, expressed as a rate of return on investment, expected from the last increment of capital.
Motives to hold money
The demand for money is a demand for real balances. In other words, people hold money for its purchasing power, for the amount of goods they can buy with it. They are not concerned with the nominal money holdings, that is, the number of currency bills they hold.
There are three major motives underlying the demand for money:
• The transactions motive, which is the demand for money arising from the use of money in making regular payments.
• The precautionary motive, which is the demand for money to meet unforeseen contingencies.
• The speculative motive, which arises from uncertainties about the money value of other assets that an individual can holds.
These theories of money demand are built around a tradeoff between the benefits of holding more money versus the interest costs of doing so. Money generally earns no interest or less interest than other assets. The higher the interest loss from holding a rupee of money, the less money we expect the individual to hold.
Transactions Demand
The transactions demand for money arises from the use of money in making regular payments for goods and services. In the course of each month, an individual makes a variety of payments for rent or a mortgage, groceries, the newspaper, and other purchases.
The tradeoff here is between the amount of interest an individual forgoes by holding money and the costs and inconveniences of holding a small amount of money.
Precautionary Motive
Here we concentrate on the demand for money that arises because people are uncertain about the payments they might want, or have, to make. Realistically, an individual does not know precisely what payments (s)he will be receiving in the next few weeks and what payments will have to be made. The person might decide to have a pizza, or need to take a cab in the rain, or have to pay for a prescription. If the person does not have money with which to pay, he will incur a loss.
The more money an individual holds, the less likely he or she is to incur the costs of illiquidity (that is, not having money immediately available). But the more money the person holds, the more interest (from banks or other such sources) he or she is giving up. We are back to a tradeoff similar to that examined in relation to the transactions demand. The added consideration is that greater uncertainty about receipts and expenditures increases the demand for money.
The Speculative Demand for Money
The transactions and precautionary demand for money emphasize the medium of exchange function of money, for each refers to the need to have money on hand to make payments. Now we move over to the store of value function of money and concentrate on the role of money in the investment portfolio of an individual.
An individual who has wealth has to hold that wealth in specific assets. Those assets make up a portfolio. One would think an investor would want to hold the asset that provides the highest returns. However, given that the return on most assets is uncertain, it is unwise to hold the entire portfolio in a single risky asset.
Money is a safe asset in that its nominal value is known with certainty. It would be held as the safe asset in the portfolios of investors. The demand for money – the safest asset – depends on the expected yields as well as on the riskiness of the yields on other assets. An increase in the expected return on other assets – an increase in the opportunity cost of holding money (that is, the return lost by holding money) – lowers money demand. By contrast, an increase in the riskiness of the returns on other assets increases money demand.
An investor’s aversion to risk certainly generates a demand for a safe asset.
The Liquidity Trap
This is a phenomenon that occurs in the money market of an economy. The supply of money is decided upon by the central bank of the country and is assumed to not be affected by any other factors. This is why the money supply curve in the diagram is a straight vertical line.
The demand for money is a function of rate of interest, among other things. This implies that when the rate of interest is high, people want to hold less of liquid cash because they can earn more by keeping their money in the bank. Similarly, if the rate of interest is low, people prefer to hold ready cash with them because they cannot earn much in terms of interest on their savings.
The theory states that the equilibrium rate of interest is arrived at when the demand for money is equal to its supply. But sometimes due to certain reasons, the rate of interest goes so low that it is not expected to go any lower. Consequently, the demand for money becomes independent of the ROI. That is to say, people do not care what the ROI then is, and just prefer to hold liquid cash with them. This is when the money demand curve becomes flat.
In such a case, the government tries to use its monetary policy in order to stimulate demand and correct the problems in the economy. So it pumps in more cash into the market which results in a rightward shift of the money supply curve. It hopes that this will result in greater spending and consumption by people and also greater investment thereby giving stimulus to the economy. But the rate of interest does not move, and the all the extra money supplied is held by the people because the opportunity cost of holding money is minimum. Banks also behave in the same way because they do not get much benefit from lending out money, so they hoard money.
When the economy is in a liquidity trap, real interest rates are expected to rise because according to the speculative theory the ROI cannot fall any further. High interest rates discourage private investment in the economy and widen the output gap.
This is usually a spiral, and one of the most effective ways of overcoming this situation is known to be fiscal expansion.
Unemployment
Cost of unemployment –
• For the economy:
There is loss of aggregate output in the economy.
• For people at individual level:
Loss of income, self respect, and stress.
Unemployment Rate –
Unemployment rate measures the number of jobless persons actively seeking work compared to the total number of working-age persons participating in the labor force.
Basic Types of Unemployment
Frictional Unemployment
Occurs because people will always be fired, quitting jobs, taking time to look for the right job, and relocating from one community to another.
•Better information about alternative sources of jobs and available workers could help to reduce length of such unemployment.
•It is highest when economy is growing as there are more job opportunities in the market.
• People are more optimistic about finding better job opportunities.
Voluntary Frictional Unemployment
•Time is needed to find the “right” job.
•Workers do not have perfect information about all available jobs and possible rates of pay.
• They can get improved information by searching the market.
• With little job market information, it may be wise for an unemployed person to refuse his/her first job offer.
• By searching, an unemployed person gains valuable information about the labor market.
•This type of unemployment is a productive activity that has benefits as well as costs:
(1) Benefit: information about job opportunities and pay
(2) Cost: foregone wage associated with the first job opportunity available.
Cyclical Unemployment
•Happens when we have less than full utilization of all productive resources in the economy due to recession.
•Unemployment resulting from business recessions that occur when aggregate demand is insufficient to create full employment.
Seasonal Unemployment
•This kind of unemployment occurs due to seasonal pattern of products or services of an industry.
•Construction
•Tourism, summer resorts
•Agriculture, Canning
Structural Unemployment
•Occurs due to fundamental change in the structure of the economy.
•Reasons:
1. Demand for a product could fall drastically so that workers specializing in the production of it become unemployed.
2. May result from technological changes that reduce the demand for labor to do specific tasks (production welders).
3. An imbalance exists between the skills possessed by workers and the skills demanded in the labor markets.
4. Some of the unemployed people lack proper skills and training while others lack the geographic mobility to take advantage of job opportunities.
5. Some are unemployed because they are covered by a mandated wage/benefit package so high that they become unqualified for work because their value to employers is less than the mandated minimum.
Structural unemployment can last for a long time.
• Significant retraining time.
•Industries
-Automobiles
-Steel
-Banking
Full Employment/Natural Rate of Unemployment
•An arbitrary level of unemployment that corresponds to “normal” friction in the labor market.
•Does not mean the unemployment rate is zero. There will always be some frictional unemployment.
INFLATION
Persistent tendency for the general level of prices to rise is known as Inflation.
Inflation is defined as the rate at which the general price level of goods and services is rising, causing purchasing power to fall. This is different from a rise and fall in the price of a particular good or service. Individual prices rise and fall all the time in a market economy, reflecting consumer choices or preferences and changing costs. So if the cost of one item, say a particular model car, increases because demand for it is high, this is not considered inflation. Inflation occurs when most prices are rising by some degree across the whole economy. This is caused by four possible factors, each of which is related to basic economic principles of changes in supply and demand:
1. Increase in the money supply.
2. Decrease in the demand for money.
3. Decrease in the aggregate supply of goods and services.
4. Increase in the aggregate demand for goods and services.
Types of Inflation
There are 2 kinds of inflations in which we ignore the effects of money supply and concentrate specifically on the effects of aggregate supply and demand: cost-push and demand-pull inflation.
Cost-Push Inflation
Aggregate supply is the total volume of goods and services produced by an economy at a given price level. When there is a decrease in the aggregate supply of goods and services stemming from an increase in the cost of production, we have cost-push inflation.
Cost-push inflation basically means that prices have been “pushed up” by increases in costs of any of the four factors of production (labour, capital, land or entrepreneurship) when companies are already running at full production capacity. With higher production costs and productivity maximized, companies cannot maintain profit margins by producing the same amounts of goods and services. As a result, the increased costs are passed on to consumers, causing a rise in the general price level (inflation).
Production Costs
To understand better their effect on inflation, one must understand how and why production costs can change. A company may need to increases wages if labourers demand higher salaries (due to increasing prices and thus cost of living) or if labour becomes more specialized. If the cost of labour, a factor of production, increases, the company has to allocate more resources to pay for the creation of its goods or services. To continue to maintain (or increase) profit margins, the company passes the increased costs of production on to the consumer, making retail prices higher. Along with increasing sales, increasing prices is a way for companies to constantly increase their bottom lines and essentially grow. Another factor that can cause increases in production costs is a rise in the price of raw materials. This could occur because of scarcity of raw materials, an increase in the cost of labour and/or an increase in the cost of importing raw materials and labour (if the they are overseas), which is caused by a depreciation in their home currency. The government may also increase taxes to cover higher fuel and energy costs, forcing companies to allocate more resources to paying taxes.
Putting It Together
To visualize how cost-push inflation works, we can use a simple price-quantity graph showing what happens to shifts in aggregate supply. The graph below shows the level of output that can be achieved at each price level. As production costs increase, aggregate supply decreases from AS1 to AS2 (given production is at full capacity), causing an increase in the price level from P1 to P2. The rationale behind this increase is that, for companies to maintain (or increase) profit margins, they will need to raise the retail price paid by consumers, thereby causing inflation.
Demand-Pull Inflation
Demand-pull inflation occurs when there is an increase in aggregate demand, categorized by the four sections of the macro economy: households, businesses, governments and foreign buyers. When these four sectors concurrently want to purchase more output than the economy can produce, they compete to purchase limited amounts of goods and services. Buyers in essence “bid prices up”, causing inflation. This excessive demand, also referred to as “too much money chasing too few goods”, usually occurs in an expanding economy.
Factors Pulling Prices Up
The increase in aggregate demand that causes demand-pull inflation can be the result of various economic dynamics. For example, an increase in government purchases can increase aggregate demand, thus pulling up prices. Another factor can be the depreciation of local exchange rates, which raises the price of imports and, for foreigners, reduces the price of exports. As a result, the purchasing of imports decreases while the buying of exports by foreigners increases, thereby raising the overall level of aggregate demand (we are assuming aggregate supply cannot keep up with aggregate demand as a result of full employment in the economy). Rapid overseas growth can also ignite an increase in demand as more exports are consumed by foreigners. Finally, if government reduces taxes, households are left with more disposable income in their pockets. This in turn leads to increased consumer spending, thus increasing aggregate demand and eventually causing demand-pull inflation. The results of reduced taxes can lead also to growing consumer confidence in the local economy, which further increases aggregate demand.
Putting It Together
Demand-pull inflation is a product of an increase in aggregate demand that is faster than the corresponding increase in aggregate supply. When aggregate demand increases without a change in aggregate supply, the ‘quantity supplied’ will increase (given production is not at full capacity). Looking again at the price-quantity graph, we can see the relationship between aggregate supply and demand. If aggregate demand increases from AD1 to AD2, in the short run, this will not change (shift) aggregate supply, but cause a change in the quantity supplied as represented by a movement along the AS curve. The rationale behind this lack of shift in aggregate supply is that aggregate demand tends to react faster to changes in economic conditions than aggregate supply.
As companies increase production due to increased demand, the cost to produce each additional output increases, as represented by the change from P1 to P2. The rationale behind this change is that companies would need to pay workers more money (e.g. overtime) and/or invest in additional equipment to keep up with demand, thereby increasing the cost of production. Just like cost-push inflation, demand-pull inflation can occur as companies, to maintain profit levels, pass on the higher cost of production to consumers’ prices.
Inflation is not simply a matter of rising prices. There are endemic and perhaps diverse reasons at the root of inflation. Cost-push inflation is a result of decreased aggregate supply as well as increased costs of production, itself a result of different factors. The increase in aggregate supply causing demand-pull inflation can be the result of many factors, including increases in government spending and depreciation of the local exchange rate. If an economy identifies what type of inflation is occurring (cost-push or demand-pull), then the economy may be better able to rectify (if necessary) rising prices and the loss of purchasing power.
CONTROLS OF INFLATION
There are 2 main methods used to control the inflation in an economy. Fiscal policy and Monetary measures. These two policies are used in various combinations in an effort to direct a country's economic goals
Fiscal policy
Fiscal policy is the means by which a government adjusts its levels of spending in order to monitor and influence a nation's economy. Fiscal policy is the deliberate and thought out change in government spending, government borrowing or taxes to stimulate or slow down the economy. It contrasts with monetary policy, which describes policies concerning the supply of money to the economy.
Fiscal policy is described as being either neutral, expansionary, or contractionary. An expansionary fiscal policy occurs when the government lowers taxes and/or increases spending; thus expanding output (national income). An increase in government spending or a cut in taxes shifts the aggregate demand curve to the right. An expansionary fiscal policy will expand the economy's growth. A contractionary fiscal policy occurs when the government raises taxes and/or lowers spending; thus lowering output (national income). A decrease in government purchases or an increase in taxes shifts the aggregate demand curve to the left. A contractionary fiscal policy will constrict the economy's overall growth.
Monetary Policy
It is the process by which the government, central bank, or monetary authority manages the supply of money, or trading in foreign exchange markets. Monetary theory provides insight into how to craft optimal monetary policy.
Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy has the goal of raising interest rates to combat inflation (or cool an otherwise overheated economy). Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation.
There are different types of monetary policies:
Open market operations - The process of changing the liquidity of base currency through the open sales and purchases of (government-issued) debt and credit instruments is called open market operations.
Changing the Cash Reserve Ratio – The RBI has the power to set an amount, or percentage, of deposits that its member banks must keep in reserve at them. If the RBI raises its reserve requirements then banks have less money on hand and thus have less to lend. This lowers the amount of money in circulation and could have the impact of slowing the economy and inflation. Conversely if the fed lowers the reserve requirement , banks have more money on hand, more to lend and more money goes into circulation, thus increasing spending and possibly inflation.
Changing of discount Rates - One of the most important functions of the RBI is the changing of the discount rate, the discount rate is interest rate that the RBI charges banks on money the banks borrow from the RBI. Member banks borrow money from the RBI to pay out loans and other investments but they must pay a fee, the discount rate. The reason this can be done is because the RBI acts as the central bank and makes loans to other depository institutions. These institutions may borrow money from the RBI because they either have an unexpected drop in their member bank reserves or because they are faced with seasonal demands for loans.
If the RBI lowers the discount rate, banks are charged less for the money they borrow and thus more people borrow. This increases the amount of money in circulation, speeds up the economy and increases inflation. Conversely, if the RBI raises the discount rate this lowers the amount of money in circulation because fewer loans are expended as the Prime goes up. This slows the economy and lowers inflation.
Printing Money - The simplest and clearest of all the RBI’s operations. The government does not, as a matter of sound economic policy, print money or destroy money in order to effect changes in the economy. The power, however to do so, does exist. If the government prints money it increases the amount in circulation and if it destroys money it restricts the amount in circulation. This has a corresponding effect on inflation.
INFLATIONARY GAP
Inflationary Gap may be defined as a situation in which the demand of the economy exceeds productive potential, leading immediately to inflation and an unfavorable balance in trade.
Inflationary gaps can arise when the economy has grown for a long time on the back of a high level of aggregate demand. Total spending may rise faster than the economy's ability to supply goods and services. As a result, actual GDP may exceed potential GDP leading to a positive output gap in the economy.
Controlling an inflationary Gap
The government may use monetary and or fiscal policy to help reduce the size of the inflationary gap. This would involve controlling total spending by either increasing interest rates or raising taxation.
• An improvement in the supply-side performance of the economy would also achieve this.
• Monetary Policy: Higher interest rates to curb consumer demand
• Fiscal Policy: A rise in the burden of taxation to reduce real disposable incomes
• Supply-side Policy: Measures to increase productivity and efficiency. This leads to a rise in aggregate supply and reduces the amount of excess demand in the long run.
MONETARY POLICY
The Monetary and Credit Policy is the policy statement, traditionally announced twice a year, through which the Reserve Bank of India seeks to ensure price stability for the economy. These factors include - money supply, interest rates and the inflation. In banking and economic terms money supply is referred to as M3 - which indicates the level (stock) of legal currency in the economy.
Besides, the RBI also announces norms for the banking and financial sector and the institutions which are governed by it. These would be banks, financial institutions, non-banking financial institutions, Nidhis and primary dealers (money markets) and dealers in the foreign exchange (forex) market.
Monetary policy can be summarized as the central bank’s actions to influence the availability and cost of money and credit in the economy. The primary objective of these actions is to ensure price stability.
2. HOW DOES MONITARY POLICY WORK
As an illustration, consider that an economy is growing too fast. This is also referred to as overheating of the economy: a situation that typically happens in the boom phase when GDP (gross domestic product) growth exceeds the long-term growth potential of the economy. The producers of goods are not able to make enough goods to meet the rising demand. The resultant demand-supply mismatch creates inflationary pressures in the economy. This situation is regarded as unsustainable, as the high growth translates into higher inflation. In this situation, the RBI raises interest rates to depress spending and reduce the pressure on inflation.
3. OBJECTIVES OF THE MONETARY POLICY
The objectives are to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy.
Stability for the national currency (after looking at prevailing economic conditions), growth in employment and income are also looked into. The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through short-term implications.
There are four main 'channels' which the RBI looks at:
• Quantum channel: money supply and credit (affects real output and price level through changes in reserves money, money supply and credit aggregates)
• Interest rate channel
• Exchange rate channel (linked to the currency)
• Asset price
4. DIFFERENCE BETWEEN MONETARY AND FISCAL POLICIES
Two important tools of macroeconomic policy are Monetary Policy and Fiscal Policy. The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements.
The Monetary Policy is different from Fiscal Policy as the former brings about a change in the economy by changing money supply and interest rate, whereas fiscal policy is a broader tool with the government. The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices.
For instance, at the time of recession the government can increase expenditures or cut taxes in order to generate demand. On the other hand, the government can reduce its expenditures or raise taxes during inflationary times. Fiscal policy aims at changing aggregate demand by suitable changes in government spending and taxes.
The annual Union Budget showcases the government's Fiscal Policy.
5. SOME MONETARY POLICY TERMS
5.1 Bank Rate
Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate. Usually, an increase in bank rate results in commercial banks increasing their lending rates. Changes in bank rate affect credit creation by banks through altering the cost of credit.
5.2 Repo & Reverse Repo
A repurchase agreement or ready forward deal is a secured short-term (usually 15 days) loan by one bank to another against government securities.
Legally, the borrower sells the securities to the lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the securities at a slightly higher price, the difference in price representing the interest.
Repo rate is the rate that RBI charges the banks when they borrow from it. Repo operations increase liquidity in the system. Reverse repo rate is the rate that RBI offers the banks for parking their funds with it. Reverse repo operations suck out liquidity from the system.
5.3 Cash Reserve Ratio
All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the cash reserve ratio. The current CRR requirement is 8 per cent.
CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation.
Unlike repo and reverse repo rates, which act as signaling devices, CRR is a blunt instrument that directly acts on liquidity. By raising CRR, the RBI sucks out liquidity from the system and puts upward pressure on interest rates.
5.4 Statutory Liquidity Ratio
Banks in India are required to maintain 25 per cent of their demand and time liabilities in government securities and certain approved securities.
These are collectively known as SLR securities. The buying and selling of these securities laid the foundations of the 1992 Harshad Mehta scam.
Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. The government securities (also known as gilt-edged securities or gilts) are bonds issued by the Central government to meet its revenue requirements. Although the bonds are long-term in nature, they are liquid as they can be traded in the secondary market.
5.5 Inflation
Inflation refers to a persistent rise in prices. Simply put, it is a situation of too much money and too few goods. Thus, due to scarcity of goods and the presence of many buyers, the prices are pushed up.
The converse of inflation, that is, deflation, is the persistent falling of prices. RBI can reduce the supply of money or increase interest rates to reduce inflation.
5.6 Money Supply (M3)
This refers to the total volume of money circulating in the economy, and conventionally comprises currency with the public and demand deposits (current account + savings account) with the public. The RBI has adopted four concepts of measuring money supply.
The first one is M1, which equals the sum of currency with the public, demand deposits with the public and other deposits with the public. Simply put M1 includes all coins and notes in circulation, and personal current accounts.
The second, M2, is a measure of money, supply, including M1, plus personal deposit accounts - plus government deposits and deposits in currencies other than rupee.
The third concept M3 or the broad money concept, as it is also known, is quite popular. M3 includes net time deposits (fixed deposits), savings deposits with post office saving banks and all the components of M1.
5.7 Open Market Operations
An important instrument of credit control, the Reserve Bank of India purchases and sells securities in open market operations. In times of inflation, RBI sells securities to mop up the excess money in the market. Similarly, to increase the supply of money, RBI purchases securities.
6. MEASURES TO REGULATE MONEY SUPPLY
The RBI uses the interest rate, OMO, changes in banks' CRR and primary placements of government debt to control the money supply. OMO, primary placements and changes in the CRR are the most popular instruments used.
