Analysis of Turbulent Market Environments

R.A.
Podar College Of Commerce And Economics EXECUTIVE SUMMARY
Analysis of Turbulent Market Environments
R.A.Podar College Of Commerce And Economics CHAPTER 1 INTRODUCTION Besides the consumer demands and the business costs, the decisions of the firms also depend on the number, size and behaviour of the other firms in the industry. The strength of the competition faced by a company can profoundly affect its pricing, its output decisions and its input purchases. Strong competitive pressures, sometimes taking subtle forms, can severely limit the freedom pf choice by management in setting prices and, in process, protect the interests of consumers. Giant corporations may also find themselves under this sort of pressure, even where there are few rival domestic firms. Industries differ dramatically in how populated they are and in the size of a typical firm. Some industries contain a great many very small firms; others are composed of a few industrial giants.
R.A.Podar College Of Commerce And Economics CHAPTER 2 MARKET AND ITS TYPES What is a market? Economists do not reserve the term market to denote only an organized exchange operating in a well defined physical location. In its more general and abstract usage, a market refers to a set of sellers and buyers whose activities affect the price at which a particular commodity is sold. With the development of transportation, communication and banking, the markets have widened and dealings in come commodities worldwide. Therefore, the essential feature of a market is that buyers should be able to strike bargains with sellers. According to Wicksteed, thus market is the characteristic phenomenon of economic life and the constitution of markets and market prices is the central problem of Economics. The type of market in which the firm operates makes a great deal of difference for the way in which it can and does behave. Under some market forms, for example, the firm has no control over its price. In others, the firm has the power to adjust its price in a way that adds to its profits and which, in the opinion of some, constitutes exploitation of consumers. Economist distinguish among different kinds of markets according to (1) How many firms they include, (2) Whether the products of the different firms are identical or somewhat different, and (3) How easy it is for new firms to enter the market. Perfect competition is at one extreme (many small firms selling an identical product), while pure monopoly (a single firm) is at the other. In between are hybrid forms- called monopolistic competition (many small firms selling products slightly different from the others) and oligopoly (a few large rival firms) - that share some of the characteristics of perfect competition and some of the characteristics of monopoly. These kinds of markets are explained in detail as follows.
R.A.Podar College Of Commerce And Economics I. Perfect Competition A market is said to operate under perfect competition when following four conditions are satisfied: 1. Numerous Small Firms and Customers. So many buyers and sellers that each one constitutes a negligible portion of the market- so small, in fact, that its decisions have no effect on the price. This requirement rules out trade associations or other collusive arrangements strong enough to affect price. 2. Homogeneity of product. The product offered by any seller is identical to that supplied by any other seller. Because the product is homogeneous product, consumers do not care from which firm they buy. 3. Freedom of entry and exit. New firms desiring to enter the market face no impediments that the existing firms can avoid. Similarly, if production and sale of the good proves unprofitable, there are no barriers preventing firms from leaving the market. 4. Perfect information. Each firm and each customer is well informed about the available products and their prices. They know whether one supplier is selling at a price lower than another is. Perfectly competitive industries have four characteristics: 1. The industry is fragmented. It consists of many buyers and sellers. Each buyer's purchases are so small that they have an imperceptible effect on market price. Each seller's output is so small in comparison to market demand that it has an imperceptible impact on the market price. In addition, each sellers purchases are so small that it has an imperceptible impact on input prices 2. Firms produce undifferentiated products. That is, consumers perceive the products to be identical no matter who produces them. When you buy fresh, cut roses from a local flower shop, it probably does not matter to you that they were produced by which firm. As far as you are; concerned, the roses from one grower are just as good as the roses from any other grower. And because this is true for you, it is also true for the flower shops and the wholesalers who buy the roses
R.A.Podar College Of Commerce And Economics directly from the growers. If the final consumer sees no difference in the roses grown by the different growers then florists and wholesalers don't care who they buy roses from either, as long as they get the best price. Roses are thus an example of an undifferentiated product. 3. Consumers have perfect information about prices all sellers in the market charge . This is certainly true in the rose market. The wholesalers and florists that buy roses from the growers are keenly aware of the prevailing prices. In fact, as just noted, these consumers need to be deeply knowledgeable about the prices because the price is the main thing they care about when deciding which growers to buy roses from. 4. The industry is characterized by equal access to resources. All firms-those currently in the industry, as well as prospective entrants-have access to the same technology and inputs. Firms can hire inputs, such as labor, capital, and materials, as they need them, and they can release them from their employment when they do not need them. This characteristic is generally true of the fresh-cut rose industry: the technology for growing roses is well understood, and the key inputs necessary to operate a rose growing firm (land, greenhouses rose bushes, and labor) are readily available in well-functioning markets. These characteristics have three implications for how perfectly competitive markets work: The first characteristic-the market is fragmented-implies that sellers and buyers act as price takers. That is, a firm takes the market price of the product as given when making an output decision and a buyer takes the market price as given when making purchase decisions. Condition 1 also implies that a firm takes input prices as fixed when making decisions about input quantities. The second and third characteristics-firms produce undifferentiated products and consumers have perfect information about prices-implies a law of one price: that is, transactions between buyers and sellers occur at a single market price. Because the products of all firms are perceived to be identical and the prices of all sellers are known, a consumer will purchase at the lowest price available in the market. No sales can be made at any higher price.
R.A.Podar College Of Commerce And Economics The fourth characteristic-equal access to resources-implies that the industry is characterized by free entry. That is, if it is profitable for new firms to enter the industry, they will eventually do so. Free entry does not mean that a new firm incurs no cost when it enters the industry but that it has access to the same technology and inputs that existing firms have.
II. Pure Competition: Economists like Chamberlin and others often make distinction between pure competition and perfect competition. The term pure competition is used in a restricted sense. It is also known as atomistic competition. In order that competition be pure it requires the fulfillment of three conditions of perfect competition, namely, the existence of large number of buyers and sellers, homogeneity of the product, and freedom of entry and exit. These conditions together mean that no individual firm can exert any influence over the market price. In short, the essential feature of pure competition is the absence of monopoly element. But the term perfect competition is a wider concept, in the sense that it includes the features of pure completion and some additional conditions such as perfect knowledge on the part of buyers and sellers, perfect mobility of factors of production and absence of transportation costs. This means that in addition to the absence of monopoly element i.e., absence of any control over price by an individual firm, perfect competition requires that there should be no imperfections in the market. Such imperfections arise due to imperfect knowledge or immobility of the factors of production. In fact, pure competition is a part and parcel of perfect competition. American economists prefer to use the term pure competition, while English economists prefer the term perfect competition. However, both the terms are used to analyze the features of perfect markets.
R.A.Podar College Of Commerce And Economics III. Monopoly The definition of pure monopoly is quite stringent. First, there must be only one firm in the industry-the monopolist must be the only supplier in town. Second, there must be no close substitute for the monopolists product. Thus, even the sole provider of natural gas in a city is not considered a pure monopoly, since other firms offer close substitutes like heating oil and electricity. Third, there must be some reason why survival of potential competitor is extremely unlikely, for otherwise monopolistic behaviour and its excessive profits could not persist. These rigid requirements make pure monopoly a rarity in the real world. The local telephone company and the post office may be examples of one-firm industries that face little or no effective competition on some of their activities. But most firms face at least a degree of competition from substitute products. Even if only one railroad serves a particular town, it must compete with bus lines, trucking companies and airlines. Similarly, the producer of a particular brand of beer may be the only supplier of that specific product but the firm is not a monopolist by our definition. Since many other beers are close substitutes for its product, the firm will lose much of its business if it tries to raise its price much above the prices of other brands. And there is one further reason why the unrestrained pure monopoly of economic theory is rarely encountered in practice. Pure monopoly can have a number of undesirable features. As a consequence, in markets where pure monopoly might prevail, the government has intervened to prevent monopolization or to limit the discretion of the monopolist to set its price. Causes of monopoly: Barriers to entry and cost advantages: The key element in preserving a monopoly is keeping potential rivals out of the market. One possibility is that some specific impediment prevents the establishment of a new firm in the industry. Economists call such impediments barriers to entry. Some examples are: 1. Legal restrictions. Local monopolies of various kinds are sometimes established either because government grants some special privilege to a single firm (for example, the right to operate a food concession in municipal stadium) or prevents
R.A.Podar College Of Commerce And Economics other firms from entering the industry (for instance, by licensing only a single cable television supplier.) 2. Patents. A special, but important, class of legal impediments to entry are patents. To encourage inventiveness, the government gives exclusive production rights for a period of time to the inventor of certain products. As long as the patent is in effect. The firm has a protected position and is a monopoly. For example, Xerox had for many years (but no longer has) a monopoly in plain paper copying. 3. Control of a scare resource or input. If a certain commodity can be produced only by using a rare input, a company that gains control of the source of that input can establish a monopoly position for itself. 4. Deliberately-erected entry barriers. A firm may deliberately attempt to make entry difficult for others. One way is to start costly lawsuits against new rivals, sometimes on trumped-up charges. Another is to spend exorbitant amounts on advertising, thus forcing any potential entrant to match the expenditure. 5. Large sunk costs. Entry into an industry will, obviously, be very risky if entry requires an investment of a large amount of money and if that investment is sunkmeaning that one cannot hope to recoup the money for a considerable period of time. Thus, the need for large sunk investment serves to discourage entry into an industry, and many analysts therefore consider sunk costs to be the most important type of naturally imposed barrier to entry. Obviously such barriers can keep rivals out and ensure that an industry is monopolized. But monopoly can also occur in the absence of such barriers to entry if a single firm has important cost advantages over its potential rivals. Two examples of this are: 6. Technical superiority. A firm whose technological expertise vastly exceeds that of potential competitors can, for a period of time, maintain a monopoly position. 7. Economies of scale. If mere size gives large firm a cost advantage over a smaller rival, it is likely to be impossible for anyone to compete with the largest firm in the industry.
R.A.Podar College Of Commerce And Economics IV. Monopolistic Competition The two market structures viz. perfect competition and monopoly are far from reality. The conditions of neither perfect competition nor monopoly are experienced in practice. We hardly come across a situation in which an indefinite number of firms produce identical or homogeneous product Similarly, a situation in which there is only one firm regulating the entire supply of a product is equally unrealistic. In reality, we come across a market structure in which elements of both the competition as well as monopoly are interwoven. In other words, the real market exhibits both monopoly and competitive elements. Such a situation is called monopolistic competition. Thus, there are a small number of firms producing similar product. According to Chamberlin who introduced the concept "Monopolistic competition is a challenge to the traditional viewpoint of economists that competition and monopoly are alternative and that individual prices are to be explained in terms of either one or the other. By contrast, it is held that most economic situations are composites of both competition and monopoly". This argument makes it clear that perfect competition and monopoly are not mutually exclusive situations. The real market presents both the elements. Characteristics: Monopolistic competition exhibits certain unique characteristics because of which it distinguished from other market structures. 1. Large number of firms. Monopolistic competition is characterized by large number of sellers. In this respect it is close to perfect competition. The number may not be as large as that under perfect competition but it is also not very small. In fact, the firms under this market structure are "Too many too small". Consequently no individual has any significant control over the market. 2. Absence of interdependence. Since number of firms is sufficiently large and the size of individual firms is small enough no appreciable interdependence exists among the different firms. No single firm can influence or is influenced by the others in the market. It means different firms cannot produce any significant impact on market by changing their price policies.