Under the OMO, the RBI buys or sells government bonds in the secondary market. By absorbing bonds, it drives up bond yields and injects money into the market. When it sells bonds, it does so to suck money out of the system. When inflationary pressures exist, the RBI sells securities to mop up excess cash from the system; and vice-versa in case of tight liquidity/shortage of funds.
The changes in CRR affect the amount of free cash that banks can use to lend - reducing the amount of money for lending cuts into overall liquidity, driving interest rates up, lowering inflation and sucking money out of markets.
Primary deals in government bonds are a method to intervene directly in markets, followed by the RBI. By directly buying new bonds from the government at lower than market rates, the RBI tries to limit the rise in interest rates that higher government borrowings would lead to.
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7. IMPACT OF MONETARY POLICIES
7.1 Impact on Individuals
In recent years, the policy had gained in importance due to announcements in the interest rates. Earlier, depending on the rates announced by the RBI, the interest costs of banks would immediately either increase or decrease. A reduction in interest rates would force banks to lower their lending rates and borrowing rates. So if you want to place a deposit with a bank or take a loan, it would offer it at a lower rate of interest. On the other hand, if there were to be an increase in interest rates, banks would immediately increase their lending and borrowing rates. Since the rates of interest affect the borrowing costs of corporate and as a result, their bottom lines (profits), the monetary policy is very important to them also.
But over the past 2-3 years, RBI Governor Bimal Jalan has preferred not to wait for the Monetary Policy to announce a revision in interest rates and these revisions have been when the situation arises. Since the financial sector reforms commenced, the RBI has moved towards a market-determined interest rate scenario. This means that banks are free to decide on interest rates on term deposits and loans. Being the central bank, however, the RBI would have a say and determine direction on interest rates as it is an important tool to control inflation.
The bank rate is a tool used by RBI for this purpose as it refinances banks at this rate. In other words, the bank rate is the rate at which banks borrow from the RBI. The central bank can influence the cost of funds and availability of credit in the economy by altering the repo/reverse repo rates, changing the reserve requirements, and engaging in open market operations.
7.2 Impact of cut in CRR on interest rates
From time to time, RBI prescribes a CRR or the minimum amount of cash that banks have to maintain with it. The CRR is fixed as a percentage of total deposits. As more money chases the same number of borrowers, interest rates come down.
7.3 Impact of change in SLR and gilts products on interest rates
SLR reduction is not so relevant in the present context for two reasons:
First, as part of the reforms process, the government has begun borrowing at market-related rates. Therefore, banks get better interest rates compared to earlier for their statutory investments in government securities.
Second, banks are still the main source of funds for the government. This means that despite a lower SLR requirement, banks' investment in government securities will go up as government borrowing rises. As a result, bank investment in gilts continues to be high despite the RBI bringing down the minimum SLR to 25 per cent a couple of years ago.
Therefore, for the purpose of determining the interest rates, it is not the SLR requirement that is important but the size of the government's borrowing program. As government borrowing increases, interest rates, too, rise.
Besides, gilts also provide another tool for the RBI to manage interest rates. The RBI conducts open market operations (OMO) by offering to buy or sell gilts. If it feels interest rates are too high, it may bring them down by offering to buy securities at a lower yield than what is available in the market.
7.4 Impact on domestic industry and exporters
Exporters look forward to the monetary policy since the central bank always makes an announcement on export refinance, or the rate at which the RBI will lend to banks which have advanced pre-shipment credit to exporters.
A lowering of these rates would mean lower borrowing costs for the exporter.
7.5 Impact on jobs, wages and output
At any point of time, the price level in the economy is determined by the amount of money floating around. An increase in the money supply - currency with the public, demand deposits and time deposits - increases prices all round because there is more currency moving towards the same goods and services.
Typically, the RBI follows a least-inflation policy, which means that its money market operations as well as changes in the bank rate are generally designed to minimize the inflationary impact of money supply changes. Since most people can generally see through this strategy, it limits the impact of the RBI's monetary moves to affect jobs or production. The markets, however, move to the RBI's tune because of the link between interest rates and capital market yields. The RBI's policies have maximum impact on volatile foreign exchange and stock markets.
Jobs, wages and output are affected over the long run, if the trends of high inflation or low liquidity persist for very long period. If wages move slower than other prices, higher inflation will drive real wages lower and encourage employers to hire more people. This in turn ramps up production and employment.
This was the theoretical justification of a long-term trend that showed that higher inflation and employment went together; when inflation fell, unemployment increased.
8. STOCK MARKET AND MONEY MARKET
The stock markets and money move similarly, in some ways. Most people attribute the link between the amount of money in the economy and movements in stock markets to the amount of liquidity in the system. This is not entirely true.
The factor connecting money and stocks is interest rates. People save to get returns on their savings. In true market conditions, this made bank deposits or bonds (whose returns are linked to interest rates) and stocks (whose returns are linked to capital gains), competitors for people's savings.
A hike in interest rates would tend to suck money out of shares into bonds or deposits; a fall would have the opposite effect. This argument has survived econometric tests and practical experience.
9. TRANSMISSION MECHANISM
It is the ‘how’ of monetary policy impacting the economy through various channels, directly as well as indirectly.
At the cost of simplification, let us take an illustration. Assume that inflation is rising in the economy and the RBI, to tackle it, decides to signal a rate hike by raising the reverse repo rate. This reduces money supply in the economy as banks are induced to park their cash with the RBI. That puts pressure on the longer term interest rates in the economy — for example, the lending rates for housing, consumer loans, etc. These rates tend to go up.
The impact of RBI actions on longer-term commercial rates also depends on the expectations of financial market participants, which are shaped by both actions and statements of the central bank.
9.1 Flip side to controlling inflation
Continuing the example, higher interest rates discourage consumption and investment, leading to a reduced aggregate demand (GDP growth) in the system. As a consequence of reduced demand, the pressure on inflation eases. The policy objective of reducing inflation is achieved but at the cost of growth. This is often referred to as the growth-inflation trade-off.
9.2 Time taken by monetary policies to attain its objective
Monetary policy impulses do not impact the real sector and inflation immediately but with a lag, which varies across countries and sectors. In economies such as the US, the lag of monetary policy transmission to the real sector is estimated to be around one-and-a-half years. In India, the transmission mechanism of monetary policy and the lags involved are not very well understood.
9.3 Other challenges for the conduct of monetary policy face in India
Apart from the issues related to monetary policy transmission, the huge inflow of foreign capital has complicated the conduct of monetary policy. The capital inflows have increased the supply of dollars, which makes the rupee stronger.
10. STERILIZATION
It refers to the selling of securities to suck liquidity. The extent of sterilization depends on the stock of securities with the government available for intervention. The entire process is quite cumbersome. To understand the dilemma faced by the RBI, one needs to bring in the macroeconomic dilemma of ‘impossible trinity’.
Impossible Trinity states that a country cannot simultaneously have an inflexible exchange rate, independent monetary policy, and free capital mobility. With massive capital inflows, the RBI is finding it difficult to simultaneously protect the currency and pursue its monetary policy objectives.
11. CONSTITUENTS OF INDIAN MONEY MARKET
Mumbai, Kolkata, Delhi, Chennai, Ahmedabad and Bangalore are the principal centers of the organized sector of the Indian money market, of which Mumbai is the most prominent. The Mumbai money market has now become synonymous with the Indian money market. Today the Mumbai money market occupies the same position in India as the London money market in England and New York money market in the U.S.A. The presence of the head offices at the Reserve Bank and other commercial banks, the leading stock exchange, well organized market of the government securities, the bullion exchange and cotton exchange have made Mumbai the most prominent financial centre of the country.
• The Call Money Market
• The Treasury Bill Market,
• The Repo Market,
• The Commercial Bill Market,
• The Certificate of Deposits Market,
• The Commercial Paper Market,
• Money Market Mutual Funds.
• Government Securities Market
11.1 The Call Money Market
The call mane market exists in almost all developed money markets. It is generally the most sensitive part of the financial system. Any change in flow of funds and the demand for them clearly reflected in it and the response is generally quick. In India, the call money market is centered at mainly Mumbai, Kolkata and Chennai. Among these the market at Mumbai is the most important. In the call money market borrowing and lending transactions are carried out for one day. These loans, often called as call loans may or may not be renewed the next day. The call money market is also known as inter-bank call money market. Scheduled commercial banks, co-operative banks and the Discount and Finance House of India (DFHI) operate in it. As a special case, institutions like the UTI, the LIC, the mc, the IDBI and the NABARD were allowed to operate in the call money market as lenders. Among the banks the State Bank of India on account of its strong liquidity position is on the lender's side of the market.
Brokers lay an important role in the call money market as they keep in touch with banks in the city and continuously try to bring borrowing and lending banks together. In the banking system there are no permanently surplus or deficit banks. In fact, their cash position keeps on changing from hour to hour. Therefore, there has to be a system whereby temporary cash surpluses of some banks should be available to others who have temporary deficit. The call money market provides an institutional arrangement which serves this purpose. On account of its highly sensitive nature is considered to be the most appropriate indicator of the liquidity position of the money market. The Reserve Bank of India, therefore, takes note of it in adjusting its day to day monetary policy.
11.2 The Treasury Bill Market
The Market which deals in Treasury bills is known as the treasury bill market. In India, Treasury bills are short term (l4-day, 2lday, 82-day and 364-day) liability of the Central government. Theoretically Treasury bills should be issued for meeting temporary benefits which a government faces due to its excess of revenue over expenditure at some point of time.
The Treasury Bill Market in India is very much undeveloped. Except the Reserve Bank of India there are no major holders of Treasury bills. In fact, even the Reserve Bank as been a passive or captive holder of these bills which implies that it is under an obligation to purchase all the Treasury bills which are being offered to it by the government. It is also required to rediscount whatever Treasury bills are presented to it by banks and others for this purpose. This has resulted in the monetization of public debt and has become a major source of inflationary expansion of money supply.
At present Treasury bills are largely held by the Reserve Bank. Other holders, such as commercial banks, State governments and semi-government bodies do not hold them in large quantities. Non-bank financial intermediaries, such as the LlC and the UTI and corporate and non-corporate firms do not hold Treasury bills. In contrast, in the U.S.A. and the U.K., Treasury bills are the most important money market instrument, and as a result the open market operations of the central bank in these countries are quite effective.
11.3 The Repo Market
Repo is a money market instrument which helps in collateralized short-term borrowing and lending through sale/purchase operations in debt instruments. Under a repo transaction, securities are sold by their holder to an investor with an agreement to repurchase them at a predetermined rate and date. Under reverse repo transaction, securities are purchased with a simultaneous commitment to resell at a predetermined rate and date.
Initially repos were allowed in the Central government treasury bills and dated securities created by converting some of the treasury bills. In order to make the repo market an equilibrating force between the money market and the government securities market, the RBI gradually allowed repo transactions in all government securities and treasury bills of all maturities. Lately State government securities, public undertaking bonds and private corporate securities have been made eligible for repos to broaden the repo market. ¬
Repos help to manage liquidity conditions at the short-end of the market spectrum. Repos have been used to provide banks an avenue to park funds generated by capital inflows to provide a floor to the call money market. During times of foreign exchange volatility, repos have been used to prevent speculative activities as the funds tend to flow from the money market to the foreign exchange market.
11.4 The Commercial Bill Market
The commercial big market is the sub-market in which the trade bills or the commercial bills are handled. The commercial bill is a bill drawn by one merchant firm on the other. Generally commercialize out of domestic transactions. The legitimate purpose of a commercial bill is to reimburse the seller while the buyer delays payment. In India, the commercial bill market is undeveloped. The two major factors which have arrested the growth of a bill market are:
(i) popularity of cash credit system in bank lending and
(ii) Unwillingness of the larger buyer to associate himself to bind himself to payment discipline associated with the commercial bills.
The commercial bills as instruments are useful to both business firms and banks. Secondly, since the drawees of the bill usually manage to recover the cost of the goods form their resale or processing and sale during the time it matures, the bill acquires a self- liquidating character.
The old bill market scheme introduced in January 1952 was not correctly designed to develop a bill market. It merely provided for further accommodation to banks in addition to facilities they had already enjoyed. Not satisfied, the RBI came up with a new scheme in 1970, in this the bills covered under the scheme are genuine trade bills and the scheme provided for their rediscounting.
In order to increase the use of the same, the RBI advised banks that at least 25% of their inland credit purchases should be through these bills.
11.5 The Certificate of Deposit (CD) Market
A Certificate of Deposit (CD) is a certificate issued by a bank to depositors of funds that remain on deposit at the bank for a specified period. Thus CDs are similar to traditional term deposits but are negotiable and tradable in the short-term money markets. In the mid-1980s, the short-term bank deposit rates were much lower than other comparable interest rates. The Vaghul Committee stressed that it was necessary for the introduction of the CD that the short-term bank deposit rates were aligned with other inter rates.
In 1988-89, the Reserve Bank, as a corrective measure revised upwards the rate of interest on term deposits of 46 to 90 days. Once this was done in March 1989, the Reserve Bank of India took a decision to introduce Certificates of Deposit (CD) with the objective of widening the range of money market instruments and to provide investors eater flexibility in the deployment of their short-term surplus funds.
CD’s are issued at a discount to face value and the discount rate is freely determined. They are further freely transferable by endorsement and delivery. Banks pay a high interest rate on CD’s.
11.6 The Commercial Paper Market
The Commercial Paper (CP) is a hart-term instrument of raising funds by corporate. It is essentially a sort of unsecured promissory note sold by the issuer to a banker or a security house. The issuance of CP is not related to any underlying self-liquidating trade. Therefore, maturity of this instrument is flexible. Usually borrowers and lenders adapt the maturity of a CP to their needs. Highly rated corporate which can obtain funds at a cost lower than the cost of borrowing from banks are particularly interested in it. Institutional investors also find CP’s as an attractive outlet for their short-term funds.
The Vaghul Committee had strongly recommended the introduction of CP’s in the Indian money market. In its observations on this instrument, the Committee had stated, "the issue of commercial paper imparts a degree of financial stability to the system as the issuing company has an incentive to remain financially strong. The possibility of raising short-term, finance or relatively cheaper cost would provide an adequate incentive to the corporate clients to improve the financial position and in the process the financial health of the corporate sector should show visible improvement.
A CP can be issued by a listed company with a working capital of more than 5 Crore. With maturity ranging from three to six months they can be issued in multiples of 25 laks subject to a minimum size of Rs.1 Crore.
11.7 Money Market Mutual Funds
A scheme of Money Market Mutual Funds (MMMFs) was introduced by the Reserve Bank in 1992. The objective of the Scheme was to provide an additional short-term avenue to the individual investors. As the initial guidelines were not attractive, the scheme did not receive a favorable response. Hence, with a view to making the scheme more flexible, the Reserve Bank permitted certain relaxations in November 1995. The existing guideline allows banks, public financial institutions and also the institutions in the private sector to set up MMMFs. The ceiling of Rs. 50 crore on the size of MMMFs, stipulated earlier has been withdrawn. The prescription of limits on any investments in individual instruments by MMMF’s has been generally deregulated.
Since April 1996, MMMFs are allowed to issue units to corporate enterprises and others on par with other mutual funds. Resources mobilized by the MMMFs are now required to be invested in call/notice money, CDs, CPs, Commercial bills arising out of genuine trade transactions, treasury bills and government dated securities having an unexpired maturity up to a year. The MMMFs have been brought/under the purview of the SEBI regulations since March 7, 2000. Banks are not allowed to set up MMMFs as a separate entity. Currently there are three MMMFs functioning in the country.
11.8 Government Securities Market
It is also known as the gilt-edged market. Since the securities guaranteed by the government are risk-free they are known as gilt-edged. Thus there is no scope for speculation or manipulation in the market. It consists of two parts – the new issues market and the secondary market. Since the RBI manages the entire public debt operations of the Central as well as the State governments, it is responsible for all the new issues of the government loans. In the government securities market RBI plays a dominant role and its position is that of a monopolist.
The investors in the government securities market are predominantly institutions which are required statutorily to invest a certain portion of their funds in government securities. These are commercial banks, LIC, GIC, and provident funds. Also, these are the most liquid debt instruments. Many private sector mutual funds have entered this market because of the risk- free returns. Many individual investors too have welcomed this opportunity due to better liquidity and exemption from tax on dividends.
12. DEFICIENCIES OF THE INDIAN MONEY MARKET
• Lack of integration
• Lack of rational interest rates structure
• Absence of an organized bill market
• Shortage of funds in the money market
• Seasonal stringency of funds and fluctuating interest rates.
• Inadequate banking facilities
12.1 Lack of Integration
As already stated, the Indian money market is divided into two sectors, viz,, the organized sector and the unorganized sector. As the two sectors are completely separate from each other, their financial operations are quite independent, and whatever goes on in one sector has little effect on the other. There is more of competition than cooperation and coordination between various components of the Indian money market. For example, cooperative banks compete with the commercial banks, particularly in the countryside. Commercial banks not only compete among themselves but also with the foreign banks.
To make matters worse, the indigenous bankers have absolutely no connections with the Reserve Bank of India. This sorry state of affairs in the banking system is most regrettable in the context of development needs of the country. Moreover,' if even after around six and a half decades of the establishment of the Reserve Bank its monetary policy, particularly the bank rate policy has not been found sufficiently effective, then it is the lack of adequate integration in' the money market that we shall have to blame.
12.2 Lack of rational interest rates structure
For a long time a major defect of the Indian money market has been lack of rational interest rates structure in it. This was particularly due to lack of adequate coordination between different banking institutions. Lately situation has somewhat improved due to the authority of the Reserve Bank. Further, standardization of interest rates has also introduced some rationality in the structure of interest rates. However, the prevailing system of interest rates suffers from various defects. These are: (1) relatively low yield on government securities, (2) certain concessional rates of interest, and (3) inappropriate deposit and lending rates of commercial banks. These defects in interest rates have led to a situation in which there is often excess demand for credit. The policy of subsidizing bank lending has also led to displacement of labor by capital and is thus responsible for sub-optimal utilization of productive resources.
12.3 Absence of an organized Bill market
Though both inland and foreign bills are purchased and discounted by the commercial banks, it cannot be said that an organized bill market exists in the country. Only a limited bill market that has been created by the Reserve Bank of India under its schemes of 1952 and 1971 now exists but it has failed to popularize bill finance in this country. Before the first Bill Market Scheme was introduced in 1952 by the Reserve Bank very few banks other than Foreign Banks discounted bills of approved parties fulfilling certain conditions. Since no bill market existed in the country, further dealings in bills were not possible. Therefore, banks had either to keep them until they matured or they got them rediscounted in the London money market. The latter was possible only in respect of export bills.
Some say popularity of cash credit system and lack of uniformity in commercial bills proved to be serious obstacles to the development of the bill market.
12.4 Shortage of funds in the Money Market
The Indian money market is characterized by shortage of funds. Invariably demand for loanable funds in the money market far exceeds its supply. This is attributed to a variety of factors. In the first place, savings are small due to low per capita income. Because of widespread poverty a vast multitude of population has virtually no ability to save. Those of the people who have the ability to save often indulge in wasteful consumption. Secondly, inadequate banking facilities, lack of banking habit among the people and absence of ample diversified investment opportunities have contributed to the shortage of funds. Finally, emergences of a large parallel economy and vast amount of black money in the country have also caused shortage of financial resources in the money market.
12.5 Seasonal stringency of funds
Being an agricultural country, farm operations have a large bearing on the demand as well as the supply of funds in the money market. From October to June when farm operations and trading in agricultural produce require additional finance there is a stringency created in the market. If the money market had been sufficiently elastic, and if the supply of funds could be augmented more o less automatically in response to seasonal rise in the demand, interest rates would have been much more stable.
12.6 Inadequate Banking facilities
Though commercial banks have opened branches on a huge scale, yet banking facilities are somewhat inadequate. Mobilization of small savings is both difficult and uneconomic, but in an underdeveloped country like ours where very bit of saving is to be used for productive purposes. Banking facilities have to be expanded.
13. SCENARIO PRIOR TO RECENT LIBERALISATION
Prior to recent liberalization, the RBI resorted to direct instruments like interest rates regulation, selective credit control and CRR (cash reserve ratio) as monetary instruments. One of the risks emerging in the past 5-7 years (through the capital flows and liberalization of the financial sector) is that potential risk has increased for institutions. Thus, financial stability has become crucial and there are concerns relating to credit flows to the agricultural sector and small-scale industries.
14. IS THE MONETARY POLICY LOSING ITS IMPORTANCE
Considering that interest rates are now tweaked looking at market conditions is the Monetary Policy losing its importance? Bimal Jalan has said he would make the Credit Policy a 'non-event' and would use the policy only to review developments in the banking industry and money markets. Interest rate announcements since 1998-99 were based on economic and market developments. The policy now concentrates mostly on structural issues in the banking industry.
History of Banking in India
Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors.
For the past three decades India's banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reason of India's growth process.
The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalisation of 14 major private banks of India.
Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dial a pizza. Money have become the order of the day.
The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below:
• Early phase from 1786 to 1969 of Indian Banks
• Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms.
• New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991.
To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase III.
PhaseI
The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders.
In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.