R.A.Podar College Of Commerce And Economics 3. Freedom of Entry. Like perfect competition monopolistic competition also grants unrestricted entry to rival in the market. It means there are no restrictions. This leads to occurrence of only normal profits in the long run. However, the nature of this feature is not the same as that under perfect competition. Under perfect competition new firms enter the market with an identical product while under monopolistic competition the new firm may produce only similar but not identical product. In other words new firm can start producing tooth paste or hair oil but it cannot produce a Colgate or a Binaca or a Tata Hair Oil. What it, brings is a different product. 4. Product Differentiation. Under monopo1istic competition different firms produce similar (but not homogeneous) products. It means the different firms produce what may be properly described as a differentiated product. Thus, product differentiation is the core of monopolistic competition. The firms produce a product belonging to a particular class, say tooth paste; but individual product is differentiated from other rival products. It is because of such product differentiation that firms enjoy some monopoly power, that is, the power to control the price in a narrow circle, but in the wider circle, it faces g the competition from the rival firms. Hence, the firms may be called as competing monopolists and the situation may be rightly described as monopolistic competition. 5. Selling Costs. Another feature of monopolistic competition is the existence of selling costs which is absent under any other market situation. Under perfect competition and monopoly, there is no need for incurring the expenditure on creating demand (i.e. selling costs). Under perfect competition, a firm can sell any quantity at a given price while under monopoly, the absence of close substitutes, there is no need for incurring the selling costs. Thus, it is only under monopolistic competition that the selling costs find a place
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R.A.Podar College Of Commerce And Economics V. Oligopoly The theory of perfect competition stands only as an ideal but has lost its significance due to non-existence of its two basic features viz. large number of firms and homogeneous product. The real market exhibits a number of departures from the ideal market situation. These impurities or imperfections emerge due to deliberately differentiated products and the less than large number of firms. Under monopolistic competition, the number of firms is sufficiently large but the product stands differentiated. The pricing policy of any firm depends upon two factors viz., the number of rivals and the nature and extent of product differentiation. Oligopoly is a distinct form of imperfect market which is characterized by the existence of few sellers producing homogeneous or differentiated products. The term 'Oligopoly' owes its origin to two Greek words, 'Oligos' meaning 'a few' and 'pollen' meaning to sell. It differs from monopoly (single firm) and perfect competition as well as monopolistic competition (large number of firms), as it consists of a few firms. In a broad sense this market form is described in a variety of ways such as, limited competition, incomplete monopoly, multiple monopoly etc. A large number of products such as automobiles, steel, cement, heavy electricals etc. are supplied by oligopolistic markets. Definition and Features Stigler defines Oligopoly in the following words: "Oligopoly is that situation in which a firm bases its market policy in part on the expected behaviour of a few close rivals". This clearly reveals the fact that Oligopoly consists of a few firms as a result of which there is a close interdependence among them in respect of price output policy. The simplest way to clearly grasp the meaning and nature of Oligopolistic Market is to analyze and understand the essential features of the same. The study of the unique features of Oligopoly will be very useful in understanding the price output determination under this market form. 1. Few Sellers. It is the number of sellers or firms that distinguishes oligopoly from other market forms such as monopoly, perfect competition and monopolistic competition. The number of sellers under Oligopoly is very small. Naturally each
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R.A.Podar College Of Commerce And Economics individual firm has a sizeable share of the market demand. This leads to the fact that action of each firm in respect of price and output has a close bearing on the market. The decision of a single firm to expand or contract the output affects the entire market under oligopoly. His decision to expand the output leads to fall in price and profit while contraction of output produces an opposite effect. Since the number of firms under Oligopoly is small, it is rightly described as 'competition among few'. The product of these sellers may be homogenous i.e. perfect substitute or just a close substitute. 2. Interdependence. Extreme interdependence among the Oligopolistic firms is an unique feature of this market form. Under perfect competition or monopolistic competition, under which the number of firms is very large, the question of interdependence does not arise. An individual firm in a competitive market has too small a share in the total market supply to produce any significant impact on the rivals. In case of monopoly, which implies absence of a rival, the question of interdependence is irrelevant. It is only under Oligopoly that one witnesses a close interdependence among the different firms. Any policy decision of an individual firm affects and is affected by the rivals. With close substitutes offered by different Oligopolistic firms the products have high cross elasticity of demand as a result of which every move by any single firm receives a sharp reaction from the others. Thus, a close interdependence based on moves and counter-moves is a distinct feature of Oligopoly. The interdependence is so intense that every firm has to predict and analyze the possible reaction of the rivals before taking any decision. 3. Indeterminate Demand Curve. It is difficult to derive a definite demand curve i.e. AR curve of an Oligopolist. This situation arises due to extreme interdependence among the firms. Such an interdependence generates uncertainty because none can precisely predict the possible outcome of a particular decision. Demand Curve is derived from the knowledge of various quantities of a product that can be sold at different prices. This knowledge i.e. a demand schedule is difficult to obtain under Oligopoly. This is due to the fact that the effect of any decision say price reduction by a firm, cannot be precisely predicted. Neither the rivals nor the firm
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R.A.Podar College Of Commerce And Economics reducing the price of its product can estimate exactly what will be the effect of such an action on the demand for their product. The price cutting firm does not know what will be the rise in demand, nor the rivals can estimate if there would be a decline in demand for their product and to what extend. All this leads to an intermediate or uncertain demand curve for an Oligopolist. In this context an oligopoly firm differs from other market structures. Under perfect competition an individual firm faces a definiate demand curve which is horizontal straight line at a given price. Since the product is homogeneous and the price given and constant an individual firm under perfect competition has hardly any decision to make. Similar is the situation under monopoly which definite and determinate demand or AR Curve. A monopolist can take his own decision regarding price-output without any need to wait for the reaction of the rivals. It can thus precisely predict its sales at different prices. An Oligopolist is caught in a peculiar situation of an indeterminate demand curve for though he knows his decision is bound to produce a reaction, he does not know what and how strong that reaction will be. E.g. a firm cuts its price to acquire larger share of the market. Now whether its sales will expand and if they do to what extent are the key questions which lack definite answers. There may be different types and intensities of reactions by the rivals. As such a firm is not in a position to locate a definite demand curve. Similarly, his sales are affected by the decisions of other firms. Some of them may begin the process through change in the price of their products. Here again what will be the effect nobody can predict. Hence the indeterminate AR curve. 4. Conflicting attitudes of firms. The uncertainty existing under Oligopoly is intensified due to the conflicting attitude of the firms. It is often observed that the Oligopolistic firms sometimes resort to cooperation amongst them while on certain other occasions they take up fights and conflicts. The entire issue revolves round the urge for profit maximization. In some cases the Oligopolistic firms realize the declining profits due to undesirable competition. Hence they adopt the strategy of cooperation and therefore unite together. This is known as the tendency towards 'Collusion' among the firms for the purpose
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R.A.Podar College Of Commerce And Economics of achieving the common objective of maximization of profits. Exactly opposite behaviour is experienced in some other cases when they fight against each other like enemies on the issue of distribution of profits and sharing of the markets. Thus the two conflicting trends of cooperation and conflict are experienced in the behaviour of the firms. This attitude enhances the unpredictable nature of this market form. 5. Price Rigidity. Existence of price rigidity is a unique feature of Oligopoly with product differentiation. The Oligopoly price appears to be stuck up or rigid or fixed at a certain level. This implies that there is no departure in either direction i.e., increase or decrease, from the prevailing price. No firm will resort to price reduction as it benefits none. This is because an attempt by an individual firm of price cutting for snatching away the customers of the rivals is immediately followed by others. Hence hardly any benefits are received through price-cut. What it really leads to, is a competitive price reduction, harmful to all. As against it the policy of price-rise, for increasing the profits, is also not advantageous. This is because the act of raising the price by one firm is not followed by the rivals. As a result the price raising firm loses the customers to rivals and instead of increasing the profits, faces the danger of fall in the same. Thus, no firm thinks of changing the price from the existing level. Naturally there is price rigidity. 6. Element of Monopoly. With the existence of a few firms there is an element of monopoly under oligopoly market. Small number of firms producing a differentiated product naturally generates monopoly power. In its limited area every firm enjoy monopoly as it commands an adequately large share of market. Such monopoly power is exerted by the firm in respect of fixation of price-output. The attachment of customers to a given product enhances the monopoly power of the firm which enables it to have greater freedom in fixing price and output.
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R.A.Podar College Of Commerce And Economics ATTIBUTES OF THE FIVE MARKET FORMS Table 1
Market forms Perfect competition Pure Competition Pure
Number
of Frequency
Entry barriers None None
Public interest results Good Good
Long-run profit Zero Zero May be high Zero Varies
firms in the in reality market Very many Many One Rare (if any) Frequent Rare Widespread Produces large of GDP share
Likely to be Misallocates high Minor Varies resources Inefficient Varies
Monopoly Monopolistic Many Competition Oligopoly Few
CHAPTER 3
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R.A.Podar College Of Commerce And Economics ENVIRONMETAL SCAN One of the trademarks of the modern planning approach is its external orientation. We have to address ourselves to the careful appreciation of environmental trends leading to an understanding of the attractiveness of the industry in which the business resides. We should be alert to all developments in our industry, especially to the behaviour of competitors. Only a deep knowledge of the structural characteristics of the industry in which the business operate along with a sound awareness of competitors actions, can generate the high-quality strategic thinking required for the healthy long term development of a firm. Structural Analysis of Markets: The Five Forces Model In order to select the desired competitive position of a business, it is necessary to begin with the assessment of the industry to which it belongs. To accomplish this task, we must understand the fundamental factors that determine its long-term profitability prospects because this indicator embodies an overall measure of industry attractiveness. By far the most influential and widely used framework for evaluating industry attractiveness is the five forces model proposed by Michel E. Porter. Essentially, he postulates that there are five forces that typically shape the industry structure: 1. Intensity of rivalry among competitors 2. Threat of new entrants 3. Threat of substitutes 4. Bargaining power of the buyers 5. Bargaining power of the suppliers These five forces delimit prices, costs and investment requirements, which are the basic factors that explain long-term profitability prospects and henceforth industry attractiveness.
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R.A.Podar College Of Commerce And Economics
Figure 1 The Five Forces Model New Entrants New Entrants
Threat of New Entrants
Suppliers Suppliers
Bargaining Power of Suppliers
Industry Competitors/ Intensity of Rivalry
Buyers Buyers
Bargaining Power of Buyers
Threat of Substitutes
Substitutes Substitutes
1. Intensity of rivalry among the competitors The rivalry among the competitors is at the center of the forces contributing to industry attractiveness. Out of the many determinants of rivalry, four of them stand out: industry growth, the share of fixed cost to total value added to the business, the depth of product differentiation, and the concentration and balance among competitors.