During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in india as the Central Banking Authority.
During those days public has lesser confidence in the banks. As an aftermath deposit mobilisation was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover funds are largely given to traders.
PhaseII
Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th July, 1969, major process of nationalisation was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country was nationalised.
Second phase of nationalisation Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership.
The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country:
• 1949 : Enactment of Banking Regulation Act.
• 1955 : Nationalisation of State Bank of India.
• 1959 : Nationalisation of SBI subsidiaries.
• 1961 : Insurance cover extended to deposits.
• 1969 : Nationalisation of 14 major banks.
• 1971 : Creation of credit guarantee corporation.
• 1975 : Creation of regional rural banks.
• 1980 : Nationalisation of seven banks with deposits over 200 crore.
After the nationalisation of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions.
PhaseIII
This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalisation of banking practices.
The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money.
The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.
BANKING TODAY:
Banks in India can be categorized into non-scheduled banks and scheduled banks. Scheduled banks constitute of commercial banks and co-operative banks. There are about 67,000 branches of Scheduled banks spread across India. During the first phase of financial reforms, there was a nationalization of 14 major banks in 1969. This crucial step led to a shift from Class banking to Mass banking. Since then the growth of the banking industry in India has been a continuous process.
As far as the present scenario is concerned the banking industry is in a transition phase. The Public Sector Banks (PSBs), which are the foundation of the Indian Banking system account for more than 78 per cent of total banking industry assets. Unfortunately they are burdened with excessive Non Performing assets (NPAs), massive manpower and lack of modern technology.
On the other hand the Private Sector Banks in India are witnessing immense progress. They are leaders in Internet banking, mobile banking, phone banking, ATMs. On the other hand the Public Sector Banks are still facing the problem of unhappy employees. There has been a decrease of 20 percent in the employee strength of the private sector in the wake of the Voluntary Retirement Schemes (VRS). As far as foreign banks are concerned they are likely to succeed in India.
Indusland Bank was the first private bank to be set up in India. IDBI, ING Vyasa Bank, SBI Commercial and International Bank Ltd, Dhanalakshmi Bank Ltd, Karur Vysya Bank Ltd, Bank of Rajasthan Ltd etc are some Private Sector Banks. Banks from the Public Sector include Punjab National bank, Vijaya Bank, UCO Bank, Oriental Bank, Allahabad Bank, Andhra Bank etc.
Financial and Banking Sector Reforms
The last decade witnessed the maturity of India's financial markets. Since 1991, every governments of India took major steps in reforming the financial sector of the country. The important achievements in the following fields is discussed under serparate heads:
• Financial markets
• Regulators
• The banking system
• Non-banking finance companies
• The capital market
• Mutual funds
• Overall approach to reforms
• Deregulation of banking system
• Capital market developments
• Consolidation imperative
Financial Markets
In the last decade, Private Sector Institutions played an important role. They grew rapidly in commercial banking and asset management business. With the openings in the insurance sector for these institutions, they started making debt in the market.
Competition among financial intermediaries gradually helped the interest rates to decline. Deregulation added to it. The real interest rate was maintained. The borrowers did not pay high price while depositors had incentives to save. It was something between the nominal rate of interest and the expected rate of inflation.
Regulators
The Finance Ministry continuously formulated major policies in the field of financial sector of the country. The Government accepted the important role of regulators. The Reserve Bank of India (RBI) has become more independant. Securities and Exchange Board of India (SEBI) and the Insurance Regulatory and Development Authority (IRDA) became important institutions. Opinions are also there that there should be a super-regulator for the financial services sector instead of multiplicity of regulators.
The banking system
Almost 80% of the business are still controlled by Public Sector Banks (PSBs). PSBs are still dominating the commercial banking system. Shares of the leading PSBs are already listed on the stock exchanges.
The RBI has given licences to new private sector banks as part of the liberalisation process. The RBI has also been granting licences to industrial houses. Many banks are successfully running in the retail and consumer segments but are yet to deliver services to industrial finance, retail trade, small business and agricultural finance.
The PSBs will play an important role in the industry due to its number of branches and foreign banks facing the constrait of limited number of branches. Hence, in order to achieve an efficient banking system, the onus is on the Government to encourage the PSBs to be run on professional lines.
Development finance institutions
FIs's access to SLR funds reduced. Now they have to approach the capital market for debt and equity funds.
Convertibility clause no longer obligatory for assistance to corporates sanctioned by term-lending institutions.
Capital adequacy norms extended to financial institutions.
DFIs such as IDBI and ICICI have entered other segments of financial services such as commercial banking, asset management and insurance through separate ventures. The move to universal banking has started.
Non-banking finance companies
In the case of new NBFCs seeking registration with the RBI, the requirement of minimum net owned funds, has been raised to Rs.2 crores.
Until recently, the money market in India was narrow and circumscribed by tight regulations over interest rates and participants. The secondary market was underdeveloped and lacked liquidity. Several measures have been initiated and include new money market instruments, strengthening of existing instruments and setting up of the Discount and Finance House of India (DFHI).
The RBI conducts its sales of dated securities and treasury bills through its open market operations (OMO) window. Primary dealers bid for these securities and also trade in them. The DFHI is the principal agency for developing a secondary market for money market instruments and Government of India treasury bills. The RBI has introduced a liquidity adjustment facility (LAF) in which liquidity is injected through reverse repo auctions and liquidity is sucked out through repo auctions.
On account of the substantial issue of government debt, the gilt- edged market occupies an important position in the financial set- up. The Securities Trading Corporation of India (STCI), which started operations in June 1994 has a mandate to develop the secondary market in government securities.
Long-term debt market: The development of a long-term debt market is crucial to the financing of infrastructure. After bringing some order to the equity market, the SEBI has now decided to concentrate on the development of the debt market. Stamp duty is being withdrawn at the time of dematerialisation of debt instruments in order to encourage paperless trading.
The capital market
The number of shareholders in India is estimated at 25 million. However, only an estimated two lakh persons actively trade in stocks. There has been a dramatic improvement in the country's stock market trading infrastructure during the last few years. Expectations are that India will be an attractive emerging market with tremendous potential. Unfortunately, during recent times the stock markets have been constrained by some unsavoury developments, which has led to retail investors deserting the stock markets.
Mutual funds
The mutual funds industry is now regulated under the SEBI (Mutual Funds) Regulations, 1996 and amendments thereto. With the issuance of SEBI guidelines, the industry had a framework for the establishment of many more players, both Indian and foreign players.
The Unit Trust of India remains easily the biggest mutual fund controlling a corpus of nearly Rs.70,000 crores, but its share is going down. The biggest shock to the mutual fund industry during recent times was the insecurity generated in the minds of investors regarding the US 64 scheme. With the growth in the securities markets and tax advantages granted for investment in mutual fund units, mutual funds started becoming popular.
The foreign owned AMCs are the ones which are now setting the pace for the industry. They are introducing new products, setting new standards of customer service, improving disclosure standards and experimenting with new types of distribution.
The insurance industry is the latest to be thrown open to competition from the private sector including foreign players. Foreign companies can only enter joint ventures with Indian companies, with participation restricted to 26 per cent of equity. It is too early to conclude whether the erstwhile public sector monopolies will successfully be able to face up to the competition posed by the new players, but it can be expected that the customer will gain from improved service.
The new players will need to bring in innovative products as well as fresh ideas on marketing and distribution, in order to improve the low per capita insurance coverage. Good regulation will, of course, be essential.
Overall approach to reforms
The last ten years have seen major improvements in the working of various financial market participants. The government and the regulatory authorities have followed a step-by-step approach, not a big bang one. The entry of foreign players has assisted in the introduction of international practices and systems. Technology developments have improved customer service. Some gaps however remain (for example: lack of an inter-bank interest rate benchmark, an active corporate debt market and a developed derivatives market). On the whole, the cumulative effect of the developments since 1991 has been quite encouraging. An indication of the strength of the reformed Indian financial system can be seen from the way India was not affected by the Southeast Asian crisis.
However, financial liberalisation alone will not ensure stable economic growth. Some tough decisions still need to be taken. Without fiscal control, financial stability cannot be ensured. The fate of the Fiscal Responsibility Bill remains unknown and high fiscal deficits continue. In the case of financial institutions, the political and legal structures hve to ensure that borrowers repay on time the loans they have taken. The phenomenon of rich industrialists and bankrupt companies continues. Further, frauds cannot be totally prevented, even with the best of regulation. However, punishment has to follow crime, which is often not the case in India.
Deregulation of banking system
Prudential norms were introduced for income recognition, asset classification, provisioning for delinquent loans and for capital adequacy. In order to reach the stipulated capital adequacy norms, substantial capital were provided by the Government to PSBs.
Government pre-emption of banks' resources through statutory liquidity ratio (SLR) and cash reserve ratio (CRR) brought down in steps. Interest rates on the deposits and lending sides almost entirely were deregulated.
New private sector banks allowed to promote and encourage competition. PSBs were encouraged to approach the public for raising resources. Recovery of debts due to banks and the Financial Institutions Act, 1993 was passed, and special recovery tribunals set up to facilitate quicker recovery of loan arrears.
Bank lending norms liberalised and a loan system to ensure better control over credit introduced. Banks asked to set up asset liability management (ALM) systems. RBI guidelines issued for risk management systems in banks encompassing credit, market and operational risks.
A credit information bureau being established to identify bad risks. Derivative products such as forward rate agreements (FRAs) and interest rate swaps (IRSs) introduced.
Capital market developments
The Capital Issues (Control) Act, 1947, repealed, office of the Controller of Capital Issues were abolished and the initial share pricing were decontrolled. SEBI, the capital market regulator was established in 1992.
Foreign institutional investors (FIIs) were allowed to invest in Indian capital markets after registration with the SEBI. Indian companies were permitted to access international capital markets through euro issues.
The National Stock Exchange (NSE), with nationwide stock trading and electronic display, clearing and settlement facilities was established. Several local stock exchanges changed over from floor based trading to screen based trading.
Private mutual funds permitted
The Depositories Act had given a legal framework for the establishment of depositories to record ownership deals in book entry form. Dematerialisation of stocks encouraged paperless trading. Companies were required to disclose all material facts and specific risk factors associated with their projects while making public issues.
To reduce the cost of issue, underwriting by the issuer were made optional, subject to conditions. The practice of making preferential allotment of shares at prices unrelated to the prevailing market prices stopped and fresh guidelines were issued by SEBI.
SEBI reconstituted governing boards of the stock exchanges, introduced capital adequacy norms for brokers, and made rules for making client or broker relationship more transparent which included separation of client and broker accounts.
Buy back of shares allowed
The SEBI started insisting on greater corporate disclosures. Steps were taken to improve corporate governance based on the report of a committee.
SEBI issued detailed employee stock option scheme and employee stock purchase scheme for listed companies.
Standard denomination for equity shares of Rs. 10 and Rs. 100 were abolished. Companies given the freedom to issue dematerialised shares in any denomination.
Derivatives trading starts with index options and futures. A system of rolling settlements introduced. SEBI empowered to register and regulate venture capital funds.
The SEBI (Credit Rating Agencies) Regulations, 1999 issued for regulating new credit rating agencies as well as introducing a code of conduct for all credit rating agencies operating in India.
Consolidation imperative
Another aspect of the financial sector reforms in India is the consolidation of existing institutions which is especially applicable to the commercial banks. In India the banks are in huge quantity. First, there is no need for 27 PSBs with branches all over India. A number of them can be merged. The merger of Punjab National Bank and New Bank of India was a difficult one, but the situation is different now. No one expected so many employees to take voluntary retirement from PSBs, which at one time were much sought after jobs. Private sector banks will be self consolidated while co-operative and rural banks will be encouraged for consolidation, and anyway play only a niche role.
In the case of insurance, the Life Insurance Corporation of India is a behemoth, while the four public sector general insurance companies will probably move towards consolidation with a bit of nudging. The UTI is yet again a big institution, even though facing difficult times, and most other public sector players are already exiting the mutual fund business. There are a number of small mutual fund players in the private sector, but the business being comparatively new for the private players, it will take some time.
We finally come to convergence in the financial sector, the new buzzword internationally. Hi-tech and the need to meet increasing consumer needs is encouraging convergence, even though it has not always been a success till date. In India organisations such as IDBI, ICICI, HDFC and SBI are already trying to offer various services to the customer under one umbrella. This phenomenon is expected to grow rapidly in the coming years. Where mergers may not be possible, alliances between organisations may be effective. Various forms of bancassurance are being introduced, with the RBI having already come out with detailed guidelines for entry of banks into insurance. The LIC has bought into Corporation Bank in order to spread its insurance distribution network. Both banks and insurance companies have started entering the asset management business, as there is a great deal of synergy among these businesses. The pensions market is expected to open up fresh opportunities for insurance companies and mutual funds.
It is not possible to play the role of the Oracle of Delphi when a vast nation like India is involved. However, a few trends are evident, and the coming decade should be as interesting as the last one.
MARKETING
Evolution of marketing
A brief history:
As a field of study, marketing has not always been
viewed from a management perspective. At different
phases in its evolution, marketing thought leaders have
variously emphasized commodities, institutions, functions,
markets, consumers, management of firms, and society at
large. Four eras of marketing
thought development:
Era I: Founding the Field, 1900–1920.
Era II: Formalizing the Field, 1920–1950.
Era III: A Paradigm Shift—Marketing, Management, and the
Sciences, 1950–1980.
Era IV: The Shift Intensifies—A Fragmentation of the Mainstream,
1980–Present.
In the academic arena as reflected in its literature over the
past three decades or so (late Era III into Era IV), marketing
has trended from a managerial focus to an analytical one,
two perspectives that need not be but often are, in fact, in
competition. There is evidence that marketing has lost its
importance and relevance as a management function in
many companies . Perhaps marketing
thought development has lagged behind shifts in the
market environment and has become less relevant for managers,
particularly those who are responsible for strategy
and general management. Most recently, however, marketing
thought leaders have pointed the way toward a
customer-oriented, service-dominated concept of marketing
as the definition, development, and delivery of customer
value that focuses on marketing as a set of business processes
rather than as a separate management function.
Marketing as Management
A distinct view of marketing as a management discipline
(rather than an economic activity) emerged in the 1950s
though marketing management
had certainly been evolving as a practice for some
time, with origins as a form of support for the sales function.
This transition was marked by two major developments:
first was the perspective of the marketing concept as a management
philosophy emphasizing customer orientation, and
the second was the integration of quantitative methods and
behavioural science into the marketing discipline. Two significant environmental trends drove this transition, one in
the marketplace and one in education.
In the economic and social environment, the post-World
War II marketplace offered huge business opportunities that
were created by pent-up demand, rapidly increasing consumer
affluence (with commensurate economic and political
power), and the dramatic development of television as a
low-cost mass medium. Marketing strategy came to rely
increasingly on statistical analysis of market research data.
Market segmentation strategy was entirely consistent with
the philosophy of customer orientation.
Marketing Management as an Optimization
Problem
Of equal importance as environmental forces, two path setting
studies of business education advocated a shift from a narrow vocational
and skills emphasis to a deeper and more rigorous
analytical approach based on quantitative analysis and the
behavioural sciences. The two lines of development—the marketing
(management) concept and quantitative analysis—can be
identified as equally important and influential at the outset of Era III, they have developed in a very different fashion.
Rigorous analytical methods proved to have greater appeal
to many marketing educators than the “softer” and more
conceptual approaches of customer orientation and the marketing
concept and their managerial and organizational
implications. With the active support of their colleagues in
economics and finance, the dominant culture in most leading
business school faculties, marketing academics eagerly
adopted a price–theory-based view of marketing management
as essentially an optimization problem. Allocating resources until marginal returns were equal across spending opportunities, if only the analyst
could accurately estimate the demand curve, could optimize
each of the four P’s.Aided by the availability of large-scale computers and
increasingly large and reliable databases, marketing scholars
were strongly encouraged by the academic culture to
emphasize empirical data, quantitative methods of data
analysis, and mathematical modelling in their research.
The Rise and Fall of the Strategic
Planning Empire
On the general management and business policy side of the
academic field, the area of formal strategic management was
emerging. An important element of this
approach was the famous DuPont model of management,
which was based on return on investment, by which large
companies could be effectively controlled through the careful
allocation of financial resources across strategic business
units (SBUs) competing for these limited funds. A central
feature of most of these formal strategic planning
approaches was the “product portfolio,” a matrix that
depicted firms’ SBUs on two dimensions: their position relative
to those of competitors (market share) in their respective
markets and the rate of growth in those markets. Return
on investment became the dominant criterion for evaluating
business performance and for budgeting expenditures
including marketing. Attributing revenue and profit results
to marketing expenditures is known to be especially difficult
because of multiple causation, lagged effects, and similar
measurement and estimation problems.
By the mid-1970s, the discipline of strategic planning was
in full bloom, evidenced by the proliferation of corporate
strategic planning departments. It was not uncommon for
the corporate marketing function to merge formally into
strategic planning, seeking two benefits: to make the marketing
concept and customer orientation strategically operational
and to make strategic planning more customer
focused and market driven.
These trends prompted strategists to contend that
with their bias toward marketing tactics and optimization,
marketers were unlikely to use their tools and concepts to
address strategic management issues because of their orientation
to methodological rigor. They questioned
whether marketers were interested in raising their level of
aggregation to the business unit or industry level and to their
time horizon over the long run, and he concluded that it
would be up to strategic management students to make the
transfer of marketing concepts and methods to strategic
issues. That appears to be what happened.
By the early 1980s, however, formal strategic planning as
an activity at the corporate level was in decline, and most
strategic planning departments were being dismantled.
The bureaucratic strategic planning process
had proved to be an expensive undertaking in management
time and organizational and administrative costs, often
causing serious lags in responding to a changing market
environment (“paralysis by analysis”). Measurement problems
in making operational such central constructs as market
share and the definition of “served market” also proved
to be difficult and a continuing source of disagreement and
debate between corporate analysts and SBU-level management
In many companies, responsibility for marketing strategy
was delegated to SBU managers. Corporate marketing
departments were also widely downsized or eliminated,
which left little or no customer advocacy or marketing management
competence at the top level of the organization,
unless the chief executive officer happened to come from
that background. Part of the rationale for eliminating marketing as a corporate
function was embedded in the fundamental assertion of the
marketing concept that customer orientation should pervade
the organization and, according to Drucker (1954), thus was
not a separate function at all but rather the entire business as
seen from the customer’s point of view.
Although strategic planning departments at the corporate
level have disappeared, the discipline of strategic management
and the related field of strategic management consulting
have continued to have the ear of practicing managers.
Today, it is a literature more widely read and valued by
managers than the marketing literature, evidenced by the
large number of management subscribers compared with
those of the marketing journals. Throughout the 1970s and
1980s, the marketing discipline continued to emphasize the
development of enhanced methodological sophistication
and analytical rigor, whereas the strategic management journals
were more likely to report interesting, new conceptual
developments and (perceived) best business practices.
The Changing Role of Marketing
There is no question that marketing management has experienced
significant changes during Era IV: “A Fragmentation
of the Mainstream.” Among the many environmental
forces that have reshaped the marketing function within the
firm during the past two decades are as follows:
•Evolution from bureaucratic to more flexible organizational
forms;
•Rapid diffusion of computer and telecommunications technology,
including the Internet;
•Dominance of large, low-cost retailers in most product
categories;
•The stock-market boom of the 1990s, followed by a dramatic
decrease in stock prices;
•Continued emphasis on quarterly earnings per share as a measure
of business performance and company value;
•Globalization and increased competitive pressures; and
•Outsourcing of many parts of value-creation and value-delivery
processes.
As corporate structures have moved away from centralized
bureaucratic control to a stronger emphasis on SBUs
and strategic partnering, marketing at the corporate level has
become much less important. Either marketing management
responsibilities have been shifted outward to the field sales
organization or into SBUs, or they have simply been eliminated
as a distinct activity. Marketing communications dollars
have been reallocated to short-term price incentives and
other sales promotional activities and to the selling function,
to support increased field sales effort and larger discounts to
increasingly powerful resellers. For example, the product-level brand management
function in many consumer packaged-goods companies
has been redefined and relocated to the field sales
organization, with primary responsibility for working with
major resellers on in-store promotional activities, rather
than to the traditional roles of brand development in which
consumer advertising is heavily used. At the corporate level,
remaining marketing management positions tend to focus on
global brand strategy (across SBUs and geographies) and
marketing communications. Product and pricing strategy,
sales management, and channel strategy and management
are SBU-level responsibilities, often with a relatively short-term,
tactical focus. Innovation for long-range product
development tends to lose priority.
Production concept: It is the oldest concept. This concept came into being during the industrial revolution when manufacturing started for the first time. The demand exceeded the supply, therefore marketers expected their entire produce to be bought by the consumers.
This concept simply suggests that customers
prefer inexpensive products that are readily available. In effect, "if
we make it, they will come." This orientation makes sense in developing countries, where consumers are more interested in obtaining the product than in its features.
THE PRODUCTION CONCEPT WAS THE IDEA THAT A FIRM
SHOULD FOCUS ON THOSE PRODUCTS THAT IT COULD
PRODUCE MORE EFFICIENTLY AND AT A LOW COST,
WHICH IN THE END WOULD ITSELF CREATE THE DEMAND
FOR THE PRODUCT.
Their focus is to:
PRODUCE the product
PRODUCE enough OF the product / at the low cost.
MASS DISTRIBUTION
Product concept: It suggests that companies that build the "better mousetrap" will gain
favour. The thinking here is that customers want products that have
higher quality, that offer better performance or do something unique.
Still demand was higher than the supply. Improvement in product quality as per the notions and understanding of the seller and not the buyers. Changes were brought about just to differentiate their own product from that of their consumers as competition started making its way into the market.
This orientation holds that consumers will favor those products that offer the most quality, performance, or innovative features. Managers focusing on this concept concentrate on making superior products and improving them over time. They assume that buyers admire well-made products and can appraise quality and performance. However, these managers are sometimes caught up in a love affair with their product and do not realize what the market needs. Management might commit the “better-mousetrap” fallacy, believing that a better mousetrap will lead people to beat a path to its door.
Developing products that are aligned with current or emerging customer needs . Technology companies are often challenged to develop competitive new products while meeting short windows of opportunity. Success requires effective decision making about product features, packaging, positioning, and pricing.
Product CONCEPT involves:
Exploratory research
Needs Segmentation
Opportunity Assessment
Voice of the Customer
Concept Viability
Competitive Assessment
Concept Optimization
Ideation
Portfolio Management
Business Case Rationale
Product Retrieval
Market Research
Trend Monitoring
Selling concept: From the 1920's until the 1950's,
most firms had a sales orientation. Competition had grown, and there
was a need to pursue the scarce customer. Sales could mean everything
from sales people to advertising to public relations, but little effort
was made to coordinate any overall marketing function. What we often
saw in the Selling Concept was the "hard sell" and the belief that
consumers wouldn't purchase unless they were sold.
The firm sold what one produce and try to convince the customers
through advertising and personal selling.
It holds that consumers and businesses, if left alone, will ordinarily not buy enough of the selling company’s products. The organization must, therefore, undertake an aggressive selling and promotion effort. This concept assumes that consumers typically sho9w buyi8ng inertia or resistance and must be coaxed into buying. It also assumes that the company has a whole battery of effective selling and promotional tools to stimulate more buying. Most firms practice the selling concept when they have overcapacity. Their aim is to sell what they make rather than make what the market wants.
Their focus is
-can we sell the product
-can we charge enough for the product.
Marketing concept: An organization with a market orientation focuses its efforts on 1)continuously collecting information about customers' needs and
competitors' capabilities, 2) sharing this information across
departments, and 3) using the information to create customer value.
The market orientation simply defines an organization that understands the
importance of customer needs, makes an effort to provide products of
high value to its customers, and markets its products and services in a
coordinated holistic program across all departments. In what we call
the "Marketing Concept," the company embraces a philosophy that the
"Customer is King."
The Marketing Concept is an attitude. It's a philosophy that is driven down throughout the
organization from the very top of the management structure. The
Marketing Concept communicates that "the customer is king." Everything
that the company does focuses on the customer. Via the Marketing
Concept, a company makes every effort to best understand the wants and
needs of its target market and to create want-satisfying goods that
best fulfill the needs of that target market and to do this better than
the competition.
The term market refers to the place where buyers and sellers meet for the purpose of satisfying their respective needs. Before industrial revolution, the market for goods was very limited. People were almost self sufficient in their daily requirements for goods. A few products which people needed were usually purchased from near their houses either on barter system or on cash. The luxury products of that time such as spices, furs, skins, expensive cloth were brought into the market on a very small scale and these were purchased by the rich people. The goods in those days were produced and sold with very little thought of the customers.
After the Industrial Revolution, the scope of the market has greatly widened due to increase in production of goods, increase in competition, increase in population, increase in income, increase in fashion, improvements in the means of communication and transport etc. Goods are now produced to satisfy the needs of the customers. Marketing here occupies an important position with the business executives and is now an accepted feature of commerce.
In the early days of business the market concept was product oriented. In the 20th century there is a mass production of goods and increased advertisement for their sales.
It is the philosophy that the firm should analyze
the needs of their customers[ current /potential ] and then make
the decisions to satisfy those needs , better than the competition. It is the most desirable orientation:
1) Understands existing and potential needs of the customers-meaningful direction to business.
2) Selection of better market opportunities where they can give better products/services than their customers.
3) Design an appropriate production capacity to suit the need of their chosen market.
4) Design an appropriate marketing program-distribution, pricing, servicing etc
5) Market the right values t the customers
6) Customer satisfaction along with profit for the firm
Its central tenets crystallized in the 1950s. It holds that the key to achieving its organizational goals (goals of the selling company) consists of the company being more effective than competitors in creating, delivering, and communicating customer value to its selected target customers. The marketing concept rests on four pillars: target market, customer needs, integrated marketing and profitability.
Distinctions between the Sales Concept and the Marketing Concept:
1. The Sales Concept focuses on the needs of the seller. The Marketing Concept focuses on the needs of the buyer.
2. The Sales Concept is preoccupied with the seller’s need to convert his/her product into cash. The Marketing Concept is preoccupied with the idea of satisfying the needs of the customer by means of the product as a solution to the customer’s problem (needs).
The Marketing Concept represents the major change in today’s company orientation that provides the foundation to achieve competitive advantage. This philosophy is the foundation of consultative selling.
Societal marketing concept: This is embraced in the 21st century results in companies looking at their overall marketing efforts. This includes how their marketing affects society, as a whole. Marketing is also done internally
within the company. Without customers, a company will quickly flounder
-- thus the importance of the relationship. Holistic marketing looks
at the connectivity of the company, its people, its customers, and the
society in which it operates.
The societal marketing concept can be defined as the organizations task which tries to identify the needs and interests of the consumers and delivers quality services or products as compared to its competitors and in a way that consumer's and society's well being is maintained. In other words organizations have to balance consumer satisfaction, company profits and long term welfare of society.
This is a new marketing philosophy and tries to reduce the inequalities at various levels. This theory emphasizes that organizations should not only think of cut-throat policies to achieve targets and jump ahead of competitors but should have ethical and environmental policies and then back them up with action and regulation.
Societal marketing can be achieved by following a few principles. It should always be remembered that consumer's needs are of paramount interest. Improvements in products which are both real and innovative should be carried out to give long term value to the product; do what is good for the society with a sense of mission and trust. In this way the focus shifts from transaction to relationships. If a client 'repeats business' a bond is created between him and the product and is worth its while for the organization to nurture this bond.
It may sound appropriate and ethical, but societal marketing concept is hard to implement as not all companies have a social conscience. Whether it is legal and essential in industries like the tobacco and liquor industry needs analysis as they have a tremendous influence on consumer welfare.
The societal marketing holds that the organization should determine the needs, wants, and interests of target markets. It should then deliver superior value t customers in a way that maintains or improves the consumer's and the society's well being. The societal marketing concept is the newest of the five marketing management philosophies.
The societal marketing concept questions whether the pure marketing concept is adequate in an age of environmental problems, and neglected social services. It asks if the firm that sense, serves and satisfies individual wants is always doing what's best for consumers and society in the long run. According to the societal marketing concept, the pure marketing concept overlooks possible conflicts between consumer short run wants and consumer long run welfare.
Consider the fast food industry. Most people see today's giant fast food chains as offering tasty and convenient food at reasonable prices. Yet many consumer and environmental groups have voiced concerns. Critics point out that hamburger, fried chicken, French fries and most other foods sold by fast food restaurants are high in fat and salt. The products are wrapped in convenient packaging, but this leads to waste and pollution.
This concept holds that the organization’s task is to determine the needs, wants, and interests of target markets and to deliver the desired satisfactions more effectively and efficiently than competitors (this is the original Marketing Concept). Additionally, it holds that this all must be done in a way that preserves or enhances the consumer’s and the society’s well-being.
This orientation arose as some questioned whether the Marketing Concept is an appropriate philosophy in an age of environmental deterioration, resource shortages, explosive population growth, world hunger and poverty, and neglected social services.
Are companies that do an excellent job of satisfying consumer wants necessarily acting in the best long-run interests of consumers and society?
The marketing concept possibly sidesteps the potential conflicts among consumer wants, consumer interests, and long-run societal welfare. Just consider:
The fast-food hamburger industry offers tasty but unhealthy food. The hamburgers have a high fat content, and the restaurants promote fries and pies, two products high in starch and fat. The products are wrapped in convenient packaging, which leads to much waste. In satisfying consumer wants, these restaurants may be hurting consumer health and causing environmental problems.
Conclusion:
For the marketing educators eager for a rejuvenation of a
managerial point of view within the field, there is cause for
cautious optimism. The issue of the decline of relevance and
the relative lack of attention to important areas of marketing
strategy, such as new product development, channel strategy,
and sales force management, is increasingly recognized,
discussed, and written about by marketing thought
leaders. Fundamentally new paradigms of marketing management
are being offered that shift the core focus of the
field from firms to customers, from products to services and
benefits, from transactions to relationships, from manufacturing
to the co creation of value with business partners and
customers, and from physical resources and labour to knowledge
resources and the firm’s position in the value chain.
Properly developed and communicated, this new conceptualization
has the potential to bridge the gap between managers
and scholars, to integrate rigor and relevance, and to
reinvigorate a managerial view of marketing. The biggest
challenge in the future, as in the past, will be meaningful
communication among marketing scholars, marketing managers,
and general managers so that rigorous work becomes
more relevant while the practical becomes more analytical
and marketing decisions become better informed by better
marketing science
Core Concepts
Selling Vs Marketing
Selling Concept: The selling concept holds that consumers and businesses, if left alone will ordinarily not buy enough of the organisation’s products. The organisation, must therefore undertake an aggressive selling and promotion effort. The selling concept is epitomised in the thinking of Sergio Zygman, Coca-Cola’s former Vice President, Marketing: The purpose of marketing is to sell more stuff to more people more often for more money in order to make more profit.
The selling concept is practised most aggressively, with unsought goods, goods that buyers do not normally think of buying, such as insurance and encyclopaedia. Most firms practise the selling concept when they have overcapacity. Their aim is to sell what they make, rather than make what the market wants. However, marketing based on hard selling carries high risks. It assumes that customers that are coaxed into buying a product will like it and that if they do not, they will not return it or bad-mouth it or complain to consumer organisations, or might even buy it again.
Marketing Concept: The marketing concept emerged in the mid 1950’s. Instead of a product centred “make and sell” philosophy, business shifted to customer centred, “sense and respond” philosophy. Instead of “hunting” marketing is “gardening”. The job is not to find the right customers for your product, but the right product for your customers. The marketing concept holds that the key to achieving organisational goals consists of the company being more effective than the competitors in creating, delivering and communicating superior customer value to its chosen target markets.
Theodore Levitt of Harvard drew a perceptive contrast between the selling and marketing concepts: Selling focuses on the needs of the seller; marketing on the needs of the buyer. Selling is pre-occupied with the seller’s need to convert his product into cash; marketing with the idea of satisfying the needs of the customer by means of the product and the whole cluster of things associating with creating, delivering and finally consuming it.
Several scholars have found that companies who embrace the marketing concept achieve superior performance. This was first demonstrated by companies practising a reactive market orientation- understanding and meeting customers’ expressed needs. Some critics say this means companies develop only low level innovation is possible if the focus is on customer’s latent needs. He calls this a proactive marketing orientation. Companies such as 3M, HP and Motorola have made a practise of researching or imaging latent needs through a “probe and learn” process. Companies that practise both reactive and proactive marketing orientation are implementing a “total market orientation” and are likely to be the most successful.
In the course of converting to a marketing orientation, a company faces three hurdles: organised resistance, slow learning and fast forgetting. Some company departments (often manufacturing, finance and R&D) believe a stronger marketing function threatens their power in the organisation. Initially, the marketing function is seen as one of several equally important functions in a check-and-balance relationship. Marketers argue that their function is more important. A few enthusiasts go further and say that marketing is the major function of the enterprise, for without customers at the centre of the company. They argue for a customer orientation in which all functions work together to respond to, serve and satisfy the customer.
Exchange, Transfer, Transaction
A person can obtain a product in one of four ways. One can self-produce the product or service, as one hunts, fishes or gathers fruits. One can use force to get a product, as in a holdup or burglary. One can beg, as happens when a homeless person asks for food; or one can offer a product, a service or money in exchange for something he or she desires.
Exchange, which is the core concept of marketing, is a process of obtaining a desired product from someone by offering something in return. For exchange potential to exist, five conditions must be satisfied:
1. There are atleast two parties.
2. Each party has something that may be of value to the other party.
3. Each party is capable to communication and delivery.
4. Each party is free to accept or reject the exchange offer.
5. Each party believes it is appropriate or desirable to deal with the other party.
Whether exchange actually takes place depends on whether the two parties can agree on terms that will leave both better off (or atleast not worse off) than before. Exchange is a value creating process because it normally leaves both parties better off.
Two parties are engaged in exchange if they are negotiating- trying to arrive at mutually agreeable terms. When an agreement is reached, we say a transaction takes place. A transaction is a trade of valued between two or more parties. A gives X to B and receives Y in return. Pratap sells a TV set to Samir and Samir pays Rs. 20,000 to Pratap. This is a classic monetary transaction; but transactions do not require money as one of the traded values. A barter transaction involves trading goods or services for other goods or services, as when lawyer Jones writes a will for physician Smith in return for a medical examination.
A transaction involves several dimensions: at least two things of value, agreed upon conditions, a time of agreement, and place of agreement. A legal system supports and enforces compliance on the part of the transactors. Without a law of contracts, people would approach transactions with some distrust, and everyone would lose.
A transaction differs from a transfer. In a transfer, A gives X to B but does not receive any thing tangible in return. Gifts, subsidies and charitable contributions are all transfers. Transfer behaviour can also be understood through the concept of exchange. Typically, the transferer expects to receive something in exchange for his or her gift- for example, gratitude or changed behaviour in the recipient. Professional fund raisers provide benefits to donors, such as thank you notes, donor magazines and invitation to events. Marketers have broadened the concept of marketing to include the study of transfer behaviour as well as transaction behaviour.
In the most generic sense, marketers seek to elicit a behavioural response from another party. A business firm wants a purchase, a political candidate wants a vote, a church wants an active member, and the social group wants the passionate adoption of some cause. Marketing consists of actions undertaken to elicit desired responses from a target audience.
To make successful exchanges, marketers analyse what each party expects from the transaction. Simple exchange situations can be mapped by showing the two actors and the wants and offerings flowing between them. Mahindra & Mahindra is a leader in the tractor market in India. Suppose its farm-equipment division researches the benefits that a typical farmer wants when he buys a tractor. These benefits include high quality equipment, a fair price, timely delivery, good financing terms, and reliable parts and service. The items on this want list are not equally important and may vary from buyer to buyer. One of M&M’s tasks is to discover the relative importance of these different wants to the buyer.
M&M also has a want list. It wants a good price for the tractor, on-time payment and positive word of mouth. If there is sufficient match or overlap in the want lists, a basis of transaction exists. M&M’s task is to formulate an offer that motivates the farmer to buy an M&M tractor. The farmer might in turn make a counter offer. The process of negotiation leads to mutually acceptable terms for a transaction.
Value & satisfaction
The offering will be successful if it delivers value and satisfaction to the target buyer. The buyer chooses between different offerings on the basis of which is perceived to deliver the most value. Value reflects the perceived tangible and intangible benefits and costs to customers. Value can be seen as primarily a combination of quality, service and price (QSP), called the “customer value triad.” Value increases with quality and service and decreases with price, although other factors can also play an important role.
Value is a central marketing concept. Marketing can be seen as the identification, creation, communication, delivery and monitoring of customer value. Satisfaction reflects a person’s comparative judgements resulting from a product’s perceived performance (or outcome) in relation to his or her expectations. If the performance falls short of expectations, the customer is dissatisfied and disappointed. If the performance matches the expectations, the customer is satisfied. If the performance exceeds the expectations, the customer is highly satisfied or delighted.
Needs, Wants and demands
The marketer must understand the target market’s needs, wants and demands.
Needs are the basic requirements. People need food, air, water, clothing and shelter to survive. People also have strong needs for recreation, education and entertainment. These needs become wants when they are directed to specific objects that might satisfy the need. An American needs food, but may want a hamburger, French fries and a soft drink. A person in Mauritius needs food but may want mango, rice, lentils and beans. Wants are shaped by one’s society. Demands are wants for specific products backed by an ability to pay. Many people want a Mercedes; only a few are willing and able to buy one. Companies must measure not only how many people want their product but also how many would actually be willing and able to buy it.
These distinctions shed light on the frequent criticism that “marketers create needs” or “marketers get people to buy things they don’t want.” Marketers do not create needs: Needs pre-exist marketers. Marketers, along with other societal factors, influence wants. Marketers might promote the idea that a Mercedes would satisfy s person’s needs for social status. They do not however create the need for social status.
Understanding customer needs and wants is not always simple. Some customers have needs of which they are not fully conscious, or they can not articulate these needs or they use words that require some interpretation. What does it mean when customers ask for a powerful lawnmower, a fast lathe or an attractive bathing suit or a restful hotel? Consider the customer who says he wants an inexpensive car. The marketer must probe further. We can distinguish among 5 types of needs:
1. State Needs (the customer wants an inexpensive car)
2. Real Needs (the customer wants a car whose operating cost, not its initial price, is low)
3. Unstated needs (the customer expects good service from the dealer)
4. Delight needs (the customer would like the dealer to include onboard navigation system)
5. Secret Needs (the customer wants to be seen by friends as a savvy consumer)
Responding only to the stated need may short-change the customer. Many consumers did not know what they want in a product. Consumers did not know much about Cellular phones when they were first introduced. Nokia and Ericsson fought to shape consumer perceptions of cellular phones. Consumers were in a learning mode and the companies’ forger strategies to shape their wants. As stated by Carpenter, “Simply giving customers what they want isn’t enough anymore- to gain an edge companies must help customers what they want”
In the past, “responding to customer needs” meant studying customer needs and making a product that fits these needs on the average, but some of today’s companies respond to each customer’s individual needs. Dell computer does not prepare a perfect computer for its target market. Rather, it provides product platforms on which each person customises the features he or she desires in the computer. This is a change from a “make-and-sell” philosophy to philosophy of “sense-and-respond.”
THE MARKETING ENVIRONMENT- MACRO & MICRO
The marketing environment surrounds and impacts upon the organization. There are three key perspectives on the marketing environment
- Macro-environment
- Micro-environment
- Internal environment.
MACRO ENVIRONMENT:
Macro Environment refers to the external factors that affect an organization’s planning and performance. Successful companies recognize and respond to profitably to unmet needs and trends that shape opportunities and pose threats. These forces represent the “uncontrollables”, which the company must monitor. It is constantly changing and the company needs to be flexible to adapt to it. Globalization means that there is always the threat of substitute products and new entrants. The wider environment is also ever changing, and the marketer needs to compensate for changes in culture, politics, economics and technology.
Companies conduct what is known as the “PESTEL” study which covers the six arenas of the macro environment namely:
- Political
- Economic
- Socio- cultural
- Technological
- Environmental
- Legal
POLITICAL- LEGAL ENVIRONMENT
Marketing decisions are strongly affected by developments in the political and legal environment. This environment is composed of laws, government agencies, and pressure groups that influence and limit various organizations and individuals. Sometimes these laws also create opportunities. The companies have to keep up with the changing political environment in order to utilize these opportunities to their full potential. To many companies, domestic political considerations are likely to be of prime concern. However, firms involved in international operations are faced with the additional dimension of international political developments. Many firms export and may have joint ventures or subsidiary companies abroad. In many countries, particularly in the ‘Developing Nations’, the domestic political and economic situation is usually less stable than in the developed countries. Marketing firms operating in such volatile conditions clearly have to monitor the local political situation very carefully.
ECONOMIC ENVIRONMENT:
Markets require purchasing power as well as people. The available purchasing power in an economy depends on current income, prices, savings, debt, and credit availability. Marketers must pay careful attention to trends affecting purchasing power because they can have a strong impact on business, especially the companies whose products are geared to high income and price- sensitive consumers. Political and economic forces are often strongly related to the economic environment. A much quoted example in this context is the ‘oil crisis’ caused by the Middle East War in 1973 which produced economic shock waves throughout the Western world, resulting in dramatically increased crude oil prices. This, in turn increased energy costs as well as the cost of many oil-based raw materials such as plastics and synthetic fibres. This contributed significantly to a world economic recession, and it all serves to demonstrate how dramatic economic change can upset the traditional structures and balances in the world business environment. As mentioned earlier, an understanding of economic changes and forces in the domestic economy is also of vital importance as such forces have the most immediate impact. Economic changes pose a set of opportunities and threats, and by understanding and carefully monitoring the economic environment, firms should be in a position to guard against potential threats and to capitalize on opportunities.