Case I: Monopolistic Competition: The Beauty Soap Industry in India
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R.A.Podar College Of Commerce And Economics The population of India is over one billion. The market potential is very high. The industry life cycle of beauty soaps is in the maturity stage in the urban areas and in the growth stage in the rural areas. The fixed costs involved in setting up a business in this industry are high, since the entire manufacturing department would be needed to set up, but the value added to business is also high. There are a number of different kinds of soaps available in the market, ranging from the imported branded ones to the locally manufactured ones. The rivalry is intense as each firm is trying hard to get a substantial market share. Case II: Oligopoly: The Mobile Networking Industry in India The increased popularity of using mobile phones to keep in touch with near and dear ones has increased the attractiveness of this industry. Hence, there is an increasing demand for mobile services. Also, there is a wide rural market which is untapped. Hence, the industry life cycle is in the growth. But the number of firms in the industry is limited. This is due to the high initial fixed costs. Each firm provides with different services. 2. Threat of new entrants on many occasions, the most critical strategic issue for a given firm does not reside in understanding the existing set of competitors and achieving an advantage over them, but in directing the attentions to possible and sometimes inevitable new entrants. Case I: The threat of new entrants is high in case of the beauty soap industry. This is because of not very high fixed costs and low switching costs. We have already seen that the potential market is huge and hence economies of scale can be achieved if properly directed efforts are taken. If a product, which is not available, is introduced by the new firm then its can achieve the desired sales in a short span of time. Case II: The threat of new entrants in the mobile networking industry is low because of huge initial fixed costs. The demand is huge and so is the potential market but the initial setup costs are quite high that it makes the industry less attractive.
3. Threat of Substitutes
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R.A.Podar College Of Commerce And Economics It is not only the firms participating in the industry and the potential newcomers that are central forces in determining industry attractiveness; we have to add firms offering substitutes, which can either replace the industry products and services or present an alternative to fulfill that demand. Substitutes could affect in different ways the attractiveness of an industry. Their mere presence establishes a ceiling for profitability, whenever there is a price threshold after which a massive transfer of demand takes place. Case I: The threat of substitutes is very high in this case. If one firm increases its products price beyond a certain limit, then it is likely that the consumer will switch the brand. There is increasing popularity of body wash as against the use of soaps. Hence, the threat of substitutes is increasing. Case II: The threat of substitutes is very low. This is because there are no substitutes available for mobile phones. 4. & 5. Bargaining Power of Buyers and Suppliers Porters wording bargaining power of suppliers and buyers suggest that there is a threat imposed on the industry by excessive use of power on the part of these two agents. Porter can be interpreted as indicting that a proper strategy to be pursued by a business firm will have, as a key component, the attempt to neutralize suppliers and buyers bargaining power. Moreover, buyers are the most important constituency of the firm, to be treated not as rivals, but as the depositories of a long-lasting, friendly relationship based on performance and integrity. Case I: The bargaining power of the buyer is high as compared to the supplier as the number of suppliers is high and also there are substitutes available for change. There are more number of firms, hence there is increased competition. Case II: The bargaining power of the supplier is high as compared to that of the buyer as there are no substitutes for the products and the number of players is also limited. Case Analysis
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R.A.Podar College Of Commerce And Economics Barriers To Entry Table 2 Economies of scale Product differentiation Brand identification Switching costs Capital requirements Barriers To Exit Table 3 Asset specialization One time cost of exit Government and social restrictions Rivalry Among Competitors Table 4 Number of equally balanced competitors Relative industry growth Diversity of competitors Strategic stakes Capacity increases Power Of Buyers Table 5 Number of important buyers Availability of substitutes Buyer switching costs Case I Many Few Low Case II Many Few Low Case I Large Fast High Low Large increments Case II Medium Fast Medium Low Small increments Case I Low Low Low Case II High High Medium Case I Small High Low Low Low Case II High Little High High High
Power Of Suppliers Table 6 Number of important suppliers Availability of substitutes for suppliers products Suppliers contribution to quality and service Case I Many Many Medium Case II Few Few High
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CHAPTER 4 BUSINESS PERFORMANCE The performance of any business is based on two kinds of elements:
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Figure 2 Business Performance Business Performance
Key Certainties
Key Uncertainties
1. Key Certainties They are those elements which will be constant irrespective of the changes in the market environment. The certainties in the business are as follows: 2. Key Uncertainties They are those elements which will change with the change in time, place, industry and market environment. The uncertainties in business are as follows:
CHAPTER 5 TURBULENT MARKET ENVIRONEMENT Introduction
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R.A.Podar College Of Commerce And Economics Modern organizations operate in an external environment in which conditions are often changing rapidly and unpredictably. This type of environment is called turbulent environment by Emery and Trist. Turbulence arises in part from changes in various elements that make up the environment. It occurs also as a result of interaction between organizations that have conflicting objectives and that compete with one another for benefits in the environment. Each of these organizations is seeking to progress from its existing stage to one that is judged to be preferable relative to its objectives. However, no organization can be sure that it can achieve its most preferred future position in view of the competition from others in the environment. Those responsible for dealing with complex decision problems in modern turbulent environment experience uncertainty with regard to future conditions and with respect to the future actions by others. Many of the formal decision making methods that have been developed in disciplines of operational research and decision analysis do not take full account of these factors. The basis for most of these methods is optimization of the benefits of a single participant in a static environment. These methods themselves consist for a search for a uniquely rational solution in terms of that single participant. These methods have been developed for use in decision situations that are relatively well understood, where firm and reliable data on the characteristics of the situation are available and where such uncertainty as exists can be represented by the use of simple probability distributions. They are clearly not applicable in turbulent environments, in which interaction between objectives, intentions and actions of many participants have to be taken into account in the resolution of decision problems.
CHAPTER 6 DEMAND FORECASTING METHODS
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R.A.Podar College Of Commerce And Economics Significant gains have been made in forecasting for marketing in the past quarter century. Advances have occurred in the development of qualitative methods such as Delphi, role playing, intentions and opinions surveys, and bootstrapping. They have also occurred for quantitative methods such as extrapolation and econometrics. An attempt is made here to build on the experience in applying these methods by researchers so generalizations can be made about which methods would be most appropriate to forecast demand. In general, experts advocate the use of structured methods that avoid intuition, unstructured meetings, focus groups, and data mining. In situations where there is sufficient data, use of quantitative methods is encouraged, including extrapolation, quantitative analogies, rule-based forecasting and causal methods. In other cases, use methods that structure judgement including surveys of intentions and expectations, judgmental bootstrapping, structured analogies, and simulated interaction. Green & Armstrong (2005) strongly advocate the integration of Judgmental and statistical methods. Managers domain knowledge should be incorporated into statistical forecasts. Methods for combining forecasts improve accuracy. I. Econometric methods "Econometric methods" are defined as quantitative approaches that attempt to use causal relationships in forecasting. In particular, they refer to models based on regression analysis and include all methods which forecast by explicitly measuring relationships between the dependent variable and some causal variables. For market demand forecasting, there is empirical evidence to support the use of econometric methods rather than subjective methods for long-range forecasts. To date, most econometric researchers have devoted their efforts to short-term forecasting, an area that has yielded unimpressive or contradictory results. Econometric methods would be expected to be more useful for long-range forecasting because the changes in the causal variables are not swamped by random error, as in the short run. In fact, econometric methods are more accurate. Armstrong reported seven empirical comparisons of methods used in long-range forecasting. In all comparisons econometric
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R.A.Podar College Of Commerce And Economics methods were more accurate than extrapolations. Also, there was a 3 to 0 advantage for econometric versus subjective forecasts. Fildes located 20 studies on long-range forecasting; he coded them as 15 showing econometric to be more accurate, 3 ties, and 2 showing econometric to be less accurate than other methods. Thus it may be concluded that Causal econometric methods provide more accurate long-range forecasts. While more expensive, the methods are expected to be the most accurate method when large changes are expected. What must however be borne in mind is that to improve predictive capacity, these causal models need not be complex. II. Naive versus Causal Methods A continuum of causality exists in forecasting models. At the naive end, no statements are made about causality; at the causal end, the model may include many factors. Causal methods are more complex than naive methods. First, data must be obtained on the causal factors. Estimates of causal relationships are obtained from these data. These estimates of the causal relationships should be, adjusted so that they are relevant over the forecast horizon. Next, one must forecast the changes in the causal variables. Finally, the forecasts of the causal variables and the relationships are used to calculate the overall forecast. Causal methods are of more obvious value in forecasting. However, naive methods can be used in some phases. For example, naive methods can provide forecasts of environmental factors.
III. Intentions Surveys
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R.A.Podar College Of Commerce And Economics Theoretical literature in psychology that suggests that a good predictor of an individuals future behavior is his or her stated intention. However, the psychological literature also suggests that past behavior is an important predictor of future behavior. With intentions surveys, people are asked how they intend to behave in specified situations. In a similar manner, an expectations survey asks people how they expect to behave. Expectations differ from intentions because people realize that unintended things happen. For example, if you were asked whether you intended to purchase a particular product you might say no. However, you realize that a problem might arise that would necessitate such a purchase, so your expectations would be that the event had a probability greater than zero. This distinction was proposed and tested by Juster and its evidence on its importance was summarised by Morwitz. Expectations and intentions can be obtained using probability scales such as Justers eleven-point scale. The scale should have descriptions such as 0 = No chance, or almost no chance (1 in 100) to 10 = Certain, or practically certain (99 in 100). To forecast demand using a survey of potential consumers, the administrator should prepare an accurate and comprehensive description of the product, its benefits and conditions of sale. He should select a representative sample of the population of interest and develop questions to elicit expectations from respondents. Purchase intentions are routinely used to forecast demand of existing products and services. While past studies have shown that intentions are predictive of sales, they have only examined the absolute accuracy of intentions, not their accuracy relative to other forecasting methods. For different products and time horizons, intentions-based forecasting methods were more accurate than an extrapolation of past sales. Combinations of these forecasting methods using equal weights lead to even greater accuracy, with error rates about one-third lower than extrapolations of past sales. Thus, it appears that purchase intentions can provide better forecasts than a simple extrapolation of past sales trends. Purchase intentions are inexpensive to acquire and easily understood, which may account for their widespread use. Many studies have found a positive correlation between purchase intentions and purchase behavior.
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R.A.Podar College Of Commerce And Economics Buyer-Intentions and expectations surveys are especially useful in forecasting demand when demand data are not available, such as for new or specialty product forecasts. The theoretical literature is equivocal about whether intentions-based forecasts or past sales trends should be more accurate. Received wisdom suggests that the best predictor of future behavior is past behavior. On the other hand, the social psychology literature states that a good predictor of what individuals will do is their stated intentions to perform the behavior. Other research suggests that intentions data are useful for predictions under certain conditions. Armstrong summarizes these conditions: (1) The event being predicted is important, (2) The respondent has a plan (at least the high intenders do), (3) The respondent can fulfill the plan, (4) New information is unlikely to change the plan over the forecast horizon, (5) Responses can be obtained from the decision maker, and (6) The respondent reports correctly. Such conditions are likely to be met for purchase intentions of high involvement goods and services. Once convinced of the utility, the consumer makes a definite plan to buy the goods at a fixed time. With the increase in purchasing power, the consumer in a position to convert potential demand into effective demand. It is also possible to accurately obtain intensions information from the consumers. This suggests that intentions data could potentially improve accuracy of forecasts based solely on past sales behavior for these products. A variety of survey questions have been used to measure consumers purchase intentions. Among the most commonly used measures are Justers 11-point purchase probability scale and a 5-point likelihood of purchase scale. Justers 11-point purchase probability scale provides substantially better predictions of purchase behavior than other types of intentions scales. Purchase probabilities and expectations are broader than direct intentions questions because they refer to actions that might be unplanned as well as planned.