SOCIO- CULTURAL ENVIRONMENT
Purchasing power is directed towards certain goods and services and away from others according to people’s tastes and preferences. Society shapes the beliefs, values and norms that largely define these tastes and preferences. Core cultural values are firmly established within a society and are therefore difficult to change. They are perpetuated through family, the church, education and the institutions of society and act as relatively fixed parameters within which marketing firms are forced to operate. Secondary cultural values, however, tend to be less strong and therefore more likely to undergo change. Marketers have some chance of changing the latter than the former. For example, Mothers against drunk drivers (MADD) does not try to stop the sale of alcohol, but it does promote the idea of appointing a designated driver who will not drink that evening. Changes in attitudes towards working women have led to an increase in demand for convenience foods, ‘one-stop’ shopping and the widespread adoption of such time-saving devices as microwave cookers. Marketing firms have had to react to these changes to be successful.
TECHNOLOGICAL ENVIRONMENT:
One of the most dramatic forces shaping people’s lives is technology. Technology is a major macro-environmental variable which has influenced the development of many of the products we take for granted today, for example, television, calculators, video recorders and desk-top computers. Marketing firms themselves play a part in technological progress, many having their own research department or sponsoring research through universities and other institutions, thus playing a part in innovating new developments and new applications.
One example of how technological change has affected marketing activities is in the development of electronic point of sale (EPOS) data capture at the retail level. The ‘laser checkout’ reads a bar code on the product being purchased and stores information that is used to analyze sales and re-order stock, as well as giving customers a printed readout of what they have purchased and the price charged. Manufacturers of fast-moving consumer goods, particularly packaged grocery products, have been forced to respond to these technological innovations by incorporating bar codes on their product labels or packaging. In this way, a change in the technological environment has affected the products and services that firms produce and the way in which firms carry out their business operations.
ENVIRONMENTAL FACTORS
The deterioration of the natural environment is a major global concern. In many world cities, air and water pollution have reached dangerous levels. There is a great concern about “green house gases”. Organizations have to be responsible towards the environment in order to protect it. Other environmental factors to be considered are shortage of raw materials, increased energy costs, anti- pollution pressures, etc.
MICRO ENVIRONMENT
The term micro-environment denotes those elements over which the marketing firm has control or which it can use in order to gain information that will better help it in its marketing operations. In other words, these are elements that can be manipulated, or used to glean information, in order to provide fuller satisfaction to the company’s customers. The objective of marketing philosophy is to make profits through satisfying customers. This is accomplished through the manipulation of the variables over which a company has control in such a way as to optimize this objective. The marketing manager has to build relationships with customers and this is done by creating customer values and satisfaction. However this cannot be done alone. Marketing success will require building relationships with the following microenvironments:
- The company
- Suppliers
- Marketing intermediaries
- Customers
- Competitors
- Publics
COMPANY
The company aspect of microenvironment refers to the internal environment of the company. This includes all departments, such as management, finance, research and development, purchasing, operations and accounting. Each of these departments has an impact on marketing decisions. For example, research and development have input as to the features a product can perform and accounting approves the financial side of marketing plans and budgets. Purchasing worries about getting supplies and materials whereas operations are responsible for producing and distributing the desired quality of products. Accounting has to measure revenues and costs to help marketing know how well it is achieving its objectives. The marketing department has to work closely with the all these departments because together all these departments have an impact on the marketing department’s plan and actions.
SUPPLIERS
Suppliers form an important link in the company’s overall customer value delivery system. The suppliers of a company are an important aspect of the microenvironment because even the slightest delay in receiving supplies can result in customer dissatisfaction. Marketing managers must watch supply availability and other trends dealing with suppliers to ensure that product will be delivered to customers in the time frame required in order to maintain a strong customer relationship. In other words, supply shortage, labor strikes and other events can cost sales in the short run and damage customer satisfaction in the long run. Most marketers today treat their suppliers as partners in creating and delivering customer value. Wal-Mart goes to great length to test new products in its stores.
MARKETING INTERMEDIARIES
Marketing intermediaries refers to resellers, physical distribution firms, marketing services agencies, and financial intermediaries. These are the people that help the company promote, sell, and distribute its products to final buyers. Resellers are those that hold and sell the company’s product. They match the distribution to the customers and include places such as Wal-Mart, Target, and Best Buy. Physical distribution firms are places such as warehouses that store and transport the company’s product from its origin to its destination. Marketing services agencies are companies that offer services such as conducting marketing research, advertising, and consulting. Financial intermediaries are institutions such as banks, credit companies and insurance companies.
CUSTOMERS
Customers are the most important publics of the organization. There are different types of customer markets including consumer markets, business markets, government markets, international markets, and reseller markets. The consumer market is made up of individuals who buy goods and services for their own personal use or use in their household. Business markets include those that buy goods and services for use in producing their own products to sell. This is different from the reseller market which includes businesses that purchase goods to resell as is for a profit. These are the same companies mentioned as market intermediaries. The government market consists of government agencies that buy goods to produce public services or transfer goods to others who need them. International markets include buyers in other countries and includes customers from the previous categories.
COMPETITORS
The basic rule in marketing is that to be successful, a company has to offer a better value and customer satisfaction than its competitors. Thus marketers must do more than simply adapt to the needs of target customers. The company has to first discover their competitors and then adapt a strategy that would put them in a better position as compared to their competitors in the minds of the consumers.
PUBLICS
A public is any group that has an interest in or impact on the organization’s ability to meet its goals. Every organization has two publics- internal and external.
Internal public includes all those who are employed by the company and deal with the organization and construction of the company’s product.
External public can further be divided into the following:
- Financial public- Can hinder a company’s ability to obtain funds affecting the level of credit a company has.
- Media public- Include newspapers and magazines that can publish articles of interest regarding the company and editorials that may influence customers’ opinions.
- Government public- Can affect the company by passing legislation and laws that put restrictions on the company’s actions.
- Citizen action public- Include environmental groups and minority groups and can question the actions of a company and put them in the public spotlight.
- Local publics- Includes neighborhood and community organizations who will question a company’s impact on the local area and the level of responsibility of their actions.
- General public- Can greatly affect the company as any change in their attitude, whether positive or negative, can cause sales to go up or down because the general public is often the company’s customer base.
MARKET SEGMENTATION
LEVELS OF MARKET SEGMENTATION-
In Mass Marketing, the seller engages in the mass production, mass distribution and mass promotion of one product from all buyers. Example- Coca cola practiced Mass marketing when it sold only one kind of coke in a 6.5 ounce bottle.
An argument for mass marketing is that it creates the largest potential market, which leads to lowest costs, which may lead to lower prices or higher profits. However, splintering of markets, proliferation of advertising media and distribution channels are making it difficult and increasingly expensive to reach a mass audience. Thus, more companies are turning to ‘micro marketing’ at one of the four levels: Segments, Niches, local areas and individuals.
Segment Marketing-
A market segment consists of a group of customers who share a similar set of needs and wants. The marketer’s task is to identify them and decide which one(s) to target. Segment marketing offers key benefits over mass marketing. The company can offer better design, price, disclose, and deliver the product or service. It can also fine- tune the marketing programs and activities for the product/ service according to the needs and attitudes of the segment.
A perfect market segment should be Homogenous. However reality differs. Everyone, even within the same segment may not want the same thing.
Thus, Business-to-business marketing experts Anderson and Narus have urged marketers to present ‘flexible market offerings’ to all members of a segment. A Flexible market offering consists of two parts-
- The basic product or service elements that all segment members value.
- Some discretionary options that some members value. Each option may have an additional charge.
Example- Automobile companies in India offer different versions of the same car. The versions have different features. The basic version may not have power steering or power windows. For the models that have these features the buyer has to pay a higher price.
Similarly, Domestic Airlines in India offer business and executive class for travelers. The price, business class passengers have to pay is higher as they get extra facilities such as more comfortable seats, better menu, etc.
Niche Marketing-
A niche is more narrowly defined customer group seeking distinctive mix of benefits. Marketers usually define niches by dividing market segments into sub- segments.
Examples-
1) By focusing on ‘Ayurvedic’ medicines and health supplements, The Himalaya Drug Company serves a niche market.
2) Ezee, the liquid detergent from Godrej, is a fabric washing product for woolen clothes. Because of its mildness, customers use it to wash delicate clothes, which may get damaged by harsh and strong detergents.
3) Exclusive sports channels like Ten Sports, ESPN, STAR sports, and STAR cricket tend to the audiences who have very high interest in sports.
4) Magazines like ‘Better Photography’ which target niche segment of serious amateur photographic enthusiasts.
An attractive niche has customers with distinct set of needs; they will pay a premium to the firm that best satisfies them; the niche is fairly small but has size, profit and growth potential and is unlikely to attract many other competitors.
Niche marketers aim to understand their customers’ needs so well that they are willing to pay a premium. Revolution Clothing Pvt. Ltd. pioneered the concept of ‘plus sized women’ and name the apparel size categories as -2, -1, 0, 1, 2, 3, 4 instead of L, XL, XXL. The concept gave women pride and self confidence.
Local Marketing-
Target marketing is leading to marketing programs tailored to the needs and wants of local customer groups in trading areas, neighborhoods and even individual stores.
Examples-
1) Many banks in India have specialized ‘NRI branches’ to cater to the needs of families whose relatives remit money from abroad.
2) The movie Spiderman 3 was released in five different languages in India, including Bhojpuri- A regional dialect.
3) Bharatmatrimony.com is a successful matrimony website. It realized that in India, marriages are mostly community based. Thus, it emphasized on offering customized services addressing to specific requirements of customers. Thus, the service provider has initiated 15 regional websites such as punjabimatrimony.com, bengalimatromony.com, etc.
Individual marketing-
The ultimate level of segmentation leads to ‘segments of one’, ‘customized marketing’ or ‘one-to-one marketing’. Today, customers are taking initiative in determining what and how to buy. They log onto internet, look up for information and evaluations of product; talk with suppliers, users, critics, etc.
Wind and Rangaswamy see a movement towards ‘Customerizing’ the firm. It combines operationally driven mass customization with customized marketing in a way that empowers consumers to design the product and service offering of their choice.
Customization is not for every company as it may be difficult to implement for complex products like automobiles. It can raise cost, and many customers want to see the product before they buy it.
But Customization has worked well for some products like Paint Companies (Asian paints, Nerolac, Berger paints) follow the mass customization strategy in paint retailing. They facilitate customers to mix and match colors of their choice from catalogue, and the desired colors are mixed in quantities as per the requirement of customer using equipment installed in retail points- thus providing a wide range of colors to customers to choose from.
BASIS FOR SEGMENTING CONSUMER MARKETS:
There are two broad groups of variables to segment consumer markets.
- Descriptive Characteristics: Geographic, Demographic, psychographic.
- Behavioral Segmentation: Consumer responses to benefits, use occasions
Geographic Segmentation:
Division of market into different geographical units such as nations, states, regions, cities and villages. Geographical segments vary in logistics, product requirement, size, culture and food habits.
Example- In arid regions of India and Pakistan, during hot and dry summer seasons, air coolers are used. But, this product is ineffective where climate is hot and humid. Thus, Air Conditioners are preferred.
Demographic Segmentation:
Division of market into groups on the basis of variables such as age, family size, gender, income, occupation, education, nationality and social class.
Age and life cycle stage- Consumers wants and abilities change with age. Thus these are important variables to define segments. Example- Johnson and Johnson’s baby soap and talcum powder are classic examples of products for infants and children. Channels like Aastha and Sanskar are focused on older generation.
Life Stage- It defines a person’s major concern, such as getting married, deciding to marry their children, sending child to school, planning to retire and so on. These life stages help marketers who can help the consumers cope with their major concerns. Example- When a person gets married and shifts in a new home, many services such as furniture, cooking gas, utensils become necessary. Many marketers develop schemes for such people. Similarly, there are insurance-cum-savings schemes to help young parents plan for their children’s education.
Gender- Men and women have different attitudes and behave differently based on their genetic make-up and socialization. Some traditionally male oriented markets like two wheeler markets are beginning to recognize gender discrimination. They have come up with women oriented two wheelers like scooty pep, Bajaj Wave DTSi, etc.
Income- determines the ability of consumers to participate in market exchange. Example- Nirma washing powder was launched as the lowest priced detergent in India primarily targeted at middle income segment.
Psychographic segmentation:
Psychographics is the science of using psychology and demographics to better understand consumers. Even when the consumers belong to same demographics they may differ according to their Lifestyle, values and personality.
Example- In India even non-vgetarian Indians avoid Beef. Thus, McDonalds removed beef items from their menu and also introduced vegetarian burgers in India.
BEHAVIORAL SEGMENTATION-
Decision Roles: People play five role in buying decision: Initiator, Influencer, Decider, Buyer and user. Understanding roles is vital for marketers. Example: Doctors prescribe medicines, pharmacy companies influence doctors’ prescription behavious by providing technical information about product. Patients’ relatives buy and patient uses product.
Behavioral Variables: Many marketers use behavioral variables- occasions, benefits, etc. See the following points:
Occasions- Festivals and anniversaries require greeting cards. Companies like Archies and Hallmark provide them. Special gift packs are provided by chocolate companies like Cadburys at occasions.
Benefits- Customers can be classified by the benefits they seek. Example- Liril soap offers freshness, Dettol soap provides total protection.
User Status- Ex- user, non-user, potential user, first time user or regular user? Mothers to be are potential users for infant product companies.
Usage rate- light, medium or heavy usage rate? Heavy users offer small percentage of market but high percentage of revenue. Example- In mobile services, heavy users account for high revenue. Mobile services target these users by special schemes.
Loyalty stage- There are four kinds of loyalty groups:
1) Hard core loyals- Who buy only one brand every time.
2) Split Loyals- Loyal to two or three brands.
3) Shifting loyals- shift loyalty from one brand to another.
4) Switchers- No loyalty to any brand.
Hard core loyals help identify the company its products’ strength. Split loyals show which companies are in competition. Likewise companies can identify the weaknesses and strengths in its products. Many services like clubs, retails provides loyalty schemes to retain customers.
BASIS FOR SEGMENTING BUSINESS MARKETS:
Some variables used in consumer markets can be used here also like geography, benefits sought, usage rate, but business marketers also use other variables
Demographic-
1) Industry: which industry should we serve?
2) Company size: What size company should we serve?
3) Location: What area should we serve?
Operating Variables-
4) Technology: what customer technologies should we focus on?
5) User Status: should we serve heavy users, medium users, light users or nonusers?
6) Customer capabilities: Should we serve customers needing many or few services?
Purchasing approaches-
7) Purchasing- function organization- Should we serve companies with highly centralized or decentralized purchasing organization?
8) Power Structure: should we serve companies that are engineering dominated, financially dominated and so on?
9) General Purchasing Policies: should we prefer companies that prefer leasing or service contract or sealed bidding and so on.
10) Purchasing Criteria: Should we serve companies that are seeking quality, service or price.
Situational Factors-
11) Urgency: should we serve companies that need quick and sudden delivery?
12) Size or order: Should we focus on large or small orders?
Personal Characteristics-
13) Attitude risk: Should we serve risk taking or risk avoiding customers?
14) Loyalty: Should we serve companies that show high loyalty to their suppliers?
15) Should we serve companies whose people and values are similar to us?
A rubber tire company can sell tires to manufacturers of automobiles, trucks, tractors, aircraft, etc. Within the chosen segment the company can further segment by company size.
MARKET TARGETING
Market segmentation - why segment markets?
There are several important reasons why businesses should attempt to segment their markets carefully. These are summarised below
Better matching of customer needs
Customer needs differ. Creating separate offers for each segment makes sense and provides customers with a better solution
Enhanced profits for business
Customers have different disposable income. They are, therefore, different in how sensitive they are to price. By segmenting markets, businesses can raise average prices and subsequently enhance profits
Better opportunities for growth
Market segmentation can build sales. For example, customers can be encouraged to "trade-up" after being introduced to a particular product with an introductory, lower-priced product
Retain more customers
Customer circumstances change, for example they grow older, form families, change jobs or get promoted, change their buying patterns. By marketing products that appeal to customers at different stages of their life ("life-cycle"), a business can retain customers who might otherwise switch to competing products and brands
Target marketing communications
Businesses need to deliver their marketing message to a relevant customer audience. If the target market is too broad, there is a strong risk that (1) the key customers are missed and (2) the cost of communicating to customers becomes too high / unprofitable. By segmenting markets, the target customer can be reached more often and at lower cost
Gain share of the market segment
Unless a business has a strong or leading share of a market, it is unlikely to be maximising its profitability. Minor brands suffer from lack of scale economies in production and marketing, pressures from distributors and limited space on the shelves. Through careful segmentation and targeting, businesses can often achieve competitive production and marketing costs and become
Once the firm has decided its market segments, it must decide how many and which ones to target. However, to be useful, market segments must rate favourably on five key criteria:
Measurable- Size, purchasing power and characteristics of the segments can be measured.
Substantial- segments should be large and profitable enough to serve. Example- It may not be useful for an automobile company to make cars for people who are less than 4 feet tall.
Accessible- segments should be reachable.
Differentiable- The segment should be homogenous within itself and different from others. Example- if married and unmarried woman respond similarly to a perfume’s sales program, they may be in a same segment.
Actionable- Effective programs can be formulated for attracting and serving segments.
EFFECTIVE SEGMENTATION
Even after applying segmentation variables to a consumer or business market, marketers must realize that not all segmentations are useful. For example, table salt buyers could be divided into blond and brunette customers, but hair colour is not relevant to the purchase of salt. Furthermore, if all salt buyers buy the same amount of salt each month, believe all salt is the same, and would pay only one price for salt, this market would be minimally segmentable from a marketing perspective.
To be useful, market segments must be:
• Measurable: The size, purchasing power, and characteristics of the segments can be measured.
• Substantial: The segments are large and profitable enough to serve. A segment should be the largest possible homogeneous group worth going after with a tailored marketing program.
• Accessible: The segments can be effectively reached and served.
• Differentiable: The segments are conceptually distinguishable and respond differently to different marketing mixes. If two segments respond identically to a particular offer, they do not constitute separate segments.
• Actionable: Effective programs can be formulated for attracting and serving the segments.
Evaluating and Selecting Market Segments:
For evaluation, the firm should look at- the segment’s overall attractiveness; and the objectives and resources with firm. It should see how well the segment scores on the above stated five point criteria and also see if investing in that segment makes sense with firm’s objectives, competition and resources.
After evaluating different segments, company can consider five patterns of target market selection:
1) Single Segment Concentration- the Zodiac Shirts focus on formal shirts for executives and professionals. Specialty hospitals may focus on cardiology or cancer care. This is also known as concentrated marketing, through which firm gains strong knowledge about needs of segment and achieves strong market presence. One market segment is served with one marketing mix.
2) Selective specialization- firm select number of objectives, each objectively attractive and appropriate. There may be little or no synergy between products.
3) Product Specialization- firm specializes in one product and tailors it to different market segments. Example- A microscope manufacturer can sell the product to universities, government, labs, etc.
4) Market specialization- firm specializes in serving many needs of a market group. Example- firm can sell an assortment of products only to university laboratories. Firm gains good reputation and becomes a channel for additional products for this customer group.
5) Full market Coverage- Firm attempts to serve all customer groups with all the products they might need. Example- Microsoft company for softwares, General Motor Company for vehicle marketing. It can reach segments by undifferentiated marketing (ignores segments, goes after whole market) or differentiated marketing( operates in different segments and offers different products)
POSITIONING
In marketing, positioning has come to mean the process by which marketers try to create an image or identity in the minds of their target market for its product, brand, or organization. It is the 'relative competitive comparison' their product occupies in a given market as perceived by the target market.
The marketer would draw out the map and decide upon a label for each axis. They could be price (variable one) and quality (variable two), or Comfort (variable one) and price (variable two). The individual products are then mapped out next to each other Any gaps could be regarded as possible areas for new products.
The term 'positioning' refers to the consumer's perception of a product or service in relation to its competitors. You need to ask yourself, what is the position of the product in the mind of the consumer?
Re-positioning involves changing the identity of a product, relative to the identity of competing products, in the collective minds of the target market.
De-positioning involves attempting to change the identity of competing products, relative to the identity of your own product, in the collective minds of the target market.
Positioning is a concept in marketing which was first popularized by Al Ries and Jack Trout in their bestseller book " Positioning - a battle for your mind". They iterate that any brand is valued by the perception it carries in the prospect or customer's mind. Each brand has thus to be 'Positioned' in a particular class or segment. For example, Mercedes is positioned as a luxury brand, and Volvo is positioned for safety.
The position of the brand has to be carefully maintained. When Marlboro reduced its prices, sales dropped immediately because its customers began associating it with the generic segment. Rolex watches are even more dramatically positioned as a luxury items, and have become a symbol for accomplishment in life. If Rolex reduces its prices, it will reduce brand cachet and sales.
Developing and Communicating a positioning Strategy-
Competitive frame of reference: The firm may decide the category membership of its products- the products with which brand competes and which function as close substitutes. Deciding to target a certain type of consumer can also define competition.
To understand competitive frame of reference, marketers need to understand consumer behaviour and how they choose products.
Example- paras pharmaceuticals launched Moov as a balm for relieving joint pains that trouble older people. Later, based on consumer research, repositioned brand as ‘backache specialist’ that addresses the problems of backache that housewives encounter. The brand communicates the pain relieving promise of “ek minute moov ki malish” in ads that go with tagline “ah se aaha tak” (from pain to relief).
Points of Difference and Points of Parity:
PODs are attributes or benefits consumers strongly associate with a brand, positively evaluate, and believe they could not find same extent’s benefit with competitive brand. They are points unique to a brand. Example Apple has design as its POD.
POPs are associations that are not necessarily unique to a brand but may be shared with other brands.
Dettol dominated antiseptic market in India. It had attributes of stinging when applied, turning cloudy when poured in water and strong smell. Consumers associated these attributes with efficiency of antisepic. When Savlon was introduced, it had none of these attributes. No strong smell, no sting. Thus, to obtain consumer satisfaction it had to counter the perception by communication. It advertised the superior efficacy of product and highlighted the ‘no-sting’ property, which is its key POD.
Dove has established itself as a very gentle soap having ¼ moisturizing cream, thus promising soft skin.
MARKETING MIX
Marketing decisions generally fall into the following four controllable categories:
• Product
• Price
• Place (distribution)
• Promotion
The term "marketing mix" became popularized after Neil H. Borden published his 1964 article, The Concept of the Marketing Mix.
The ingredients in Borden's marketing mix included product planning, pricing, branding, distribution channels, personal selling, advertising, promotions, packaging, display, servicing, physical handling, and fact finding and analysis. E. Jerome McCarthy later grouped these ingredients into the four categories that today are known as the 4 P's of marketing, depicted below:
1. PRODUCT
This is an object an idea or a service that is mass produced or manufactured on a large scale with a specific volume of units. A good product makes its marketing by itself because it gives benefits to the customer.
Suppose now that the competitors products offer the same benefits, same quality, same price. You have then to differentiate your product with design, features, packaging, services, warranties, return and so on. In general, differentiation is mainly related to:
-The design: It can be a decisive advantage but it changes with fads. For example, Nokia has to keep changing the designs of the cellphones to surpass customer expectations.
-The packaging: It must provide a better appearance and a convenient use. In food business, products often differ mainly by packaging.
-The safety: It matters a lot for products used by kids.
-The "green": A friendly product to environment gets an advantage among some segments.
In business to business and for expensive items, the best mean of differentiation are warranties, return policy, maintenance service, time payments and financial and insurance services linked to the product.
2. PRICE
The price is the amount or a consideration a customer pays for the product. It is determined by a number of factors including market share, competition, material costs, product identity and the customer's perceived value of the product. The business may increase or decrease the price of product if other stores have the same product.
Pricing strategies
-Competitive pricing: If your product is sold at the lowest price amongst all your competitors, you are practicing competitive pricing. Sometimes, competitive pricing is essential. For instance, when the products are basically the same, this strategy will usually succeed. The success of competitive pricing strategy depends on achieving high volume and low costs.
-Cost-plus-profit pricing: It means that you add the profit you need to your cost. So the profit is decided first. It is also called cost-orientated strategy and is mainly used by the big contractor of public works. The authority may have access to the costing data and should like to check if the profit added to the cost is not too high. In fact, this strategy is only good for a business whose customers are public bodies or government agencies.
-Value pricing: It means that you base your prices on the value you deliver to customers. For example, when a new technology has a very large success, you can charge high prices to the customer. This practice is also called skimming. Value pricing is also common in luxury items. Sometimes, the higher the price, the more you sell: Fashionable clothing or restaurants for the snobbish appeal.
3. PLACE
Place represents the location where a product can be purchased. It is often referred to as the distribution channel. It can include any physical store as well as virtual stores on the Internet. A crucial decision in any marketing mix is to correctly identify the distribution channels.
4. PROMOTION
Promotion represents all of the communications that a marketer may use in the marketplace. Advertising, public relations and so on are included in promotion and consequently in the 4Ps.
Advertising:
It takes many forms: TV, radio, internet, newspapers, yellow pages, and so on.
Public Relations:
Public relations are more subtle and rely mainly on your own personality. It is an unpaid form of promotion. For example, you can deliver public speeches on subjects such as economics, geo-economics, futurology to several organizations (civic groups, political groups, fraternal organizations, professional associations). It is the relationship maintained with these various organisations.
Sales Promotion:
It includes fair trades, coupons, and discounts and is linked to the sales strategy.
In a customer-centric era where organisations aim at gaining competitive advantage by creating and managing excellent customer relationships the emphasis is as much on customer retention as customer acquisition. These four P's are the parameters that the marketing manager can control, subject to the internal and external constraints of the marketing environment. The goal is to make decisions that center the four P's on the customers in the target market in order to create perceived value and generate a positive response.
The following table summarizes the marketing mix decisions, including a list of some of the aspects of each of the 4Ps.
Summary of Marketing Mix Decisions
Product Price Place Promotion
Functionality/ Features
Appearance
Quality
Style
Size
Options
Packaging
Brand
Warranty
Returns
Service/Support List price
Discounts
Allowances
Financing
Payment Period
Credit Terms Channel members
Channel motivation
Market coverage
Locations
Logistics
Inventory
Transport Advertising
Personal selling
Public relations
Sales Promotion
Message
Media
Budget
The marketing mix is the combination of marketing activities that an organisation engages in so as to best meet the needs of its targeted market as it helps to create and communicate the differential advantage effectively.
Traditionally the marketing mix consisted of just 4 Ps.
For example, for a motor vehicle manufacturer like Audi:
• Produces products that are of the highest quality and fit for the needs of different groups of consumers,
• Offers a range of cars at value for money prices, depending on the market segmented they are targeted at,
• Sells the cars through appropriate outlets such as dealerships and showrooms in prime locations, i.e. in the right places, and
• Supports the marketing of the products through appropriate promotional and advertising activity.
Getting the mix of these elements right enables the organisation to meet its marketing objectives and to satisfy the requirements of customers.
In addition to the traditional four Ps it is now customary to add some more Ps to the mix to give us Seven Ps. The additional Ps have been added because today marketing is far more customer oriented than ever before, and because the service sector of the economy has come to dominate economic activity in this country. These 3 extra Ps are particularly relevant to this new extended service mix.
The three extra Ps are:
1. PHYSICAL LAYOUT / PHYSICAL EVIDENCE
Today consumers typically come into contact with products in retail units - and they expect a high level of presentation in modern shops - e.g. record stores, clothes shops etc. Not only do they need to easily find their way around the store, but they also often expect a good standard or presentation.
The importance of quality physical layout is important in a range of service providers, including:
• Students going to college or university have far higher expectations about the quality of their accommodation and learning environment than in the past. As a result colleges and universities pay far more attention to creating attractive learning environments, student accommodation, shops, bars and other facilities.
• Air passengers expect attractive and stimulating environments, such as interesting departure lounges, with activities for young children etc.
• Hair dressing salons are expected to provide pleasant waiting areas, with attractive reading materials, access to coffee for customers, etc.
• Physical layout is not only relevant to stores, which we visit, but also to the layout and structure of virtual stores, and websites.
2. PEOPLE
Customers are likely to be loyal to organisations that serve them well - from the way, in which a telephone query is handled, to direct face-to-face interactions. Although the 'have a nice day' approach is a bit corny, it is certainly better than a couldn't care less approach to customer relations. Call centre staff and customer interfacing personnel are the front line troops of any organisation and therefore need to be thoroughly familiar with good customer relation's practice.
3. PROCESSES
Associated with customer service are a number of processes involved in making marketing effective in an organisation e.g. processes for handling customer complaints, processes for identifying customer needs and requirements, processes for handling orders, etc.
The 7 Ps - price, product, place, promotion, physical evidence, people and processes comprise the modern marketing mix that is particularly relevant in service industry, but is also relevant to any form of business where meeting the needs of customers is given priority.
Consumers are constantly being interrupted by thousands of marketing messages, making it easy for one message to get lost in the overwhelming clutter of communications. Plus, consumers no longer have a well-defined set of products and vendors that they will consistently seek out to fulfill a need.
The four Ps represent the seller’s view of the marketing tools available for influencing buyers. From a buyer’s point of view, each marketing tool is designed to deliver a customer benefit. In the words of Philip Kotler, parity can be established between how the 4 P's of marketing deliver a customer benefit and can pave way for the 4 C's of marketing
Four P's vs Four C's
Product=Customer Solution/ Value
Price=Customer Cost
Place=Convenience
Promotion=Communication
Winning companies are those that can meet customer needs economically and conveniently and with effective communication.
Success will arrive at a company's doorstep when it uses the correct combination of the 4 C's and by developing products as per customer needs, provides economically viable options conveniently to it's customers through the appropriate means of communication.
CONSUMER BEHAVIOUR
Consumer Psychology:
Consumer psychology can be defined as the scientific study of the behaviour of consumers. A consumer is an individual who uses the products, goods, or services of some organization. It decides the personality, taste, attitudes of individuals or groups, life style, preferences especially on occasions like marriage. The demonstration influence is also dependent upon psychology of an individual.
Psychology of consumers is commonly known as study of lifestyle of consumers. Study of consumer psychology is the most important part of the consumer behaviour research, because it helps to know the attitude of the customers, his level of learning, knowledge, perceptions, personality, his motivation of buying a particular product or service. It helps to understand the psychology of different types of customers based on age, sex, income level, , education , their rural or urban buy ace. For instance a person living in Mumbai or Delhi thinks differently from person living in Bihar, Jharkhand or Chhattisgarh, their psychology is different, their thinking about product and services are different and their needs and perceptions are different from urban elite. The study of psychology helps marketers to segment markets and produce goods according to their requirement rather than thrusting same product on all. For instance, psychology of rural population of older generation is to wear only dhoti, they will not buy trousers whatever efforts are made. Similarly, large percentages of them do not wear shoes or chappals. Similarly, they do not use toothpaste to clean their teeth. Many of them depend on Neem or babul stick (Datun) for cleaning teeth and some use tooth powder. Why they have thinking and practice as they have can be understood only by studying their psychology and there after draw a sales promotion or marketing strategy accordingly. If this is not done marketing efforts will go waste and will not give results expected from advertisements and other sales promotion offers.
The study of consumer psychology will make us understand, “How do we make the market work better so that customers can make better decisions about what to buy”. If for social purpose , India has to reduce consumption of alcohol one has to find out through research why people drink? When in our country number of states prohibited drinking from time to time it was utter failure because prohibition was imposed without studying the psychology of the drinkers. However, in case of cigarettes, when it was told that smoking is injurious to health and can cause cancer, it had some impact and the absolute consumption of cigarettes has declined. If prohibition was imposed after studying how often and what problems are faced by discontinuing drinking alcohol and what have been their responses to their problems and their solutions might have been found, the result would have been more encouraging.
Children are psychologically vulnerable to specific advertisements but before making such advertisements, their psychology will have to be studied first to market products and services needed by them and secondly by the state to protect them against misuse of their psychology.
Study od psychology is an important tool for researchers and if one does not have resources to go in depth, study of consumer psychology can help in great deal. For, eg, the psychology of rural masses in our country is to like bright colours especially red, blue and yellow. Therefore its intelligent to manufacture fabrics in these colours for the rural area.
But, at the same tie, psychology is to try a product out which is advertised because TV has reached every corner of the country. It seems that villagers are as much concerned about commercials as the urban dwellers. Therefore in north India, many milkmen have purchased motorbikes to deliver milk. Farmers have adopted tractors, thrashers, for cultivation.
Psychographics is another discipline which has to be used for study of consumer behaviour. Psychographic research- studies life style of consumers to find out markets for certain products like items of personal health care, cosmetics, items of daily consumption like TV, car, drawing room furniture.
The stimulus situation is the complex of conditions that collectively act as a stimulus to elicit responses from the consumer. This suggests that consumer behaviour is not typically thought of
as being elicited by a single stimulus. Rather, consumer behaviour is considered to be the consequence of patterns or constellations of stimuli. For example, when the consumer purchases a can of "Coca-cola" brand beverage, that consumer behaviour was not merely the result of the cost of the product. Instead, we would have to consider the cost of the product, the characteristics of the advertisement of the product, the packaging of the product, the individual's past experiences
with the product, the placement of the product on the shelf, and so on.
At first glance, this might appear frustrating to the budding consumer psychologist; the stimulus situation that impacts upon the consumer seems to be unman¬
age ably complex. However, it is important to recognize that the world in which
consumers behave is, in reality, extremely complex, filled with continual commer¬cials, pretty packaging, and confusing choices.
Studies have shown that More than 90% of learning and advertisement is incidental. Advertisement does its job in the human brain and human brain does it in the memories.
Consumer has a conscious and a sub conscious mind. Consciously he becomes aware of a product or company, creates a perception, then he thinks and acts accordingly. Sub consciously, a customer follows his stimulus.
Advertising is all about playing with the consumers emotions which are loosely termed as expression of feelings. Emotions are result of priori assumption or instincts. Moods are of less psychological urgency and are less intensive.
Perception is typically defined as the psychological processing of information
received by the senses. The result of the internal process of perception is aware¬ness of the product, or awareness of attributes of the product. Cognition refers
to the processes of knowing or thought. The result of cognition is a collection of
beliefs about or evaluations of the product. Memory refers to the retention of
information regarding past events or ideas. The result of this process is the
acquisition, retention, and remembering of product information. Learning de¬
scribes a relatively permanent change in responses as a result of practice or
experience. The result of this internal process is the formation of associations
between stimuli or between stimuli and responses. Emotion is a state of arousal
involving conscious experience and visceral changes. The result of this internal
process is feelings about the product. Motivation is a state of tension within the
individual that arouses, directs, and maintains behaviour toward a goal. The result
of this internal process is desire or need for the product.
Belief:
Belief is based on cognition and knowledge as opposed to to affective (based on feelings). Reebok shoes are aerodynamic and Volvo cars are safe. The stronger the association of features or attributes with the product or brand, the stronger the consumer’s belief. In terms of brand associations that brands are organised in the consumer’s memory. Brand equity is a measure of the strength of those associations in the marketplace. The stronger a brand is, the more readily it is retrieved from memory, the more likely it is to be purchased, and, in most cases, the higher the level of continuing loyalty it experiences. It is through positioning brands in the minds of consumers that marketers attempt to establish or change consumer beliefs about them. The marketers use the following positioning strategies thereby strengthening or weakening beliefs, thereby increasing brand equity and market share.
Broadly there are three kinds of beliefs – central belief, central free belief, and derived belief.
Central beliefs are based on the core rigid beliefs in life like health, discipline, etc.
Derived belief is any belief that stems out of central belief like Ftv should not be banned (core belief is freedom of choice)
Central free belief is not an exclusive category and constantly keeps overlapping into the rest two. Like cold milk cures acidity. It stays inspite of the rest of factors.
Product attributes –
The simplest and most common way of positioning products is through association of specific attributes with a brand. Some marketers aim to make their products synonymous with, for example, performance attributes that make consumers buy. This differentiates them from private labels commonly found in chain supermarkets.
Consumer benefits –
Marketers attempt to influence consumer beliefs about brands by associating them with important consumer benefits. A brand of shampoo with natural protein (an attribute) is positioned to highlight the fact that it’s the only shampoo that will not damage hair, no matter how frequently it is used (a benefit). A computer with touch – screen entry (an attribute) attracts consumers looking for ease of use (a benefit).
Intangible attributes -
Product quality, technological leadership, and value for money are all intangibles – non-functional factors or bundles of factors the consumer associates with a brand. Car advertising typically relies on the power of intangibles to build brand equity. In an interesting study of consumer beliefs, subjects were shown two brands of cameras described in terms of intangible attributes – one was technically sophisticated and the other easy to use. Detailed information was provided clearly showing that the easy – to – use brand was, in fact, technically superior. When asked to recollect each brand two days later, subjects simply remembered one as easy to use and the other as technically sophisticated. They recalled not the detailed specifications they had read, but the advertising they had read, but the advertising claims, demonstrating the power of intangible attributes to influence consumer beliefs.
Price -
Consumers associate certain brands with a particular price or price range. Price, particularly price relative to that of competitors, influences the way we retrieve brand information from memory.
Application -
Consumers associate particular uses or applications with different brands. By discovering the most common use of the product, marketers position brands to gain market share. Eg: coffee is a drink to start the day, a break between meals, a break with friends, a lunch or supper drink, etc.
Celebrity recognition -
We perceive celebrities in terms of their personalities and the values they represent. Through celebrity recognition, marketers associate brands with a celebrity endorser and so connect the celebrity’s personality and values with them. Consumers ultimately respond to the brand in the same positive way in which they respond to the brand in the same positive way in which they respond to the celebrity.
Brand personality -
Several successful campaigns manufacture a “personality’ with which to associate brands. In a long and enduring rivalry, Coke is associated with a strong, family-oriented, all- American image, whereas Pepsi is positioned as exciting, innovavtive, fast-growing, and somewhat brash and pushy.
Product category -
Marketers create identifies for brands through strong association with a particular, sometimes unexpected, product category. The most obvious example is the positioning of 7up soft drink as the ‘uncola’ - the logical alternative to colas but with better taste.
Competitors -
Marketers can purposely associate their brands with competitors in order to share the consumer perceptions enjoyed by market leaders. A market follower tries to capitilize on the well- established image of the market – leader, hoping this well persuade consumers to make positive inferences about its product.
Country or Geographic area -
Brands can be associated with a particular country or geographic locale with a reputation for quality. Japan, for example, is associated with high quality cars and electronic goods, France with perfumes and fashion, Germany with cars, etc.
Value
Values are what are imbibed in us from childhood as a function of our surroundings, our parents, family and friends, and our environment at schooling and college.
Indians and value
• High degree of value orientation has labeled Indians as the most discerning consumers in the world. Even luxury brands like Swatch have to design a unique pricing strategy for India.
• High degree of family orientation. This extends to extended family and friends as well. Brands with identities that support family values tend to b strong. E.g. Colgate
• Values of nurturing and care are far more dominant than values of ambition and achievement. Hence communication with feelings and emotions will gel better with the consumers.
The value element attempts the marketer to build a personality for the product or create an image of the product user.
Values differ from beliefs-
1. They are fewer in number
2. They are enduring and difficult to influence
3. They orient the individual towards beahaviour which is acceptable to his/ her culture
4. They are not tied to specific situations
5. They are accepted by members of a society
Attitude
An attitude expresses how a person feels towards an object.
An attitude is primarily a learned predisposition to respond in a consistently favorable or unfavorable manner with respect to a given object. Thus, an attitude is the way we think, feel, and act towards some aspect of our environment, such as a product (teabags), a brand (Tata tea), an advertisement for it, etc.
Characteristics of attitude
• Attitudes have an object
Attitudes must have a focal point. It could be a physical object (say, a Maruti), or a service (ex. Customer care of ICICI Bank), or an action (ex. smoking)
• They have direction, intensity and degree
- Direction : the person is either for or against (favorably or unfavorably inclined towards) an object
- Degree : the extent of like or dislike towards the object
- Intensity : how strongly a person feels about his conviction.
The direction, degree and intensity of a persons attitude towards an product provide marketers with an estimate of how ready the customer is as far as purchase of a product is concerned.
• They have a structure
Attitudes display a certain amount of organization. This implies that they have internal consistency, are fairly stable, have varying degrees of salience and are generalisable.
• They are learned.
Learning precedes attitude formation and change. They are also derived from both direct and indirect experiences in life.
Components of attitude
1. Cognitive component
it primarily consists of a consumers belief about an object. These may or may not conform to reality.
2. Affective component
A consumers feelings or emotional reactions towards an object represent the affective component. It could be a vague, general feeling or something as a result of cognitive evaluation.
3. Behavioural component
It is ones tendency to respond in a certain manner towards an object or activity. A series of decisions to purchase or not to purchase a brand reflects this component of attitude.
Habit
Often we find a convenient way of doing things, we tend to repeat it without really thinking. A habitual decision making is characterized by-
a. Little or no information seeking, and
b. Little or no evaluation of alterbnatives.
Habit does not require a strong preference for an offering; rather, it is simply repetitive behaviour and regular purchase.
Habit helps a consumer because-
a. He does not have to evaluate the brand every time, it saves time and effort for him.
b. It reduces risk for him.
Behaviour
There are three important implications for a marketer
• He should try to develop a repeat purchase behaviour among users
• He should try to wean away habitual purchasers of other brands.
• He should make sure that habitual purchasers of his own brand continue to do so.
Personality
Research into over the last decade has been dominated by semiotics, the study of signs and their meanings. Consumer semiotics focuses on issues such a how consumers use symbols to interpret the world, how those symbols are chosen and given meaning, and how they provide insight into certain aspects of consumer’s life. Consumer semioticians study not only immediate, spontaneous consumer actions or response, they research the reasons behind such responses behind such responses, they research the reasons behind thus, introspection, and repressed attitudes and motives are all a part of consumer semiotics.
By understanding the relationship between the personality for consumers and their purchase behaviour, marketers are better equipped to target and promote their products effectively. Psychologists use two approaches : the state approach and the trait approach.