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R.A.Podar College Of Commerce And Economics Assessing purchase probabilities and expectations may be advantageous in situations where people realize that they may purchase an item even though they have no plans at the time of the survey. Therefore, a smaller proportion of respondents reports zero on purchase probability scales than report no on intentions scales. For many studies, most purchases are made by those who had reported no plans to buy. This occurs because although non-intenders seldom purchase, they are often the largest group of respondents. Models have been developed to describe how purchase intentions relate to purchase behavior Two commonly used methods to forecast sales from intentions predict that the proportion of consumers who will purchase will equal : (1) The mean intent (transformed to lie between zero and one to represent the mean probability of purchase), or (2) The proportion of respondents indicating a positive purchase intent. Intentions, by themselves, provide only a crude way to predict sales. Several studies have shown that these methods often provide biased estimates of sales, overstating or understating actual purchasing. Thus, when possible, sales data should be used to adjust for the bias in intentions. The simplest way to do this is to relate an aggregate measure of purchase intentions to an aggregate measure of sales. For new products or new product groups , intentions are sometimes used directly to forecast demand. However, when sales figures are available, it is sensible to calibrate intentions against them. In other words, we look at a category of intenders and determine what percent actually did purchase in that period. This relationship is then extended to the period to be forecast. Morrison developed a descriptive model of the relationship between purchase intentions and subsequent purchasing. Morrison proposed that there are three threats to the predictive validity of purchase intention measures. First, intentions are measured with error. Second, respondents purchase intentions might change over time because of exogenous events. Third, average stated purchase intentions might be a biased estimate of the proportion that actually buy the product because of systematic error.
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R.A.Podar College Of Commerce And Economics However, it was uniformly observed that for different products, time horizons, countries, and types of intentions questions, the intentions surveys when combined with prior sales data, were more accurate than forecasts based solely on past sales. Understanding the Intention to Try The Theory of Trying developed by Bagozzi and Warshaw emphasizes consumer uncertainty when achievement of a consumption objective is not entirely within ones volitional control. Impediments can take several of forms: market outcome information, uncertainty, unfavourable lack of knowledge/information, distortion earlier
experiences, time pressure and cultural differences, need to be self-reliant and satisfaction with current behaviour, when new solutions require efforts in terms of search costs, transaction costs, etc.
FIGURE Basic Framework for Attitude Building for a Product
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Outcome Uncertainty Outcome Uncertainty Satisfaction with Satisfaction with current behaviour current behaviour Personal, Personal, Environmental Environmental Impediments Impediments Habits & Inertia Habits & Inertia Lack of knowledge Lack of knowledge Information Distortion Information Distortion Being self reliant Being self reliant Self Expression Self Expression Differed Gratification Differed Gratification Social Stigma, Social Stigma, Cultural Cultural Differences Differences
Earlier Earlier Experiences Experiences
Recency Recency
Attitude towards Attitude towards Trying Trying
Intention Intention to try to try
Trying Trying
(Source : Agarwal & Agarwal, 2003)
These nine generic factors together affect the formation of an attitude towards trying a product. Even if the consumer forms a favourable attitude towards trying the
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R.A.Podar College Of Commerce And Economics product, this might not directly translate into an intention to try. Earlier experiences and socio-cultural norms applicable to the individual may also influence to some extent the intention to try. After the consumer develops an intention to try, the next step is to actually try the product. However besides the intention to try, actual trying is also affected by recency. If the consumer has tried out a similar product in the recent past he will be more amenable to trying out the product now. An important point to note is that earlier experiences affect both the intention to try and actual trying. When a person is not clear about his intentions to try out a product, he may rely upon his past experiences to decide whether he wants to actually try out the product. It becomes essential therefore, while using intension surveys, to understand and appreciate the factors that affect the formation of an attitude towards the product / product category. IV. Delphi Technique Since its design at the RAND Corporation over 40 years ago, the Delphi technique has become a widely used tool for measuring and aiding forecasting. Delphi is not a procedure intended to challenge statistical or model-based procedures. It is intended for use in judgment and forecasting situations in which pure model-based statistical methods are not practical or possible because of the lack of appropriate historical /economic/ technical data, and thus some form of human judgmental input is necessary. Such input needs to be used as efficiently as possible, and for this purpose Delphi technique might serve a role. Four key features may be regarded as necessary for defining a procedure as a Delphi. These are: rounds anonymity, iteration, controlled feedback, and the statistical aggregation of group response. Anonymity is achieved through the use of questionnaires. By allowing the individual group members the opportunity to express their opinions and judgments privately, undue social pressures as from dominant or dogmatic individuals, or from a majority should be avoided. Ideally, this should allow the individual group members to
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R.A.Podar College Of Commerce And Economics consider each idea on the basis merit alone, rather than on the basis of potentially invalid criteria (such as the status of an ideas proponent). Furthermore, with the iteration of the questionnaire over a number of rounds, the individuals are given the opportunity to change their opinions and judgments without fear of losing face in the eyes of the (anonymous) others in the group. Between each questionnaire iteration, controlled feedback is provided through which the group members are informed of the opinions of their anonymous colleagues. The number of rounds is variable, though it seldom goes beyond one or two iterations (during which time most change in panelists responses generally occurs). To forecast with Delphi the administrator should recruit between five and twenty suitable experts and poll them for their forecasts and reasons. The administrator then provides the experts with anonymous summary statistics on the forecasts, and experts reasons for their forecasts. The process is repeated until there is little change in forecasts between rounds two or three rounds are usually sufficient. The Delphi forecast is the median or mode of the experts final forecasts. Software to guide you through the procedure is available. Rowe and Wright provide evidence on the accuracy of Delphi forecasts. The forecasts from Delphi groups are substantially more accurate than forecasts from unaided judgment and traditional groups, and are somewhat more accurate than combined forecasts from unaided judgment. V. Unaided Judgement It is common practice to ask experts what will happen. This is a good procedure to use when experts are unbiased, large changes are unlikely, relationships are well understood by experts (e.g., demand goes up when prices go down), experts possess privileged information and experts receive accurate and well-summarized feedback about their forecasts. Unfortunately, unaided judgement is often used when the above conditions do not hold. Green and Armstrong, for example, found that experts were no better than chance when they use their unaided judgement to prepare forecasts in complex situations. Considering this, unaided judgment will not be used in this study.
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R.A.Podar College Of Commerce And Economics VI. Game Theory and Role Playing Game theory has been touted in textbooks and research papers as a way to obtain better forecasts in situations involving negotiations or other conflicts. A Google search for game theory and forecasting or prediction identified 147,300 sites. Despite a vast research effort, there is no research that directly tests the forecasting ability of game theory. However, Green tested the ability of game theorists, who were urged to use game theory in predicting the outcome of eight real (but disguised) situations. In that study, game theorists were no more accurate than university students. Role playing is well-suited to forecasting how people will respond to exogenous pressures (actions of those outside the firm). The accuracy gain of game theory over unaided judgment may be illusory, and the advantage of role playing over game theory is likely to be greater than the 44% error reduction found by Green. The improved accuracy of role playing over game theory was consistent across situations. For those cases that simulated interactions among people with conflicting roles, game theory was no better than chance (28% correct), whereas role-playing was correct in 61% of the predictions. VII. Bootstrapping According to Armstrong, Brodie & McIntyre bootstrapping (including related approaches such as expert systems and conjoint analysis) is one of the more important advances for forecasting in marketing over the past quarter century. It was also noted as one of the most significant advances in the field of agricultural forecasting. Bootstrapping has been widely applied in marketing. Occasionally it has been used with experts, but typically it is consumer intentions that are modeled. Over 1,000 marketing applications had been made by indirect bootstrapping of consumer intentions by the early 1980s. These applications have been done under the umbrella term conjoint analysis. Bootstrapping is nearly always more accurate than judgment. VIII. Focus Groups
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One popular type of survey, focus groups, violates five important principles and they should not, therefore, be used in forecasting. First, focus groups are seldom representative of the population of interest. Second, the responses of each participant are influenced by the expressed opinions of others in the group. Third, a focus group is a small sample samples for intentions or expectations surveys typically include several hundred people whereas a focus group will consist of between six and ten individuals. Fourth, questions for the participants are generally not well structured. And fifth, summaries of focus groups responses are often subject to bias. There is no evidence to show that focus groups provide useful forecasts. IX. Neural Nets Neural networks are computer intensive methods that use decision processes analogous to those of the human brain. Like the brain, they have the capability of learning as patterns change and updating their parameter estimates. However, much data is needed in order to estimate neural network models and to reduce the risk of over-fitting the data. There is some evidence that neural network models can produce forecasts that are more accurate than those from other methods. While this is encouraging, our current advice is to avoid neural networks because the method ignores prior knowledge and because the results are difficult to understand. X. Data Mining Data mining ignores theory and prior knowledge in a search for patterns. Despite ambitious claims and much research effort, we are not aware of evidence that data mining techniques provide benefits for forecasting. In their extensive search and reanalysis of data from published research, Keogh and Kasetty found little evidence for that data mining is useful. XI. Segmentation
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Segmentation involves breaking a problem down into independent parts, using data for each part to make a forecast, and then combining the parts. To forecast using segmentation, one must first identify important causal variables that can be used to define the segments, and their priorities. For each variable, cut-points are determined such that the stronger the relationship with dependent variable, the greater the non-linearity in the relationship, and the more data that are available the more cutpoints should be used. Forecasts are made for the population of each segment and the behaviour of the population within the segment using the best method or methods given the information available. Population and behaviour forecasts are combined for each segment and the segment forecasts summed. Where there is interaction between variables, the effect of variables on demand are non-linear, and the effects of some variables can dominate others, segmentation has advantages over regression analysis. Efforts at dependent segmentation have gone under the names of microsimulation, world dynamics, and system dynamics. While the simulation approach seems reasonable, the models are complex and hence there are many opportunities for judgemental errors and biases. Armstrong found no evidence that these simulation approaches provide valid forecasts and there appears no reason to change this assessment. XII. Rule Based Forecasting Rule-based forecasting incorporates information from experts and from prior research. The procedure calls for the development of empirically validated and fully disclosed rules for the selection and combination of methods. When large changes are expected, one should draw upon methods that incorporate causal reasoning. If the anticipated changes are unusual, judgmental methods such as Delphi would be appropriate. If the changes are expected to be large, the causes are well understood, and if one lacks historical data, then judgmental bootstrapping can be used to improve forecasting.
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Other Forecasting Imperatives I. Identifying causal variables Environmental forecasts are useful as an input to strategic planning. The identification of possible states of the environment and a forecast of their likelihood can provide ideas on future demand trajectories. Environmental forecasts also can help to provide better industry forecasts (e.g. the total demand for a product class in a given market). It is important that the forecasting methods first identify the possible states of the future. For this, brainstorming among a variety of experts would be useful. Particular attention would be given to the more important of these possible states. Importance should be judged not only by the likelihood of the environmental change, but also by its potential impact on the Industry if it does occur. It becomes important while forecasting long range demand to assess the likelihood of this event occurring and therefore, its potential impact on altering demand patterns of the industry. There is some evidence to show that the accuracy of forecasts of environmental variables is not as important as is identifying the key variables to include in the market forecasting model. Measurement error in the causal variables (e.g., the environmental inputs to a market forecasting model) had little impact on the accuracy of an econometric model. It is important to determine which are the important factors in the environment that might affect the industry. It is also important to predict the direction of change in the important factors, and to then get approximately correct predictions of the magnitude of the changes in these factors. For the direction of change in environmental factors, only general trends, not cycles, should be considered. Other than recurrent events owing to the seasons of the year (seasonality), cycles have been of little value for improving the accuracy of forecasts. The reason? One must also predict the phases (timing) of the cycles. If the timing is off, large errors can occur. Organizations should have a system for scanning the environment
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R.A.Podar College Of Commerce And Economics to be sure that they do not overlook variables that may have a large impact on their market. These variables can be tracked through marketing information systems. Periodic brainstorming with a heterogeneous group of experts should be sufficient to identify which variables to track. The key is to identify the important variables and the direction of their effects. Once identified, only crude estimates of the coefficients of these variables are typically sufficient in order to obtain useful forecasts. When large shocks are encountered, more sophisticated approaches may be useful. II. Estimating Uncertainty In addition to improving accuracy, forecasting is concerned with assessing uncertainty. This can help manage the risk associated with the forecasts. Much work has been done on judgmental estimates of uncertainty. One of the key findings is that judges are typically overconfident. Fischoff and MacGregor found that 95% confidence ranges that are estimated judgmentally typically fail to include the true value. This bias occurs even when subjects are warned in advance about the overconfidence phenomenon. Nevertheless, judgmental expressions of uncertainty have been found to be useful. One way to assess uncertainty has been to examine the agreement among judgmental forecasts. For example, Ashton, found that the agreement among the individual judgmental forecasts was a useful proxy for accuracy. Probably the best way to assess uncertainty is to follow the track record of a given forecasting method in actual use. Traditional error measures, such as the mean square error (MSE), do not provide a reliable basis for comparison of forecasting methods. The median absolute percentage error (MdAPE) is more appropriate because it is invariant to scale and is not influenced by outliers. When comparing methods, especially when testing on a small number of series, control for degree of difficulty in forecasting by using the median relative absolute error (MdRAE), which compares the error for a given model against errors for the naive, no change forecast. Statisticians have relied heavily on tests of statistical significance for assessing uncertainty. However, statistical significance is inappropriate for assessing
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R.A.Podar College Of Commerce And Economics uncertainty in forecasting. Furthermore, its use has been attacked as being misleading. It is difficult to find studies in marketing forecasting where statistical significance has made an important contribution. Instead of statistical significance, the focus should be on prediction intervals. Chatfield summarizes research on prediction intervals. Unfortunately, prediction intervals are not widely used in practice. Tulls survey noted that only 25% of 16 respondent companies said they provided confidence intervals with their forecasts. Dalrymple found that 48% did not use confidence intervals, and only 10% usually used them. In a survey of experts by Yokum and Armstrong half said that it was important that your forecasting methods provide confidence bounds on the forecasts, while 20% said this was not important. III. Overlooked Discontinuities Considering the wide range of random shocks that affect an industry, there is strong agreement about the importance of discontinuities in forecasting. This was surprising because this topic has been largely ignored in the forecasting literature. Identifying areas of uncertainty or disagreement among experts, or disagreements between researchers and practitioners, could help to guide further research. Also, the opinions might aid in the development of expert systems for forecasting. In a study of experts by Callopy and Armstong, 92% of the experts agreed that abrupt changes are an important consideration while forecasting demand. This is surprising given that time series forecasting research and practice have largely ignored abrupt changes. Examination of a convenience sample of indices of 28 books that discuss time series forecasting did not include any reference to abrupt changes, discontinuities, erratic fluctuations, interruptions, irregularities, ramps, shifts, steps, and variations on these terms. The experts agreed that seasonality and recent trend were key features. The experts also placed a heavy emphasis on the importance of abrupt changes in the historical data patterns. This stands in stark contrast to forecasting methods and forecasting research which have long ignored abrupt changes. We have no explanation
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R.A.Podar College Of Commerce And Economics for this mystery of the overlooked discontinuities. Fortunately, software developers are responding to this problem. IV. Combining Forecasts Considerable literature has accumulated over the years regarding the combination of forecasts. The primary conclusion of this line of research is that forecast accuracy can be substantially improved through the combination of multiple individual forecasts. Clemen is a milestone on the topic of combining forecasts. As noted by Clemen, past research has produced two primary conclusions, one expected and one surprising. The expected conclusion is that combined forecasts reduce error (in comparison with the average error of the component forecasts). The unexpected conclusion is that the simple average performs as well as more sophisticated statistical approaches. Combining forecasts is more useful for long-range forecasting because of the greater uncertainty. The level of aggregation of the data was expected to be related to the relative accuracy of alternative extrapolation methods by 88% of the experts. We speculate that the level of aggregation may be important because different causal factors might affect different components. Highly aggregated data are more likely to be subject to different causal factors than are less aggregated data. On the other hand, the reliability of data often improves when one uses larger aggregates. 83% of the experts with an opinion believe that combining will produce more accurate forecasts. Clemen advises forecasters to select a set of methods that differ substantially from one another with respect to the data used and also with respect to the procedures for analyzing the data. The experts believed that, in general, combined forecasts are more accurate than those based on a single method: 73% of the respondents agreed and only 15% disagreed. Combined forecasts improve accuracy and reduce the likelihood of large errors. In a meta-analysis, Armstrong found an average error reduction of about 12% across 30
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R.A.Podar College Of Commerce And Economics comparisons. They are especially useful when the component methods differ substantially from one another. For example, Blattberg and Hoch obtained improved sales forecast by averaging managers judgmental forecasts and forecasts from a quantitative model. Considerable research suggests that, lacking well-structured domain knowledge, unweighted averages are typically as accurate as other weighting schemes. Callopy and Armstrong favored simple methods of preparing and combining forecasts for stable and unstable situations, with a slightly stronger preference for their use in unstable situations. Schnaars results implied that simple models are most appropriate for unstable situations. The use of a simple average has proven to do as well as more sophisticated approaches. An alternative simple approach, the median, might offer additional benefits. It is less likely to be affected by errors in the data. Whether the median is superior to the mean is an empirical issue. Meta-analysis may prove useful here. Two studies that address this issue (Larrch and Moinpour, 1983, Agnew 1985, cited in Armstrong, 1989) suggest that the median would improve accuracy. Certainly, there are situations where one method is more accurate than another. V. Value of Expertise in Judgmental Forecasts An interesting issue is how much expertise is needed for judgmental forecasting. Surprisingly, research to date indicates that high expertise in the subject area is not important for judgmental forecasts of change. It is, however, important for assessing current levels. An important conclusion, then, is not to spend heavily to obtain the best experts in the field to forecast change. But one should avoid people who clearly have no expertise. Extensive research over the last two decades has examined biases that occur in judgmental forecasting. Among these biases are optimism, conservatism, anchoring, and an overemphasis on easily available data. While some sources of bias have been identified, little knowledge exists as to how these biases affect marketing forecasts. When using experts, it is essential to bear in mind that people who hold viewpoints on an issue tend to perceive the world so as to reinforce what they already believe; they look for "confirming" evidence and avoid "disconfirming" evidence. There is much
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R.A.Podar College Of Commerce And Economics literature on this phenomenon, commonly known as "selective perception." In cases where disconfirming evidence is thrust upon people, they tend to remember incorrectly. Fischhoff and Beyth, for example, found that subjects tended to remember their predictions differently if the outcome was in conflict with their prediction. Experts are typically overconfident. In McNees examination of economic forecasts from 22 economists over 11 years, the actual values fell outside the range of their prediction intervals about 43% of the time. This occurs even when subjects are warned in advance against overconfidence. Fortunately, there are procedures to improve forecasts by experts. A commonly used technique is to ask experts to write all the reasons why their forecasts might be wrong. Alternatively, use the devils advocate procedure, where someone is assigned for a short time to raise arguments about why the forecast might be wrong. However, playing devils advocate does make the person unpopular with the group. Still another way to assess uncertainty is to examine the agreement among judgmental forecasts. For example, Ashton, in a study of forecasts of annual advertising sales for Time magazine, found that the agreement among the individual judgmental forecasts was a good proxy for uncertainty. If we take Bayess theorem as the standard, people tend to adjust their predictions less than they should when they receive new information. When they consider the likelihood of an outcome from a multistage process (Hitler invades Belgium, he succeeds, Britain declares war, Hitler attacks Britain) people have the opposite tendency: they act as though their best guesses of what will happen at early stages are certainties . Stewart found that judgmental forecasts are likely to be unreliable when (1) The task is complex, (2) There is uncertainty about the environment, (3) Information acquisition is subjective, or (4) Information processing is subjective. People are willing to pay heavily for expert advice. However, expertise beyond a minimal level is of little value in forecasting. This conclusion is both surprising and useful, and its implication is clear: Don't hire the best expert, hire the cheapest expert. "Expertise breeds an inability to accept new views." - Laski (1930)
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R.A.Podar College Of Commerce And Economics Figure Value of Expertise in forecasting
(Source: Armstrong, 1980) Although experts are poor at forecasting, this does not mean that judgmental forecasting is useless. However, since all available evidence suggests that expertise beyond an easily achieved minimum is of little value in forecasting change, the most obvious advice is to hire inexpensive experts. Also, look for unbiased experts those who are not actually involved in the situation. Finally, there is safety in numbers. Robin Hogarth has suggested using at least three independent experts and preferably six to ten. VI. Using Multiple Hypotheses Green used the method of multiple hypotheses. This is an important procedure in ensuring objectivity and accuracy in forecasting.
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Evaluating the utility of the Forecasting Model The usefulness of a quantitative model depends on both "acceptability" and "quality." Acceptability refers to approval by those who would actually use the model, while quality refers to the ability to provide better predictions or decisions. A model must score well on both characteristics if it is to be judged useful. A high-quality model that is not accepted is of no value. Usually, some trade-offs must be made between quality and acceptability. A model is said to be "good" if it is better than alternative models. Quality and acceptability are characteristics that may depend not only upon the model but also upon the situation. Research in forecasting has commonly assumed that accuracy is the primary criterion in selecting among forecasting techniques. In fact, it has been used as the sole criterion in many studies. In the sixteen 1992 International Journal of Forecasting papers that compared the results of different techniques and series, only one used criteria other than accuracy. When asked Relative to other considerations (e.g. cost, ease of interpretation, cost/time, ease of use), how important is the accuracy of the forecasting methods that you use? 29% of the experts said that accuracy was extremely important and an additional 56% said that it was important. These results are similar to the opinions of practitioners and researchers as reported in Carbone and Armstrong and with those of practitioners as reported by Mentzer and Cox. Table Rankings of criteria from previous studies (number of respondents)
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(Source : Yokum and Armstrong, 1995) However, this single-minded focus on accuracy is not completely reasonable. To encourage diffusion, new techniques should be evaluated, not only in terms of comparative accuracy, but also in terms of the "ease of use, "ease of interpretation, and "flexibility. "Cost savings" varied in rank depending upon its framing from a top criterion if related to savings from improved decisions to a lower criterion if linked to savings from technique development and maintenance. Witt and Witt found that "speed" was most important for short-range forecasts, while "accuracy" was most important for medium- and long-term forecasts. The evaluation of overall quality of the model calls for an examination of four key stages. The first stage relates the "real world" to the assumptions of the model: Are the assumptions reasonable and comprehensive? A review of written documents must be carried out in order to develop an explicit listing of the key assumptions. This list may be checked by conducting interviews with the advocates of the model. The assumptions are then tested for reasonableness against: (1) Empirical evidence, (2) Judgments of managers, and (3) Assessments by the evaluator. Admittedly, this procedure is rather crude; however, the objective at this stage is merely to identify highly unreasonable" assumptions. Their appeal was strictly one of face validitythat is, the assumptions seem reasonable.