State approach - it advocates understanding the individual in the context of the whole. It is the study of personality that allows us to predict what a person will do in a given situation.
Trait approach – the fundamental assumption of this approach is that we all share the same traits, but they are expressed at different levels, resulting in different personalities. Researchers analyze market segments to ascertain the extent of influence of specific personality trait or combination of traits on the behaviour of consumers in that segment.
An important fact to be taken into account when a consumer buys a brand is that he is likely to select a brand which is in congruence with his/ her personality. Now, though a brand is built on a functional platform, it is possible to develop a personality for the brand using appropriate imagery. E.g. In the category of scooters, LML Vespa created a personality around itself when the scooter category was dominated by Bajaj. LML projected its personality as ‘ suave, sophisticated and standing apart from the crowd”.
Self concept
In almost any category in consumer products, symbolism makes sue of the concept of ‘self’. Self- concept is the image an individual holds of himself or herself.
Consumers are likely to buy brands which enhance his or her self- image. These possessions may be bought for functional or symbolic purposes, or both. For eg. A young executive about to build his career in the corporate world may choose from Van Heusen if he believes that the brand is likely to enhance his self-image.
There are a variety of self-concepts which are useful in marketing communication. They are-
1. Actual self-concept: this is the way the individual perceives himself or herself. A group of consumers may perceive themselves as rebellious non- conformists who seek individuality and freedom in their lifestyles. Thus a line of “Born Free” will appeal to them.
2. Ideal self-concept: This is concerned with how an individual would ideally like to perceive himself. The thin line of difference is that the ideal self-concept is based on a future aspiration, deeper than the active self-image. The individual may use status to impress others, but will resist from doing so ina situation where he feels others do not matter
3. Expected self-concept: this is midway between the actual and ideal self- images. It is more likely to be useful to marketers because changing the actual self-image radically to the ideal image is difficult. The expected self- image is the one that the consumer can actually identify with.
.
Consumer Decision Process
The decision-making process consists of a series of steps which the consumer undergoes. First of all, the decision is made to solve a problem of any kind. For this, information search is carried out. This leads to the evaluation of alternatives and a cost benefit-analysis is made to decide which product and brand image will be suitable, and can take care of the problem suitably and adequately. Thereafter the purchase is made and the product is used by the consumer. The constant use of the product leads to the satisfaction or dissatisfaction of the consumer, which leads to repeat purchases, or to the rejection of the product.
The marketing strategy is successful if consumers can see a need which a company’s product can solve and, offers the best solution to the problem. For a successful strategy, the marketer must lay emphasis on the product/brand image in the consumer’s mind. Position the product according to the customers’ likes and dislikes. The brand which matches the desired image of a target market sells well.
Sales are important and sales are likely to occur if the initial consumer analysis was correct and matches the consumer decision process. Satisfaction of the consumer, after the sales have been effected, is important for repeat purchase. It is more profitable to retain existing customers, rather than looking for new ones. The figure below gives an idea of the above discussion.
The Process of Decision Making
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Problem recognition:
Problem recognition is that result when there is a difference between one's desired state and one's actual state. Consumers are motivated to address this discrepancy and therefore they commence the buying process.
Sources of problem recognition include:
• An item is out of stock
• Dissatisfaction with a current product or service
• Consumer needs and wants
• Related products/purchases
• Marketer-induced
• New products
The relevant internal psychological process that is associated with problem recognition is motivation. A motive is a factor that compels action.
Information Search:
Once the consumer has recognised a problem, they search for information on products and services that can solve that problem. Consumers undertake both an internal (memory) and an external search.
Sources of information include:
• Personal sources
• Commercial sources
• Public sources
• Personal experience
The relevant internal psychological process that is associated with information search is perception. Perception is defined as 'the process by which an individual receives, selects, organises, and interprets information to create a meaningful picture of the world'
Selective exposure consumers select which promotional messages they will expose themselves to. Selective attention consumers select which promotional messages they will pay attention to. Selective comprehension consumer interpret messages in line with their beliefs, attitudes, motives and experiences. Selective retention consumers remember messages that are more meaningful or important to them.
Understanding the consumers’ perception is essential for the development of an effective promotional strategy. First, which sources of information are more effective for the brand and second, what type of message and media strategy will increase the likelihood that consumers are exposed to our message, that they will pay attention to the message, that they will understand the message, and remember our message.
Information evaluation:
Consumers evaluate alternatives in terms of the functional and psychological benefits that they offer. The marketing organization needs to understand what benefits consumers are seeking and therefore which attributes are most important in terms of making a decision.
The relevant internal psychological process that is associated with the alternative evaluation stage is attitude formation. Attitudes are 'learned predispositions' towards an object. Attitudes comprise both cognitive and affective elements - that is both what you think and how you feel about something. The multi-attribute attitude model explains how consumers evaluate alternatives on a range of attributes. The marketing organisation should know how consumers evaluate alternatives on salient or important attributes and make their buying.
Purchase decision:
Once the alternatives have been evaluated, the consumer is ready to make a purchase decision. Sometimes purchase intention does not result in an actual purchase. The marketing organization must facilitate the consumer to act on their purchase intention. The provision of credit or payment terms may encourage purchase, or a sales promotion such as the opportunity to receive a premium or enter a competition may provide an incentive to buy now. The relevant internal psychological process that is associated with purchase decision is integration.
Post purchase evaluation:
This is an important stage as this will let the marketer know whether the consumer was satisfied with the product. A feedback mechanism is thus considered so as to understand the needs of the consumers and improve the product accordingly.
Creating satisfied customers
CONSUMER BUYING ENVIRONMENT
Almost all of us are involved in taking decisions related to the various aspects of our lives. The process by which a person is required to make a choice from various alternative options is referred to as decision making.
For firms, providing consumers with alternatives is a good business strategy and can also result in substantial increase in sales. While, the consumer will be pleased when able to choose and decide on the best from the alternatives available.
Different Views on Consumer Decision Making
An Economical View or Model
Economists believe that consumers derive some utility (feeling of satisfaction) from consuming a particular product and so their consumption activity will be directed towards pursuing maximisation of utility. This the reason why if given a certain amount of purchasing power, and a set of needs and tastes, a consumer will allocate his expenditure over different products at given prices rationally so as to maximise utility.
A Cognitive View or Model
This model of a man as a thinker, views consumer as an information processor. And all the focus is on the processes by which consumers seek and evaluate information about the concerned brands and the respective retail outlets. The consumer will finally take the decision based on his satisfaction of the information received. In other words, this model talks about a person who, in the absence of the total information or knowledge of the available product alternatives, would actually seek ‘satisfactory information’ and thereby attempt to make satisfactory decisions accordingly.
An Impulsive or Economic View of Consumer
Consumers can be emotional or impulsive while taking purchase decisions. Consumers are involved in purchases by impulse or by whim. For such emotional buying, the consumer may not undergo the usual process of carefully searching, evaluating and then deciding on the brand or outlet to purchase from. Rather he is most likely to purchase the product (brand) based on a whim or an impulse. Such consumer decisions are said to be emotionally driven.
For emotional or impulsive purchases, it is the absence of a search for pre-purchase information, it is the mood and feelings of the consumer which decide on the emotional purchase decision. Emotional decisions could be rational to some extent also. That is, the consumer may take an emotional decision to purchase a product but he will be rational while deciding or choosing one brand over the other.
Even when consumers are purchasing various types of products, they may not be rational in their decision making. For instance, very often when purchasing apparel or dresses, more than rationality it the feeling (emotion) which will make the consumer purchase a particular brand of designer clothing. Hence the consumer will make the decision based on the name of the particular brand which will add to his feeling of status.
Related to consumer emotions and feelings is the ‘mood’ of the person. Mood may be defined as a feeling or a state of mind. The basic difference between an emotion and a mood is that the former is a response to a particular environment, while mood is an unfocused, pre-existing state already present, when the consumer gets motivated or experiences a positive feeling about an advertisement, or the retail brand or outlet or product.
CONSUMER NEEDS AND MOTIVATION
Marketers want to know what motivates the consumers. Basically, this is needed so that they can shape and influence human behavior.
Concept of Motivation
Motivation asks the question 'why' about human behavior. For example, why do they prefer McDonald's hamburgers than Nirula's Burgers?, Why are you reading this book?, Why he buys only from Bigjos? etc.
Very few answers to question “why?” are simple and straightforward. No one observing your behavior knows for sure why you are behaving in a particular manner.
"A person is said to be motivated when his or her system is energized (aroused), made active and behavior is directed towards a desired goal".
Components of Motivation are:
Before we go in deep, let us know the place of motivation in Buying Behavior. Following diagram shows that a given instance of buying behavior is the result of three factors multiplied by each other, the ability to buy something, the opportunity to buy it and the motivation i.e. the wish, the need or the desire to do so.
It is important for marketers to realize that motivation is only one of the essential elements that contribute to buying behavior as given above. No amount of love or money or other incentive could motivate the person who is not able to walk. Similarly, if a shopkeeper is offering sale on all the items but he / she is open on weekdays only up to 6.00 p.m., even if people are motivated the shopkeeper is giving very little opportunity to act on their motivation.
Similarly, suppose a company is offering a new product line and spending much on heavy advertisement but not ensuring that the products are available in all the outlets.
Needs, Goals and Motives
Motivation can also be described as the driving force within individuals that impels them to action. As shown in the figure, this driving force is the result of tension, which in turn is because of unfulfilled needs. To reduce tension, every individual strives for fulfilling his or her needs. This basi¬cally, depends on each individual how he or she fulfills his or her needs i.e. individual thinking and learning (experiences). Therefore, marketers try to influence the consumer's cognitive processes.
Needs
Every individual has needs; they are innate and acquired. Innate needs are also called physiological needs or primary needs, which include food, water, air, shelter or sex, etc. Acquired needs are those needs that we learn from our surroundings / environment or culture. These may include need for power, for affection, for prestige, etc. These are psychological in nature; therefore they are also called as secondary needs.
Goals
Goals are the end result of motivated behavior. As in the above diagram every individual's behavior is goal-oriented. From marketer point of view, there are four types of goals.
(a) Generic goals — General classes of goals that consumers select to fulfill their needs. For example, need for washing hands.
(b) Product specific goals — For washing hands what kind of product is used. For example, use soap, liquids etc.
(c) Brand specific goals — For example, which soap - Lux, Pears etc., to be purchased.
(d) Store specific goals — From where that product must be purchased.
Goal Selection — The goals selected by individuals depend on their personal experiences, physi¬cal capacity, goal's accessibility in the physical and social environment and above all the individual's cultural norms and values.
For example, if a person has a strong hunger need, his/her goal will depend on what is available at that moment, in which country he is i.e., if in India cannot eat steak, as it is against his values and beliefs. He will have to select a substitute goal that is more appropriate to the social environment. An individual's own perception of his/her also influence the selection of the goal. The products a person owns, would like to own, or would not like to own are often perceived in terms of how closely they are congruent with the person's self image. It is seen that usually that product is selected by an individual that has a greater possibility of being selected than one that is not.
Needs and goals are interdependent; existence of one is impossible without the other. For example, sometimes people join a club but is not consciously aware of his social needs, a woman may not be aware of her achievement needs but may strive to have the most successful boutique in town. One reason for this can be that individuals are more aware of their physiological needs than they are of their psychological needs.
Motives
Consumer researchers have given two types of motives-rational motives and irrational (emotional) motives. They say, that consumers behave rationally when they consider all alternatives and choose those that give them the greatest utility. This is also known as economic man theory. Marketers meaning of rationality is when consumers select goals based on totally objective criteria such as size, weight or price, etc. Emotional motives imply the selection of goals according to personal or subjective criteria. For example, desire for status, individuality, fear of owning the product (from society), pride, affection, etc.
It is assumed that consumers always attempt to select alternatives that in their view serve to maximize satisfaction. The measurement of satisfaction is a very personal process, based on the individual's own needs structure as well as on past behavioral and social experiences. It is seen that what may appear irrational to others may be perfectly rational in consumer's opinion. For example, if an individual purchases a product to enhance self-image and considers this to be a rational decision and if behavior does not appear rational to the person at the time of purchasing then he would have not purchased. Therefore, it is very difficult to distinguish between rational and emotional consumption motives.
Can Needs be Created?
This is a very ancient question about marketing and motivational research can help us provide an answer to it. Like the products ‘Hit’ spray for cockroaches and ‘Hit’ for mosquitoes. The consumers decided for themselves that the psychological satisfaction obtained from using the cockroach spray was more important to them than the need for a cleaner and more efficient product.
People say that needs are created for them by the marketer through subliminal. To some extent one can influence the consumer through subliminal percep¬tion, the effects are probably not very great or very specific. So, there is no evidence whatsoever that anyone can create a need in a consumer.
Marketers and advertisers can only try to stimulate an existing need or can channel consumers need in a certain direction towards one product or brand rather than another, but the results are unpredictable.
Nature of Motivation
Motivation means the driving force within individuals that impels them to action. It is considered to be dynamic in nature as is constantly changing in reaction to life experiences.
Needs and goals are constantly changing because of an individual's physical condition, social circle, environment and other experiences. When one goal is achieved, an individual tries to attain the new ones. If they are unable to attain, either they keep striving for them or finds out the substitute goal. Psychologists have given certain reasons to support the statement "Needs and goals are constantly changing"—
(1) An individual's existing needs are never completely satisfied, they continually impel them to attain or maintain satisfaction.
(2) As one need is satisfied, the next need emerges.
(3) An individual who achieves their goals set new and higher goals for themselves. Needs are never fully satisfied— Most of the human needs are never permanently satisfied. For example, most people need continuous approval from others to satisfy their social needs. There are various examples in our surroundings that show temporary goal achievement does not fully satisfy the need for power and every individual keeps striving to satisfy the need more fully. Some re¬searchers say that new needs emerge as old needs are satisfied. In motivational theories, researcher
McGuire's Psychological Motives
The classification of motives by McGuire is more specific and used more in marketing.
1. Need for consistency
People try to buy things that are consistent with their liking and taste. A sophisticated person will be consistent in his choice of colors of clothing, paintings on the wall, color of rooms. He would prefer sophisticated instead of flashy objects.
2. Need to attribute causation
We often attribute the cause of a favorable or unfavorable outcome to ourselves or to some outside element. You can buy shoes by your choice and may not like them. It can be attributed to you. If you buy a dress by the advise of your friends and companions, and do not like it, the causes are attributed to other factors.
3. Need to categorize
The objects are categorized in a number of ways. The most popular is the price. Cars can be classified around Rs. 2 lakhs or above Rs. 5.5 lakhs. Many products are categorized at 499.00 to keep them under Rs. 500. This is practiced in shoes mainly by Bata and others.
4. Need for cues
These are hints or symbols that affect our feelings, attitudes, impressions, etc. For instance, clothing can be a cue to adopt a desired lifestyle. Providing proper cues to the purchasers can enhance the use of products.
5. Need for independence
Consumers like to own products that give them a feeling of independence; symbols like a white bird flying may predict one to be free and independent.
6. Need for novelty
We sometimes want to be different in certain respects and want to be conspicuous. This is evident in impulse purchasing or unplanned purchasing. We go in for novelty products, novelty experiences. A different kind of travel with many novelties offered by a traveling agency.
7. Need for self-expression
We want to identify ourselves and go in for products that let others know about us. We may buy a suit not only for warmth but also for expressing our identity to others.
8. Need for ego defense
When our identity is threatened or when we need to project a proper image, we use products in our defense, Deodorants are used for ego defense. Mouthwash for fresh breath or, false teeth to protect our image. We use hair dye to look younger better, etc. We rely on well-known brands to give a correct social image of ourselves.
9. Need for assertion
Engaging in those kinds of activities that bring self esteem and esteem in the eyes of others fulfills these needs. We can buy an expensive car, which may be for esteem, but, if it does not perform well, we tend to complain bitterly. Individuals with a strong need for self-esteem tend to complain more with the dissatisfaction of the product.
10. Need for reinforcement
When we buy a product that is appreciated by others, it reinforces our views, our behavior, our choice and we go in for repeat purchases. More products can be sold if their reinforcement is greater by their purchases.
11. Need for affiliation
We like to use products that are used by those whom we get affiliated to. If one's friend appreciates and wears a certain brand then one also tries to use the same brands or objects for affiliation. It is the need to develop mutually helpful and satisfying relationships with others. Marketers use the-affiliation themes in advertisements that arouse emotions and sentiments in the minds of the consumers for their children and families.
12. Need for modeling
We try to copy our heroes and our parents and those we admire. We base our behavior on the behavior of others. Marketer's use these themes for selling their product, i.e. "Lux is used by heroines". "Sportsman rely on boost for their energy" and such captions are used regularly and repeatedly.
13. Utilitarian and Hedonic Needs
Utilitarian needs are to achieve some practical benefit such as durability economy, warmth etc that define product performance. Hedonic needs achieve pleasure from the product they are associated with Emotions & fantasies is derived from consuming a product.
A Hedonic Need is more experiential—The desire to be more masculine or feminine etc. Hedonic advertising appeals are more symbolic & emotional. For utilitarian shoppers the acquiring of goods is a task whereas for Hedonic shoppers it is a pleasurable activity. Shopping Malls may be considered as gathering places and consumers/buyers derive pleasure from these activities besides the selection of goods.
Murray's List of Psychogenic Needs
1. Needs Associated With Inanimate Objects
Acquisition
Conservancy
Order
Retention
Construction
2. Needs That Reflect Ambition, Power, Accomplishment, And Prestige
Superiority
Achievement
Recognition
Exhibition
Inviolacy (inviolate attitude)
Infavoidance (to avoid shame, failure, humiliation, ridicule)
Defendance (defensive attitude)
Counteraction (counteractive attitude)
3. Needs Concerned With Human Power
Dominance
Deference
Similance (suggestible attitude)
Autonomy
Contrariance (to act differently from others)
4. Sadomasochistic Needs
Aggression
Abasement
5. Needs Concerned With Affection Between People
Affiliation
Rejection
Nurturance (to nourish, aid, or protect the helpless)
Succorance (to seek aid, protection, or sympathy)
6. Needs Concerned With Social Intercourse (The Needs To Ask And Tell)
Cognizance (inquiring attitude)
Exposition (expositive attitude)
Maslow's Hierarchy of Needs
Human needs tend to be diverse in content as well as in length. Dr. Abraham Maslow has formu¬lated a widely accepted theory of human motivation based on hierarchy of human needs, which is universally accepted. He has stated five basic levels of human needs which rank in order of importance from lower level (psychological) needs to highest level (physiological) needs. This theory suggests that all individuals try to satisfy the lower level needs before higher level needs emerge. The lower level of unsatisfied needs that an individual experiences serves to motivate his or her behavior. When this needs is satisfied, then a higher level need emerges and again tension appears. To reduce this tension, the individual gets motivated and fulfills it. When this need is satisfied, a new i.e., higher need emerges and the process goes on in the life span of an individual.
Maslow's hierarchy of needs in diagrammatic form
(1) Physiological — housing, food, drink, clothing.
(2) Safety — insurance, burglar alarms, fire alarms, cars with air bags.
(3). Social — greeting cards, holiday packages, team sports equipment.
(4) Self-esteem — high status brands, goods or services like owning microwave etc
(5) Self-actualization — educational services etc.
According to this theory, however, there is some overlap between each level, as no need is ever completely satisfied. For this reason, though all levels of need below the dominant level continue to motivate behavior to some extent, the prime motivator—the major driving force within the individual is the lowest level of needs that remains largely unsatisfied.
1. Physiological Needs
Products in this category include, foods, health foods, medicines, drinks, house garments, etc.
This is the first and most basic level of needs, which are called Physiological needs. These needs are also called primary needs, which are required for sustenance for example, food, water, air, shelter, clothing, sex (all biogenic needs).
According to Maslow, physiological needs are dominant when they are chronically unsatisfied. For example, a man who is very hungry, then no other thing interests him than food. He dreams food, he remembers food, he perceives only food.
2. Safety Needs
Products are locks, guns, insurance policies, burglar alarms, retirement investments, etc.
After the physiological needs are fulfilled, safety and security needs become the driving force behind an individual's behavior. These are concerned with physical safety, for example, order, stability, familiarity, routine, control over one's life and environment, and certainty, etc. This means a person will eat lunch not only that day but also every day far into the future. Safety means not only healthwise but individual needs, other securities like need for saving accounts, insurance.
3. Social Needs
Products are general grooming, entertainment, clothing cosmetics, jewellery, fashion garments.
The third level of Maslow's hierarchy includes such needs as love, affection, belonging and acceptance. Advertisers of personal care products often emphasize all these social motives in their advertisements.
4. Egoistic Needs
Products are furniture, clothing, liquor, hobbies, fancy cars.
This is the fourth level of Maslow's hierarchy of needs. According to Maslow, this becomes operative when the social needs of a person are more or less satisfied. Egoistic needs can be inward or outward or both oriented. An individual with inward -directed ego needs reflect need for self-acceptance, for self-esteem, for success, independence etc. An outward-directed ego needs includes need for reputation, for status, for recognition from others.