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R.A.Podar College Of Commerce And Economics The second stage relates the model's assumptions to the final form of the model. Does the model follow logically from the assumptions? This is an examination of the logical structure of the model. This stage of analysis is generally the most important one for assessing the quality of a model. One possible approach is to assess the total costs associated with the model [Initial development (money and time), Maintenance (money and time), User (ease in understanding, time to get results, need for expert assistance)] versus the total benefits derived [Predictive accuracy, Ability to assess uncertainty, Identification of improved policies, Learning (the model improves as experience is gained), Ability to assess effects of alternative policies, Adaptability (can adapt as the environment changes)] The third stage relates the model and its outputs: Given the same input data, can the outputs be replicated? And the fourth stage relates the outputs to the real world: Do the benefits of the model (e.g., better predictions, better assessments of risk, or better decision making) justify the costs of the model? Based on the foregoing sections that review empirical forecasting literature, a summary of general principles to be used while developing forecasting procedures is summarized below: Domain knowledge should be incorporated into forecasting methods. When making forecasts in highly uncertain situations, be conservative. For example, the trend should be dampened over the forecast horizon. Complex methods have not proven to be more accurate than relatively simple methods. Given their added cost and the reduced understanding among users, highly complex procedures cannot be justified. In case data on actual behaviour is unavailable, forecasts based on judgments or intentions, may be used to predict behaviour. Methods that integrate judgmental and statistical data and procedures (e.g., rulebased forecasting) can improve forecast accuracy. When making forecasts in situations with high uncertainty, use more than one method and combine the forecasts, generally using simple averages. Analysis of Turbulent Market Environments 45
CHAPTER THE NEW COMPETITION
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R.A.Podar College Of Commerce And Economics A profound, but silent, transformation of our society is afoot. Our industrial system is generating more goods and services than at any point in history, delivered through an ever-growing number of channels. Superstores, boutiques, online retailers and discount stores proliferate, offering thousands of distinct products and services. This product variety is overwhelming to consumers. Simultaneously, thanks to the propagation of cell phones, Web sites, and media channels, consumers have increased access to more information, at greater speed and lower cost than ever before. But who has the leisure and the proficiency needed to sort through and evaluate all these products and services? The burgeoning complexity of offerings, as well as the associated risks and rewards, confounds and frustrates most time-starved consumers. Product variety has not necessarily resulted in better consumer experiences. For senior management, the situation is no better. Advances in digitization, biotechnology, and smart materials are increasing opportunities to create fundamentally new products and services and transform businesses. Major discontinuities in the competitive landscape ubiquitous connectivity, globalization, industry deregulation, and technology convergence- are blurring industry boundaries and product definitions. These discontinuities are releasing worldwide flows of information, capital, products, and ideas, allowing nontraditional competitors to upend the status quo. At the same time, competition is intensifying and profit margins are shrinking. Managers can no longer focus solely on costs, product and process quality, speed, and efficiency. For profitable growth, managers must also strive for new sources of innovation and creativity. Thus, the paradox of the twenty-first-century economy: Consumers have more choices that yield less satisfaction. Top management has more strategic options that yield less value. Are we on the cusp of a new industrial system with characteristics different from those we now take for granted? The emerging reality is forcing us to reexamine the traditional system of company-centric value creation that has served us so well over the past hundred years. We now need a new frame of reference for value creation. The answer, we believe, lies in a different premise centered on co-creation of value. It begins with the changing role of the consumer in the industrial system.
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CHAPTER THE INDUSTRY LIFE CYCLE
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R.A.Podar College Of Commerce And Economics The nature of new competition leads us to one conclusion. The industry life cycles are getting shorter. Every firm in every industry is trying to get a competitive advantage over the other. It tries this in various ways- publicity, differentiated products, low prices, huge advertising budgets, unique benefits of the products, degrading the competitors product, etc. But one must realize that all these are ways to survive in the market. A firm needs to give a product which is different from its competitor or else its products will not be accepted. The consumer wants to know the marginal benefit he will receive by using Company Xs product as against Company Ys. He wants the product at low price with additional features and services. He wants value for his money. All these aspects have resulted in shorter industry life cycles. And hence, shorter company life cycles. Then profit margins are reducing, the managers try to reduce the cost of production yet not compromising on the quality of the product. It is traditional to categorize enterprises as business-to-business (B2B) or business-to-consumer (B2C), decidedly putting business first and taking a firm centric view of the economy. But these conventions are challenged in todays dynamic economy. What if the individual consumer (whether an enterprise or a household) were at the center and not the firm? What if we spoke of consumer-to-business-to-consumer (C2B2C) patterns of economic activity? Consequently, we challenge the traditional notion of value an its creation, namely that firms create and exchange value with customers. The joint efforts of the consumer and the firm-the firms extended network and consumer communities together-are cocreating value through personalized experiences that are unique to each individual consumer. This proposition challenges the fundamental assumptions about our industrial system-assumptions about value itself, the value creation process, and the nature of the relationship between the firm and the consumer. In this new paradigm, the firm and the consumer co-create value at points of interaction. Firms cannot think and act unilaterally. We will now analyze how the consumers role had changed in the new environment and how a firm can operate in the using the new emerging managerial principles and hence increase the company life cycles.
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CHAPTER THE CHANGING ROLE OF CONSUMER AND VALUE CREATION
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R.A.Podar College Of Commerce And Economics The most basic change has been a shift in the role of the consumer-from isolated to connected, from unaware to informed, from passive to active. The impact of the connected, informed, and active consumer is manifest in many ways. Let us examine some of them. 1. Information Access With access to unprecedented amounts of information, knowledgeable consumers can make more informed decisions. For companies accustomed to restricting the flow of information to consumers, this shift is radical. Millions of networked consumers are now collectively challenging the traditions of industries as varied as entertainment, financial services, and health care. 2. Global View Consumers can also access information on firms, products, technologies, performance, prices, and consumer actions and reactions from around the world. Twenty years ago, the two car dealerships (General Motors and Ford) in small towns in North America would probably have influenced the driving aspirations of a local teenager. Today, a teen anywhere can dream about owning one of more than seven hundred car models listed on the Internet, creating a serious gap between what is immediately available in the neighborhood and what is most desirable. Geographical limits on information still exist, but they are eroding fast, changing the rules of business competition. For example, broader consumer scrutiny of product range, price, and performance across geographic borders is limiting multinational firms freedom to vary the price or quality of products from one location to another. 3. Networking Human beings have a natural desire to coalesce around common interests, needs, and experiences. The explosion of the Internet and advances in messaging and telephony-the number of mobile phone users is already over one billion-is fueling this desire, creating an unparalleled ease and openness of communication among consumers. Consequently, "thematic consumer communities," in which individuals share ideas and feelings without regard for geographic or social barriers, are revolutionizing emerging markets and transforming established ones. The power of consumer communities comes from their independence from the firm.
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R.A.Podar College Of Commerce And Economics 4. Experimentation Consumers can also use the Internet to experiment with and develop products, especially digital ones. Consider MP3, the compression standard for encoding digital audio developed by a student Karlheinz Brandenburg and released to the public by the Fraunhofer Institute in Germany. Once technology-savvy consumers began experimenting with MP3, a veritable audio-file-sharing movement surged to challenge the music industry. The collective genius of software users the world over has similarly enabled the co-development of such popular products as the Apache Web server software and the Linux operating system. Of course, the Internet facilitates consumer sharing in nondigital spheres as well: Aspiring chefs swap recipes, gardening enthusiasts share tips on growing organic vegetables, and homeowners share insights into home improvements. More crucial, consumer networks allow proxy experimentation-that is, learning from the experiences of others. The diversity of informed consumers around the world creates a wide base of skills, sophistication, and interests that any individual can tap into. 5. Activism As people learn, they can better discriminate when making choices; and, as they network, they embolden each other to act and speak out. Consumers increasingly provide unsolicited feedback to companies and to each other. Already, hundreds of Web sites are perpetuating consumer activism, many targeting specific companies and brands. The Web has also become a powerful tool by which groups focused on issues such as child labor and environmental protection seek corporate and governmental attention and promote reforms. Consumer advocacy through online groups may have even greater impact than company marketing. When Novartis AG launched clinical trials of a promising leukemia drug, Gleevec, word spread so fast on the Internet that the company was inundated by demand from patients wanting to participate. Activism by leukemia patients who were on the early clinical trials for this drug led to a highly effective lobbying effort via Inter- net support groups to speed up its production, and even get the Food & Drug Administration (FDA) to expedite its approval.
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R.A.Podar College Of Commerce And Economics What is the net result of the changing role of consumers? Companies can no longer act autonomously, designing products, developing production processes, crafting marketing messages, and controlling sales channels with little or no interference from consumers. Consumers now seek to exercise their influence in every part of the business system. Armed with new tools and dissatisfied with available choices, consumers want to interact with firms and thereby co-create value. The use of interaction as a basis for cocreation is at the crux of our emerging reality. Consumer- Company Interactions: The Emerging Reality of Value Creation Consider the evolution of the health care industry. Innovations in pharmaceuticals, biotechnology, nutrition, cosmetics, and alternative therapies are creating various treatment modalities and transforming our concepts of health. As both consumers and technologies advance, traditional medicine ("curing sickness"), preventive medicine, and improvements in the quality of life are rapidly merging into a wellness space. Let us examine the changing dynamics of interaction between a consumer and the firms that participate in the wellness space. Twenty years ago, when I was feeling ill and visited my doctor, I might have undergone a battery of tests that would have informed my doctors diagnosis, which he would explain to me only if he had to. He would then choose a treatment modality, prescribe some medications, and schedule a follow-up examination. Health care back then was generally doctor-centric, just as commerce was company-centric. Doctors thought that they knew how to treat me, and since I wasnt a physician I probably agreed. Similarly, most businesses figured that they knew how to create customer value-and most customers agreed. Now, health care process is far more complex. As soon as I feel ill, I will tap into the expertise and experience of other patients and :health care professionals. I can access an abundance of information, some of it reliable, some not. I can learn what I want about breast cancer or high cholesterol or liposuction. I can investigate alternative treatments for any condition and develop an opinion about what might and might not work for me. Ultimately, I can cut my own path through the wellness space, thereby constructing a personal wellness portfolio. If I'm grappling with high cholesterol, then I
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R.A.Podar College Of Commerce And Economics can include pharmaceuticals for blood pressure and cholesterol approved by the FDA, health supplements not approved by the FDA, a fitness regimen developed with an instructor, and genetic screening for hereditary heart disease. Notice that my wellness portfolio does not fit neatly into any traditional industry classification. Yes, I visit my doctor. I get tests and medications and submit the bills to my medical insurance, provided through my employer. But other services in my wellness portfolio fall outside the conventional doctor-based health care, pharmaceutical, or insurance industries. My wellness space springs from my view of wellness, my biases, values, expertise, preferences, expectations, experiences, and financial wherewithal. My spouse, meanwhile, can construct her own wellness portfolio. Rather than rely solely on my doctors expertise, I can seek experts among my peers-other health care consumersorganized into thematic communities, such as a high-cholesterol group. This networked knowledge encompasses not just the medical aspects pertinent to my condition but its sociology, psychology, and likely impact on me, my family, and the community at large. Thus, my next visit to the doctor can differ dramatically from the conventional checkup. I can ask, Why did you prescribe this treatment? Why not the alternative that I found through my exploration with other consumers and the Web? My doctor probably won't enjoy my challenging his expertise and authority. After all, Im asking him to explain and defend his approach, which takes time and energy. Whats more, Im testing the depth, breadth, and currency of his knowledge. What if Im experimenting with alternatives-herbs, dietary supplements, and so on-that he may not yet understand? Will he know of any complex interactions between these treatments modalities? Should he? Of course, health care consumers have always shaped their own treatment to a certain extend. Remember Grandma's prescribing a remedy such as chicken soup for a cold? But with today's access to information, consumer war stories, and advice from an experienced peer group, consumers are far more likely to network and experiment than ever before. As a health care consumer, I can more actively determine the "value bundle" that is appropriate for me, cutting across customary industry boundaries. Now position yourself as a manager in a pharmaceutical firm. The commingling of traditional industries into a complex, evolving wellness space challenges deeply entrenched and implicit assumptions in managerial tradition, which have evolved over
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R.A.Podar College Of Commerce And Economics decades. For starters, what constitutes or defines a product or service? Is an anti-wrinkle cream with Retinol a cosmetic, a fashion, or a pharmaceutical product? With unclear industry boundaries, how do we identify the nature of our competitive advantage? More important, what value does the pharmaceutical firm provide in wellness space of an active, involved consumer? How does the consumers increasing desire to interact with both the providers and their provisions affect the various parties involved in that consumers wellness space? Who bears the risk-the doctor, the hospital, or the patient? Patients will likely hold doctors, as experts, accountable. Lets move beyond doctors and patients. What if consumers inappropriately use or modify your products and then hold you responsible for any resulting damage? Increasingly, consumers seem to want power without accountability. They want to choose for themselves but not be liable for the consequences of their choice. Are you as a manager responsible for the product's performance even though you cannot control the consumers usage? How do you protect yourself? Is this risk a new cost of doing business? No matter how the future unfolds in terms of the roles, rights and responsibilities of companies and consumers, companies will have to engage consumers in co-creation of value. Thus we scrutinize consumer-company interactions and amplify the weak signals reverberating in the wellness space, we glimpse the emerging reality of the active involvement of consumers whether as thematic communities or as informed individuals. This fundamentally challenges two deeply embedded, traditional business assumptions: (1) that any given company or industry can create value unilaterally (2) that value resides exclusively in the company's or industry's products and services. Escaping the Past: The Traditional System of Value Creation
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The traditional belief structure that has served business leaders so well for the past hundred years is shown in the figure. The relationships between the rows and the columns in the chart depict the internal consistency of the traditional logic of value creation. Let us start with the premises in the top row of the figure. Traditional business thinking starts with the
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R.A.Podar College Of Commerce And Economics premise that the firm creates value. A firm autonomously determines the value that it will provide through its choice of products and services. Consumers represent demand for the firm's offerings. The implications for business follow from these premises. The firm needs an interface with consumers-an exchange process-to move its goods and services. This firmcustomer interface has long been the locus of the producer's extracting economic value from the consumer. Firms have developed multiple approaches to extracting this value-by increasing the variety of offerings, by efficiently delivering and servicing those offerings, by customizing them for individual consumers, or by wrapping contexts around them and staging the value creation process, as themed restaurants do. These premises and implications manifest themselves in the perspectives and practices of firms in the industrial system. Managers focus on the value chain that captures the flow of products and services through operations that the firm controls or influences. This value chain system essentially represents the linear cost build of products and services. Decisions on what to make, what to buy from suppliers, where to assemble and service products, and a host of other supply and logistics decisions all emanate from this perspective. Employees focus on the quality of the firms products and processes, potentially enhanced through internal disciplines such as Six Sigma and Total Quality Management. Innovation involves technology, products, and processes. Thus, we have a coherent system for value creation. The rows and columns are internally consistent. If the firm creates value, then the value creation process is separate from the market, where various parties simply exchange this value. The importance of efficiently matching supply from the firms value chain with demand from consumers becomes obvious. In fact, matching supply and demand has long been the bedrock of the value creation process. Consider the shifts in thinking identified thus far. Consumers are overwhelmed and dissatisfied by the product variety available today. Armed with new connective tools, consumers want to interact and co-create value, not just with one firm but with whole communities of professionals, service providers, and other consumers. The co-creation experience depends highly on individuals. Each persons uniqueness affects the cocreation process as well as the co-creation experience. A firm cannot create anything of
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R.A.Podar College Of Commerce And Economics value without the engagement of individuals. Co-creation supplants the exchange process. The New Frame of Reference for value Creation What might a new, internally consistent system based on co-creation of value look like? We present such a system in figure.
The new starting premise is that the consumer and the firm co-create value, and so the co-creation experience becomes the very basis of value. The value creation process centers on individuals and their co- creation experiences. New premises inevitably lead to new implications for business. The interaction between consumers and firms becomes the new locus of co-creation of value. Since millions of consumers will undoubtedly seek different interactions, the value creation process must accommodate a variety of co-creation experiences. Context and consumer
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R.A.Podar College Of Commerce And Economics involvement contribute to the meaning of a given experience to the individual and to the uniqueness of the value co-created. These premises and implications suggest new capabilities for firms. Managers must attend to the quality of co-creation experiences, not just to the quality of the firms products and processes. Quality depends on the infrastructure for interaction between companies and consumers, oriented around the capacity to create a variety of experiences. The firm must efficiently innovate experience environments that enable a diversity of co-creation experiences. It must build a flexible "experience network" that allows individuals to co-construct and personalize their experiences. Eventually, the roles of the company and the consumer converge toward a unique co-creation experience, or an "experience of one." Notice what co-creation is not. It is neither the transfer nor out-sourcing of activities to customers nor a marginal customization of products and services. Nor is it a scripting or staging of customer events around the firms various offerings. That kind of company-customer interaction no longer satisfies most consumers today. The change that we are describing is far more fundamental. It involves the cocreation of value through personalized interactions that are meaningful and sensitive to a specific consumer. The co-creation experience (not the offering) is the basis of unique value for each individual. The market begins to resemble a forum organized around individuals and their co-creation experiences rather than around passive pockets of demand for the firms offerings.
CO-CREATION The co-creation process, demanding as it is, raises important questions for managers: In-depth dialogue with customers is very time-intensive. What if my firm has a million consumers-or ten million? My staff can barely keep up with current
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R.A.Podar College Of Commerce And Economics interactions with customers, suppliers, and each other. How can my firm interact so intensely with each consumer and maintain operational efficiency? Co-creation allows for an unusual degree of customer input into product design. How do I maintain consistently high standards of product quality and cede some control over design? Transparency allows customers to interact with my firm in potentially intrusive ways. How much access up and down the supply chain do I allow customers? Individual consumers are at the very heart of the co-creation experience. How do I deal with the heterogeneous demands of my customer base? Discussing options openly gives customers a degree of control over the risks that they assume-but not necessarily the liabilities. Where do I draw the line on acceptable risks- and where do my legal responsibilities begin and end? Co-creation moves the firm toward an individual-centered view of demand. How does demand forecasting work under such unpredictable circumstances? These difficult questions breach the very meaning of value and the process by which a firm co-creates value. We will explore how that meaning and that process are evolving, and we will consider possible answers for the important questions that manager must confront. The Building Blocks of Co-Creation The company needs to concentrate on the total co-creation experience, as well as the process of co-creation through its key building blocks: dialogue, access, risk assessment, and transparency, which we will refer to by the acronym DART. 1. Dialogue Dialogue means interactivity, deep engagement, and a propensity to act-on both sides. Dialogue is more than listening to customers: It entails empathic understanding built around experiencing what consumers experience, and recognizing the emotional, social,
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R.A.Podar College Of Commerce And Economics and cultural context of experiences. It implies shared learning and communication between two equal problem solvers. Dialogue creates and maintains a loyal community. The dialogue involved in co-creation has several specific features: It focuses on issues that interest both the consumer and the firm. It requires a forum in which dialogue can occur. It also requires rules of engagement (explicit or implicit) that make for an orderly, productive interaction. 2. Access The traditional focus of the firm and its value chain was to create and transfer ownership of products to consumers. Increasingly, the goal of consumers is access to desirable experiences-not necessarily ownership of the product. One need not own something to access an experience. We must uncouple the notion of access from ownership. Access begins with information and tools. Access can also involve on-demand resources such as computing. Consumers may also want access to a lifestyle. Access can also transform the capacity for self expression. 3. Risk Assessment Risk here refers to the probability of harm to the consumer. Managers have traditionally assumed that firms can better assess and manage risk than consumers can. Therefore, when communicating with consumers, marketers have focused almost entirely on articulating benefits, largely ignoring risks. Today, however, there is a growing debate about risk and the trade-off between risks and benefits-a debate that the move to co-creation will intensify. Can firms unilaterally manage risks in an environment of co-creation? On the other hand, if consumers are active co-creators, should they shoulder responsibility for risks as well? The debate about informed consent and the responsibilities of companies and consumers will likely continue for years. However, we can safely assume that consumers will increasingly participate in co-creation of value. They will not cede their right to choose. However, they will insist that businesses inform them fully about risks, providing not jus data but appropriate methodologies for assessing the personal and societal risk associated with products and services.
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R.A.Podar College Of Commerce And Economics 4. Transparency Companies have traditionally benefited from information asymmentry between the consuerm and the firm. That asymmetry is rapidly disappearing. Firms can no longer assumer opaqueness of prices, costs and profit margins. And as information about products, technologies and business systems become more accessible, creating new levels of transparency becomes increasingly desirable. Combining the building blocks of DART enables companies to better engage customers as collaborators. Transparency facilitates collaborative dialogue with consumers. Constant experimentation coupled with access and risk assessment on both sides can lead to new business models and functionalities designed to enable compelling co-creation experiences. Although many firms and industries are experimenting with these elements and the evidence of the changing nature of value creation accumulates, many companies are unable to embrace the new framework of co-creation. Why? A large part of the answer is that co-creation fundamentally challenges the traditional roles of the firm and the consumer. The tension manifests itself at points of interaction between the consumer and the company-where the co-creation experience occurs, where individuals exercise choice, and where value is co-created. Points of interaction provide opportunities for collaboration and negotiation, explicit or implicit, between the consumer and the company-as well as opportunities for those processes to break down.