5. Self-Actualization
Products are education, art, sports, vacations, garments, foods.
This was not coined by Maslow but was done by Gestalt theorist called Kurt Goldstein but he popularized it. Maslow explained the term in brief, by saying that individual at this stage has need to actualize or realize all of one's unique potential and what one can be. This need can rarely be fulfilled; moreover, very few of the people reached this level. The more self-actualized people become, the more they want to become. This is a motivation with its own inner dynamic.
Maslow did not say these five levels to form a totally rigid hierarchy. He says that the same person can experience more than one level of need at the same time. Marketers have generally found Maslow's hierarchy to be conceptually stimulating in understanding consumer motivation and for framing out advertising strategies. Specific products are often targeted at specific level of need, like
An Evaluation of the Need Hierarchy and Marketing Applications
Maslow's hierarchy-of-needs theory postulates a five-level hierarchy of prepotent human needs Higher-order needs become the driving force behind human behavior as lower-level needs are satisfied The theory says, in effect that dissatisfaction, not satisfaction, motivates behavior
The need hierarchy has received wide acceptance in many social discipline because it appears to reflect the assumed or inferred motivations of many people in our society. The five levels of need postulated by the hierarchy are sufficiently generic to encompass most lists of individual needs The major problems with this theory are
(1) Concepts are too general: It is said that hunger and self-esteem are considered to be similar needs but the former is urgent and involuntary in nature whereas latter is a conscious and voluntary type.
(2) This theory cannot be tested empirically: This means that there is no way to measure precisely how satisfied one need must be before the next higher need becomes active.
Need hierarchy is also used for the basis of market segmentation with specific advertising appeals directed to individuals on one or more need levels. For example- cigarette ads, soft drink ads etc., often stress a social appeal by showing a group of young people sharing good times as well as the product advertised. It is also used for positioning products policies, education and vocational training etc.
Consumer choice is very important in satisfying all these needs, even the physiological ones is of particular importance to marketing. We can see that how the cola companies have replaced themselves with tap water to quench people's thirst. And in particular why choose coke rather than Pepsi or vice versa. It is also important to note that many products can be used to satisfy several different levels of needs for example- a car, a book, telephone etc.
Marketing Strategies Based On Motivation
Consumers do not buy products. They buy motive satisfaction or problem solutions. A person does not buy a sofa set but he buys comfort. A person does not buy cosmetics but he buys hope for looking good. Marketers therefore try to find the motives for buying, and build their products and marketing mixes around these motives. A person may buy a product for a number of motives. One of them could be reward for oneself or to self indulge in them or for a gift. Multiple motives are involved in consumption. Therefore a marketer tries to find out:
(a) The motive for buying,
(b) How to formulate a strategy to fulfill these motives
(c) How to reduce conflict between motives.
How to discover motives
This is found out by asking questions from the respondent. Some motives are disclosed by the respondent, others are not divulged or are hidden. For instance, you ask a lady why she wears designer jeans. She can say that (a) they are in style (b) they fit well (c) they are worn by her friends. These motives are disclosed. Latent motives may not be disclosed. These may be (d) they show that I have money (e) they make one look sexy and desirable (f) they show I am young (g) they project my slimness, etc.
Manifest and latent motives
Another important method to find out the motives may be by "Motivational Research" where indirect questions are asked to elicit the information from the respondents. This is done by unstructured disguised interviews or questionnaires.
Once the motives have been known, the marketing strategy is designed around the appropriate set of motives. While designing the strategy, the target market has to be decided and the communication has to be chosen for the said target market. Since there is more than one motive, more than one benefit should be communicated by advertising and other methods of promotion.
In case of a Maurti car as shown in the figure the benefit of economy, maneuverability, modern ideology must all be communicated. Usually, direct appeals are used for manifest motives and, indirect appeals for latent motives. Sometimes dual appeals are used and the target market has to be kept in mind.
Motivational conflicts
A consumer wants to fulfill a variety of needs by using a product, therefore, there are conflicts in his mind as to which motive must be given more importance. It is a conflict that has to be resolved. There are three types of motivational conflicts.
a. Approach-approach motivational conflict
There may be two acts of equally attractive choices to make. This can be reduced by the timely release of an advertisement, so that both alternatives can be given importance. A consumer may want a spacious car that is not large—Uno. A consumer may want a medium size fridge with a lot of space inside or, a fridge with a deepfreeze—double door fridge. These two choices create a conflict in the minds of the consumers.
b. Approach avoidance motivational conflict
In this the consumer is faced both by positive and negative consequences in the purchase of a particular products. If one likes chocolates and is diabetic. This conflict can be resolved by taking sugar free chocolate, or in the case of Coca Cola-Diet free Coke may resolve the conflict.
c. Avoidance-avoidance conflict
It faces the consumer with two undesirable consequences. Taking an injection once or, taking a bitter medicine a number of times. This can be avoided by choosing a lesser painful alternative according to the convenience of the consumer.
Positive And Negative Motivation
Motivation can be positive or negative in direction We may feel a driving force toward some object or condition or a driving force away from some object or condi¬tion For example, a person may be impelled toward a restaurant to fulfill a hunger need, and away from motorcycle transportation to fulfill a safety need
Some psychologists refer to positive drives as needs, wants, or desires and to negative drives as fears or aversions However, although positive and negative motivational forces seem to differ dramatically in terms of physical (and some¬times emotional) activity, they are basically similar in that both serve to initiate and sustain human behavior For this reason, researchers often refer to both kinds of drives or motives as needs, wants, and desires Some theorists distinguish wants from needs by defining wants as product-specific needs Others differentiate between desires, on the one hand, and needs and wants on the other Thus, there is no uniformly accepted distinction among needs wants, and desires
Needs wants, or desires may create goals that can be positive or negative A pos¬itive goal is one toward which behavior is directed, thus, it is often referred to as an approach object. A negative goal is one from which behavior is directed away and is referred to as an avoidance object. Because both approach and avoidance goals are the results of motivated behavior, most researchers refer to both simply as goals Consider this example A middle aged woman may have a positive goal of fitness and joins a health club to work out regularly Her husband may view getting fat as a negative goal, and so he starts exercising as well In the former case, the wife s actions are designed to achieve the positive goal of health and fitness, in the latter case, her husband's actions are designed to avoid a negative goal—a flabby physique
Sometimes people become motivationally aroused by a threat to or elimination of a behavioral freedom, such as the freedom to make a product choice This motiva¬tional state is called psychological reactance A classic example occurred in 1985 when the Coca-Cola Company changed its traditional formula and introduced "New Coke " Many people reacted negatively to the notion that their "freedom to choose" had been taken away, and they refused to buy New Coke Company management responded to this unexpected psychological reaction by reintroducing the original formula as Classic Coke and gradually developing additional versions of Coke
RATIONAL VERSUS EMOTIONAL MOTIVES
Some consumer behaviorists distinguish between so-called rational motives and emotional motives. They use the term rationality in the traditional economic sense which assumes that consumers behave rationally by carefully considering all alterna¬tives and choosing those that give them the greatest utility In a marketing context, the term rationality implies that consumers select goals based on totally objective criteria such as size, weight, price, or miles per gallon Emotional motives imply the selection of goals according to personal or subjective criteria (e g, pride, fear, affection, or status)
The assumption underlying this distinction is that subjective or emotional criteria do not maximize utility or satisfaction However, it is reasonable to assume that consumers always attempt to select alternatives that, in their view, serve to maxi¬mize their satisfaction Obviously, the assessment of satisfaction is a very personal process, based on the individual's own need structure, as well as on past behavioral and social (or learned) experiences What may appear irrational to an outside observer may be perfectly rational in the context of the consumer's own psycholog¬ical field For example, a person who pursues extensive plastic facial surgery in order to appear younger is using significant economic resources, such as the surgical fees, time lost in recovery, inconvenience, and the risk that something may go wrong To that person, the pursuit of the goal of looking younger and utilization of the resources involved are perfectly rational choices However, to many other persons within the same culture who are less concerned with aging, and certainly to persons from other cultures that are not as preoccupied with personal appearance as Westerners are, these choices appear completely irrational
Consumer researchers who subscribe to the positivist research perspective tend to view all consumer behavior as rationally motivated, and they try to isolate the causes of such behavior so that they can predict and, thus, influence future behavior Experientialists are often interested in studying the hedonistic pleasures that certain consumption behaviors provide, such as fun, or fantasy, or sensuality They study consumers in order to gain insights and understanding of the behaviors consumers display m various unique circumstances
The Dynamics of Motivation
Motivation is a highly dynamic construct that is constantly changing in reaction to life experiences Needs and goals change and grow in response to an individual's physical condition, environment interactions with others, and experiences As individuals attain their goals, they develop new ones If they do not attain their goals, they continue to strive for old goals or they develop substitute goals. Some of the reasons why need-driven human activity never ceases include the following
(1) Many needs are never fully satisfied, they continually impel actions designed to attain or maintain satisfaction
(2) As needs become satisfied, new and higher-order needs emerge that cause tension and induce activity
(3) People who achieve their goals set new and higher goals for themselves
A. Needs Are Never Fully Satisfied
Most human needs are never fully or permanently satisfied For example, at fairly regular intervals throughout the day individuals experience hunger needs that must be satisfied Most people regularly seek companionship and approval from others to satisfy their social needs Even more complex psychological needs are rarely fully satisfied For example, a person may partially satisfy a power need by working as administrative assistant to a local politician, but this vicarious taste of power may not sufficiently satisfy her need, thus, she may strive to work for a state legislator or even to run for political office herself In this instance temporary goal achievement does not adequately satisfy the need for power and the individual strives harder in an effort to satisfy her need more fully
B. New Needs Emerge As Old Needs Are Satisfied
Some motivational theorists believe that a hierarchy of needs exists and that new, higher-order needs emerge as lower-order needs are fulfilled For example, a man who has largely satisfied his basic physiological needs (e g, food, housing, etc.) may turn his efforts to achieving acceptance among his new neighbors by joining their political clubs and supporting their candidates Once he is confident that he has achieved acceptance, he then may seek recognition by giving lavish parties or build¬ing a larger house
C. Success And Failure Influence Goals
A number of researchers have explored the nature of the goals that individuals set for themselves Broadly speaking, they have concluded that individuals who successfully achieve their goals usually set new and higher goals, that is, they raise their level of aspiration. This may be due to the fact that their success in reaching lower goals makes them more confident of their ability to reach higher goals Conversely, those who do not reach their goals sometimes lower their levels of aspiration Thus, goal selection is often a function of success and failure For example, a college senior who is not accepted into medical school may try instead to become a dentist or a podiatrist
The nature and persistence of an individual's behavior are often influenced by expectations of success or failure in reaching certain goals Those expectations, in turn are often based on past experience A person who takes good snapshots with an inexpensive camera may be motivated to buy a more sophisticated camera in the belief that it will enable her to take even better photographs In this way, she even¬tually may upgrade her camera by several hundred dollars On the other hand, a person who has not been able to take good photographs is just as likely to keep the same camera or even to lose all interest in photography
These effects of success and failure on goal selection have strategy implications for marketers Goals should be reasonably attainable Advertisements should not promise more than the product will deliver Products and services are often evalu¬ated by the size and direction of the gap between consumer expectations and objec¬tive performance Thus, even a good product will not be repurchased if it fails to live up to unrealistic expectations created by ads that "over-promise " Similarly, a con¬sumer is likely to regard a mediocre product with greater satisfaction than it war¬rants if its performance exceeds her expectations
D. Substitute Goals
When an individual cannot attain a specific goal or type of goal that he or she antic¬ipates will satisfy certain needs, behavior may be directed to a substitute goal. Although the substitute goal may not be as satisfactory as the primary goal, it may be sufficient to dispel uncomfortable tension Continued deprivation of a primary goal may result in the substitute goal assuming primary-goal status For example, a woman who has stopped drinking whole milk because she is dieting may actually begin to prefer skim milk A man who cannot afford a BMW may convince himself that a Mazda Miata has an image he clearly prefers
E. Frustration
Failure to achieve a goal often results in feelings of frustration At one time or another, everyone has experienced the frustration that comes from the inability to attain a goal The barrier that prevents attainment of a goal may be personal to the individual (e g limited physical or financial resources) or an obstacle in the physical or social environment (e g a storm that causes the postponement of a long-awaited vacation) Regardless of the cause, individuals react differently to frustrating situa¬tions Some people manage to cope by finding their way around the obstacle or, if that fails, by selecting a substitute goal Others are less adaptive and may regard their inability to achieve a goal as a personal failure Such people are likely to adopt a defense mechanism to protect their egos from feelings of inadequacy
G. Defense Mechanisms
People who cannot cope with frustration often mentally redefine their frustrating situ¬ations in order to protect their self-images and defend their self-esteem For example, a young woman may yearn for a European vacation she cannot afford The coping individual may select a less expensive vacation trip to Disneyland or to a national park The person who cannot cope may react with anger toward her boss for not paying her enough money to afford the vacation she prefers, or she may persuade herself that Europe is unseasonably warm this year These last two possibilities are examples respectively, of aggression and rationalization, defense mechanisms that people some¬times adopt to protect their egos from feelings of failure when they do not attain their goals. Other defense mechanisms include regression, withdrawal, projection, autism, identification, and repression This listing of defense mechanisms is far from exhaustive, because individuals tend to develop their own ways of redefining frustrating situations to protect their self-esteem from the anxieties that result from experiencing failure Marketers often consider this fact in their selection of advertising appeals and construct advertisements that portray a person resolving a particular frustration through the use of the advertised product
H. Multiplicity Of Needs
A consumer's behavior often fulfills more than one need In fact, it is likely that spe¬cific goals are selected because they fulfill several needs We buy clothing for protection and for a certain degree of modesty; in addition, our clothing fulfills a wide range of personal and social needs, such as acceptance or ego needs Usually, however there is one overriding (pre-potent) need that initiates behavior For example, a young woman may consider joining a health club because she has nothing special to do most evenings, she wants to wear midriff-baring clothes, and she wants to meet men outside a bar setting If the cumulative amount of tension produced by each of these three reasons is sufficiently strong, she will probably join a health club However, just one of the reasons (e g , the desire to meet new men) may serve as the triggering mechanism, that would be the prepotent need.
I. Needs and Goals Vary Among Individuals
One cannot accurately infer motives from behavior People with different needs may seek fulfillment through selection of the same goal, people with the same needs may seek fulfillment through different goals Consider the following examples Five people who are active in a consumer advocacy organization may each belong for a different reason The first may be genuinely concerned with protecting consumer interests, the second may be concerned about an increase in counterfeit merchandise; the third may seek social contacts from organizational meetings, the fourth may enjoy the power of directing a large group, and the fifth may enjoy the status provided by membership in an attention-getting organization
Similarly, five people may be driven by the same need (e g an ego need) to seek fulfillment in different ways The first may seek advancement and recognition through a professional career, the second may become active in a political organization, the third may run in regional marathons, the fourth may take professional dance lessons, and the fifth may seek attention by monopolizing class room discussions
The Measurement of Motives
How are motives identified? How are they measured? How do researchers know which motives are responsible for certain kinds of behaviors? These are difficult questions to answer because motives are hypothetical constructs—that is, they can¬not be seen, touched, handled, smelled or otherwise tangibly observed. For this reason, no single measurement method can be considered a reliable index Instead researchers usually rely on a combination of various qualitative research techniques to establish the presence and / or the strength of various motives. Some psychologists are concerned that many measurement techniques do not meet the crucial test criteria of validity and reliability (Remember, validity ensures that the test measures what it purports to measure; reliability refers to the consis¬tency with which the test measures what it does measure.) Constructing a scale that measures a specific need, while meeting both criteria, can be complex. For example, a recent research project employed six different studies to develop and validate a seemingly simply five-item scale to measure status consumption (defined as the ten¬dency to purchase goods and services for the prestige that owning them bestows).
Respondents are asked to indicate their level of agreement or disagreement (a Likert scale) on the following five items
1. I would buy a product just because it has status
2 I am interested in new products with status
3 I would pay more for a product if it had status
4 The status of the product is irrelevant to me
5 A product is more valuable to me if it has some snob appeal
The findings of qualitative research methods are highly dependent on the analyst, they focus not only on the data themselves but also on what the analyst thinks they imply By using a combination of assessments (called triangulation) based on behavioral data (observation), subjective data (self-reports), and qualitative data (projective tests, collage research, etc), many consumer researchers feel confident that they are achieving more valid insights into consumer motivations than they would by using any one technique alone Though some mar¬keters are concerned that qualitative research does not produce hard numbers that objectively "prove" the point under investigation, others are convinced that qualita¬tive studies are more revealing than quantitative studies However there is a clear need for improved methodological procedures for measuring human motives
Motivational Research
The term motivational research, which should logically include all types of research into human motives, has become a "term of art" used to refer to qualitative research designed to uncover the consumer's subconscious or hidden motivations Based on the premise that consumers are not always aware of the reasons for their actions, motivational research attempts to discover underlying feelings, attitudes, and emo¬tions concerning product, service, or brand use
The Development of Motivational Research
Sigmund Freud's psychoanalytic theory of personality pro¬vided the foundation for the development of motivational research This theory was built on the premise that unconscious needs or drives—especially biological and sexual drives—are at the heart of human motivation and personality Freud con¬structed his theory from patients' recollections of early childhood experiences, analysis of their dreams, and the specific nature of their mental and physical adjust¬ment problems
Dr Ernest Dichter, formerly a psychoanalyst in Vienna, adapted Freud's psychoanalytical techniques to the study of consumer buying habits Up to this time marketing research had focused on what consumers did (i.e. quantitative, descriptive studies) Dichter used qualitative research methods to find out why they did n Marketers were quickly fascinated by the glib, entertaining, and usually surprising explanations offered for consumer behavior, especially since many of these expla¬nations were grounded in sex For example, marketers were told that cigarettes and Lifesaver candies were bought because of their sexual symbolism, that men regarded convertible cars as surrogate mistresses, and that women baked cakes to fulfill their reproductive yearnings Before long, almost every major advertising agency in the country had a psychologist on staff to conduct motivational research studies
By the early 1960s, however, marketers realized that motivational research had a number of drawbacks Because of the intensive nature of qualitative research, samples necessarily were small, thus, there was concern about generalizing findings to the total market Also, marketers soon realized that the analysis of protective tests and depth interviews was highly subjective The same data given to three different analysts could produce three different reports, each offering it< own explanation of the consumer behavior examined Critics noted that many of the projective tests that were used had originally been developed for clinical purposes rather than for studies of marketing or consumer behavior (One of the basic criteria for test development is that the test be developed and validated for the specific purpose and on the specific audience profile from which information is desired )
Other consumer theorists noted additional inconsistencies in applying Freudian theory to the study of consumer behavior First, psychoanalytic theory was struc¬tured specifically for use with disturbed people, whereas consumer behaviorists were interested in explaining the behavior of "typical" consumers Second, Freudian theory was developed in an entirely different social context (nineteenth-century Vienna), whereas motivational research was introduced in the 1950s in postwar America Finally, too many motivational researchers imputed highly exotic (usually sexual) reasons to rather prosaic consumer purchases Marketers began to question their recommendations (e g , Is it better to sell a man a pair of suspenders as a means of holding up his pants or as a "reaction to castration anxiety"? Is it easier to persuade a woman to buy a garden hose to water her lawn or as a symbol of "geni¬tal competition with males?")
Though they are not usually identified as motivational research techniques, there are a number of associated qualitative research techniques that are used to delve into the consumer's unconscious or hidden motivations These include collage research, metaphor analysis, means-end analysis, and laddering All of these qualitative research techniques provide invaluable insights to marketers who want to understand the motives underlying consumer behavior
Evaluation Of Motivational Research
Despite its criticisms, motivational research is still regarded as an important tool by marketers who want to gain deeper insights into the whys of consumer behav¬ior than conventional marketing research techniques can yield Since motiva¬tional research often reveals unsuspected consumer motivations concerning product or brand usage, its principal use today is in the development of new ideas for promotional campaigns, ideas that can penetrate the consumer's conscious awareness by appealing to unrecognized needs For example, m trying to discover why women bought traditional roach sprays rather than a brand packaged in lit¬tle plastic trays, researchers asked women to draw pictures of roaches and write stones about their sketches They found that, for many of their respondents roaches symbolized men who had left them feeling poor and powerless The women reported that spraying the roaches and "watching them squirm and die" allowed them to express their hostility toward men and gave them feelings of greater control
Motivational research also provides marketers with a basic orientation for new product categories and enables them to explore consumer reactions to ideas and advertising copy at an early stage to avoid costly errors. Furthermore, as with all qualitative research techniques, motivational research findings provide consumer researchers with basic insights that enable them to design structured, quantitative marketing research studies to be conducted on larger, more representative samples of consumers.
Despite the drawbacks of motivational research, there is new and compelling evidence that the unconscious is the site of a far larger portion of mental life than even Freud envisioned Research studies show that the unconscious mind may understand and respond to nonverbal symbols, form emotional responses, and guide actions largely independent of conscious awareness.
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