THE CO-CREATION EXPERIENCE We have seen many companies have begun to experiment with co-creation of value. Still, most managers are reluctant to let go of familiar practices and tools-their comfort zone. The result is an emerging tension between the traditional company think and the
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R.A.Podar College Of Commerce And Economics emerging consumer think around the issue of whether the firm can unilaterally control the choice of experience in the co-creation process. The answer is no. Company Think Versus Consumer Think Like all humans, business managers are socialized into a dominant logic- shaped by the attitudes, behaviors, and assumptions that they learn in their business environments. Unfortunately, most managers seem to forget that they are also consumers. Their thinking is conditioned by managerial routines, systems, processes, budgets, and incentives created under the traditional framework of value creation. They focus on technology road maps, plant scheduling, product quality, cost reduction, cycle time, and efficiency. Unsurprisingly, opportunities for interaction with consumers are approached in a similar fashion. Simply understanding the framework of co-creation will not suffice. We must explicitly recognize how deeply etched ways of thinking limit our ability to shift into cocreation mode. We must understand the differences between "company think" and "consumer think" that will drive successes in the twenty-first century. The disconnect between consumer think and company think is not new. However, as we move toward co-creation, this disconnect becomes more pronounced at points of consumer-company interaction, where choice is exercised and the consumer interacts with the firm to co-create an experience. Most managers implicitly assume that their physical product-the digital camera-is the vessel of value. They rarely consider the aspirations, frustrations, and wishes of the heterogeneous group of consumers who experience their product or service. Instead, they focus on the efficiency of production and logistical systems or on advanced technology for its own sake. Misled by company think, they clutter the marketplace with products that are feature rich but experience poor. For the consumer; "technology convergence" can create "experience divergence." The continued dominance of company think explains why technological change is creating more variety in devices, features, and formats than ever before-and more confusion, doubt, and anxiety. Depending upon the consumer's level of competence and sophistication, and her tolerance for irritants, her reaction will range from mild annoyance ill deep cynicism and anger.
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R.A.Podar College Of Commerce And Economics The tensions at the points of interaction result from the disconnect between company think and consumer think. So how can we connect the two? Dimensions of Choice in Consumer-Company Interaction As we have seen, dialogue, access, risk assessment, and transparency- DART-form the foundation for co-creation of value. But these factors alone may not produce compelling experiences in co-creation. We also must attend to the dimensions of choice in consumer-company interaction that condition the co-creation experience. We have identified four such dimensions: Consumers want the freedom of choice to interact with the firm through a range of experience gateways. Therefore, the firm mm: focus on the cocreation experience across multiple channels. Consumers want to define choices in a manner that reflects their view of value. Therefore, the firm must provide experience-centric options that reflect consumer desires. Consumers want to interact and transact in their preferred language and style. They want quick, easy, convenient, and safe access to experiences. Therefore, in consummating individual choices, the firm must also focus on the cocreation experience through transactions. Consumers want to associate choice with the experiences they are willing to pay for. They want the price of thee experiences to be fair. Therefore, the firm must focus on the totality of the price-experience relationship in co-creation. Traditional Exchange Versus Co-Creation Experiences We have identified the basic building blocks of co-creation-dialogue, access, risk assessment, and transparency (DART)-as well as the dimensions of choice in consumercompany interaction that determine the quality of co-creation experiences as seen from the consumer's perspective-experiences across multiple channels and options, transactions experiences, and a compelling price-experience relationship. In the process,
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R.A.Podar College Of Commerce And Economics we have identified the quality of interaction between the consumer and the firm as the critical link in the future of competition. The emerging reality differs dramatically from the traditional approach to the firm-customer interaction. The differences are summarized in table below. Note that: In the traditional approach, the goal of the interaction is value extraction. This occurs in the exchange process, which is the primary source of contact between the firm and the customer. By contrast, in the co-creation approach, the goal of the interaction is twofold: value creation as well as value extraction; In the traditional approach, the locus of interaction is at the end of the value chain activities. In the co-creation approach, interactions can take place repeatedly, anywhere, and anytime in the system; And most important, in the traditional approach, the notion of quality is based on what the firm has to offer. In co-creation, it is about consumers co-constructing their own experiences. Goal of Interaction Traditional Exchange Co-Creating Experience Extraction of economic Co-creation of value through value compelling experiences, extraction Locus of Interaction Company-Consumer Relationship as of co-creation well as economic
value Once at the end of the value Repeatedly, anywhere and chain Transaction-based anytime in the system Set of interactions series of and
transactions focused on a co-creation experience experiences Variety of products and Co-creation services, features functionalities,
View of Choice
and based on interactions across product multiple channels, options,
performance and operating transactions, and the pricePattern of procedures experience relationship Interaction Passive, firm-initiated, one- Active, initiated by either
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R.A.Podar College Of Commerce And Economics Between Company and on-one Quality processes, offerings of and company or consumer, oneon-one-to-many internal Quality of consumercompany company interactions and co-creation experiences
Consumer Focus of Quality
The dimensions of choice in co-creation experiences suggest the potential richness of the relationship through the quality of interactions between companies and consumers. Business managers can compete in myriad ways by discovering new opportunities through an individual-centric lens of choice in consumer-company interactions, and carefully managing the quality of co-creation experiences. The possibilities are endless, particularly if we gravitate toward innovating "experience environments" that accommodate heterogeneous consumers who seek to interact in a multitude of ways.
INNOVATION Experience environments are characterized by robustness, the capacity to accommodate a wide range of context-specific experiences of heterogeneous individuals. An experience environment facilitates a total experience for consumers. It includes products and services as well as various interfaces for individual interactions with the company, including multiple channels, modalities, employees and communities. Since value increasingly lies in the co-creation experience, then business leaders must shift focus of innovation away from products and services and toward robust experience environments capable of facilitating compelling co-creation experiences. The specific experience outcomes, by definition, cannot be detailed a priori. The focus on innovating experience environemtnts, therefore, differs from the traditional focus on innovating products and services. The experience environments must: Offer opportunites for consumers to co-construct their own experiences on demand, in specific context of space and time; Accommodate a heterogeneous group of consumers, from the very sophisticates and active to the very sophisticated and passive; Analysis of Turbulent Market Environments 66
R.A.Podar College Of Commerce And Economics Recognize that every consumer (including the active, smart consumer) does not always want to c-create; sometimes they just want to consume passively; Facilitates new ooprtunities afforded by the evolution of emerging technologies; Accommodate the involvement of consumer communities; Engage the consumer emotionally and intellectually; and Explicitly recognize both the social and the technical aspects of co-creation experiences. The New Frontier Experience innovation is a new frontier in co-creation, one that requires a seamless integration of imagination, consumer insights and advanced technology. The challenge of experience innovation is to combine the building blocks of DART with the dimensions of choice in co-creation experiences (the quality of co-creation experiences across multiple channels and options, the quality of the transaction experience, and the perceived totality of the price-experience relationship) and the levers for experience innovation (granularity, extensibility, linkage and evolvability) to create a rich new experience space for co-creation. Migrating to Experience Innovation The transition for most firms is from product/service based, fimr centric view of innovation to an experience-centric, co-creation view of innovation. The distinctions between the traditional and new perspective of innovation are summarized in the following table Table Migrating to Experience Innovation Innovation Goal Basis of Value View of Value Creation Traditional Innovation Experience Innovation Products and processes Experience environments Product and service Co-creation experiences offerings Firm creates value; supply Value is co-created; co-
push and demand pull for individual-centric Focus of Development View of technology
firms offerings creation of value Cost, quality, speed and Granularity, extensibility, modularity Features and linkage and evolvability functions; Enablers of experiences;
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R.A.Podar College Of Commerce And Economics technology Focus of infrastructure and systems experience integration Support co-construction of personalized experiences As managers, we tend to think in terms of opposites-quality versus cost, variety versus mass manufacturing, efficiency versus innovation. Such polarization often misstates reality. A deep commitment to quality can lead to dramatic cost reductions. Mass customization combines variety with large scale manufacturing. In the same way, efficiency and experience innovation must go together. We can state three simple propositions: 1. Discontinuities are destroying established industry and technology boudries, thereby increasing the demand for experimentation. 2. Co-creation of value demands de-risking experimentation. This demands efficiency in how we leverage resources, experiment in the marketplace, and shape consumer expectations and evolving needs. 3. All experiments may not succeed. When some do, we should be able to scale and expand the size of the market. That means creating systemwise efficiencies in activities, whether in manufacturing, logistics, channels, customer service, branding or community management. We call this approach efficient experience innovation. PERSONILATION If every individual is unique, how do we innovate experience environments that allow for co-creating unique value for each individual? Dimensions of personalized experience 1. Events. Events form the basis for experiences. An event is a change of state in space and time that affects one or more individuals. 2. Context of Events. Context in space and time is an inherent part of any event and thereby experience. If an event is about what happened, then context is about Analysis of Turbulent Market Environments 68
integration Support fulfillment
R.A.Podar College Of Commerce And Economics when it happened (time) and where it happened (space). These dimensions factor into the meaning ascribed to the experience. 3. Individual Involvement. Individual involvement in events may take many forms, based on interactions among the individual and various products, channels, services and company employees, as well as with other individuals in various thematic communities of interest. 4. Derivation of Personal Meaning. Personal meaning is about the relevance of an event to the individual and the knowledge, insights, enjoyment, satisfaction and excitement that emanate from it. Different individuals want different levels of involvement, levels that affect the meaning assigned to the event by each consumer. The four dimensions just described put the individual at the heat of a co-creation experience. This view suggests that firms can no longer dictate individual experience outcomes. The challenge is to allow a high degree of personalization of interactions with an experience environment as well as to accommodate heterogeneous consumer interests, knowledge, needs and desires. Migrating to Experience Personalization Business must now contend with heterogeneity (defined by interaction) that is more complex and subtle than an array of traditional market segments. Segment-of-one thinking takes us only part of the way. When managers talk about segmentation of one, they see the consumer as a marketing target. We sell to this single customer. We expect him to learn our systems. We may allow him to configure the product from out menu or offer him special discounts. But what we dont do is actively engage the consumer in cocreation. Instead, we tend to fight against co-creation. Table Migrating to Experience Personalization View of Customization Focus of Customization Traditional Customization Experience Customization Segment of one Experience of one One-off products and Personalization of services interactions with the experience environment Analysis of Turbulent Market Environments 69
R.A.Podar College Of Commerce And Economics Approach to Customization Feature menus, Events, context of events, individual involvement and
components, costs, speed View of Supply Chain
personal meaning Fulfillment of a variety of Facilitating a variety of customized products and personalized services through modularity through experiences heterogeneous
Focus of infrastructure
Configuration fulfillment services build-to-order processes
interactions and Infrastructure to support an for experience network
Starting from a traditional firm centric view of value creation, managers focus on providing products and services to a single customer at low sot. This process leads to mass customization, which combines benefits of mass (large scale production and marketing and therefore low cost) with those of customization (targeting a single customer). The focus on product feature development leads to increased product choice for consumers. Personalizing the co-creation experience means fostering individualized experiences. A personalized co-creation experience reflects how the individual chooses to interact with the experience environment that the firm facilitates. We are suggesting a totally different process-one that involves individual consumers in personalized cocreation experiences-a broad challenge that business leaders must face.
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R.A.

Podar College Of Commerce And Economics EXECUTIVE SUMMARY