Confirming Pages

2
Part
Markets,
Segments, and
Customer Value

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2
Chapter

Markets and
Competitive Space
Markets are increasingly complex, turbulent, and interrelated, creating challenges for
managers in understanding market structure and identifying opportunities for growth. The
traditional view assumes that the market and competitive space are stable and changes
are predictable. Importantly, this perspective may be misleading and even dangerous
when market boundaries reconfigure because of new technologies and competition and
the emergence of new business designs (such as Google, Inc., the world’s leading Inter-
net search engine). Sustaining and building competitive advantage increasingly requires
altered strategic thinking about market boundaries and structure. Rapid technological
change, market convergence, Internet access, global competition, and the diversity of buy-
ers’ preferences in many markets require continuous monitoring to identify promising
business opportunities, assess the shifting requirements of buyers, evaluate changes in
competitive positioning, and guide managers’ decisions about which buyers to target and
how to position brands to appeal to targeted buyers. A complete view of the market is
important, even when management’s interest centers on one or a few market segments
within a particular market. Understanding the scope and structure of the entire market
is necessary to develop strategy and anticipate market changes and competitive threats.
Understanding markets and how they are likely to change in the future are vital inputs to
market-driven strategies.
Illustrative of the challenges of transformation in markets and competitive space are
Eastman Kodak’s delayed responses to the potential disruptive impact of digital photog-
raphy on traditional film and camera markets. The pervasive impact of digital imaging
technology demanded a rapid change in Kodak’s business design and understanding of
the market.1 Kodak’s revenues from its traditional products and services declined from
$10 billion in 2001 to an estimated $5 billion in 2007, when total revenues were expected
to exceed $10 billion. The consequences of Kodak’s delayed responses to the changing
markets include major financial losses, extensive layoffs, expensive plant closures, and
escalating debt. Kodak’s prior management (new CEO in June 2005) had underestimated
the speed and rate of decline of purchases in film markets around the world. The 25 percent
annual declines in Kodak’s film sales were more than three times greater than estimated
by management. While Kodak holds a strong position in the U.S. digital camera market,
adding to the firm’s financial problems are the very small margins on digital cameras.
Management decided to stop building digital market share in late 2006 at the expense

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Chapter 2 Markets and Competitive Space 49

of profitability and halted production of digital cameras, outsourcing manufacturing to a

Singapore-based supplier. The company was expected to reach breakeven on digital camera
sales at the end of 2006.
Kodak’s competitive threats are not unique. Leica, the luxury traditional camera pro-
ducer, was close to collapse in 2005 but management forecast better performance in 2006
with the introduction of its M8 digital rangefinder model. Many companies and industries
are experiencing major changes in their core markets. Strategic thinking in changing mar-
kets confronts executives with complex challenges but also exciting opportunities. These
new challenges are driven by demanding customers with changing value requirements,
aggressive global competition, market turbulence, rapid emergence of new and increasingly
turbulent technologies, and the escalating globalization initiatives of many companies.
The Kodak illustration highlights several important issues concerning markets and
competitive space. The changes described show how competitive threats may develop from
new competition (electronics firms). Importantly, the rapid growth of digital photography
points to the importance of market sensing and strategic vision in assessing the nature and
scope of new competitive threats and guiding strategic initiatives to counter the threats.
The chapter begins with a discussion of how markets and strategies are interrelated,
followed by an approach to determining product-market scope and structure. Next, we
look at how buyers are described and analyzed, and examine the important process of
competitor analysis. Guidelines follow for developing a strategic vision about the scope
and composition of markets in the future. Finally, we consider how to estimate market size.
Financial Analysis guidelines are included in the Appendix.

Markets and Strategies

Knowledge about markets and competitive space is essential in guiding business and mar-
keting strategies. First, we look at how markets impact strategy and discuss the importance
of thinking outside the competitive box. Next, we examine several forces that are creating
changes in market boundaries and structure, and consider the need to define markets in
terms of buyers’ needs and product benefits.

Markets and Strategies Are Interlinked

Market changes often require altering business and marketing strategies. Managers who do
not understand their markets and how they will change in the future may find their strate-
gies inadequate as buyers’ value requirements change and new products become avail-
able which better satisfy buyers’ requirements. Many forces are causing the transformation
of industries and are changing the structure of markets and nature of competition. These
influences create both market opportunities and threats by altering the nature and scope of
products, markets, and competitive space. Market-driven companies proactively alter their
strategies to deliver superior value to existing and new customers. For example, PepsiCo
shows impressive performance in understanding and catering to changing tastes in the bev-
erage and snacks market, rather than trying to change them.2 The company faces the facts
about market change and adapts products to them. To capitalize on the growing market for
New Age herbally enhanced beverages, PepsiCo acquired SoBe Beverages in 2001, and
extended the brand into an energy drink for the school age market—SoBe No Fear—and
SoBe Fuerte, aimed at the Hispanic market. Sabritas chips were brought in from PepsiCo’s
Mexican subsidiary targeting the foreign-born segment of the large and escalating U.S.
Hispanic market. PepsiCo defines its mission as serving the consumer, not protecting its
existing brands.

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50 Part Two Markets, Segments, and Customer Value

Thinking Outside the Competitive Box3

Not surprisingly there is a tendency for executives to think in terms of a stable “competitive
box” around their businesses—defined by technology, geography, competitors, and the
existing customer base. This frame of reference enables analytical tools to be success-
fully applied, research to be carried out, and plans to be made. This traditional perspec-
tive is logical in stable markets but fails to address the reality that the real threats as well
as exciting opportunities may be present outside the conventional competitive box shown
in Exhibit 2.1. Increasingly, new markets, new types of competition, and new business
designs are emerging which fuel market growth and cannibalize the existing customer base
of incumbents’ markets. Importantly, effective processes for understanding markets and
competitive space and guiding the strategic initiatives appropriate for the markets require
strategic thinking outside the competitive box.

An Array of Challenges
Changes in markets are drastically altering opportunities and competitive space and
increasing the importance of strategic thinking in these changing markets. Disruptive inno-
vation, commoditization of product designs, creation of new market space, and fast chang-
ing markets are challenges that underline the need to identify changes in the market(s) and
diagnose the strategic implications of the changes.

Disruptive Innovation
These innovations provide simpler and less costly ways to match the value requirements
offered by the products (goods and services) of incumbent firms serving the market.4 Exam-
ples of disruptive innovations and new business models are illustrated by Amazon.com on
traditional bookstores, digital photography on cameras and film, and steel mini-mills on
integrated mills. The opportunity for market access by disruptive innovations is created by
the products of incumbent firms in the market which are exceeding the value requirements
of buyers. Disruptive innovations may meet the needs of new segments or entire markets.

EXHIBIT 2.1 The Competitive Box

Opportunities
Outside the
Competitive Box

New Types New

Traditional
of Business
Competitors
Competition Models

New New
Customers Customers
Conventional Value
Propositions

Existing
Customer
Base

New
Customer
Base(s)

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Strategy Feature Google’s Disruptive Impact

Google is renowned as the leading Internet search engine. Established in 1998, Google was
valued at $23 billion when it was floated on the stock market in 2004, and made annual profits
of nearly $3 billion in 2006. The company’s strategy initiatives reveal ambitions beyond search:
• Initial income was from search-related advertising—
Google had online advertising income of $11
billion in 2007.
• The company’s strategy is expressed as “100 per-
cent relevant beyond search,” indicating its inten-
tion to leverage capabilities in areas other than
simply Web searching.
• Google is targeting the global advertising industry—
online and off-line. Recent developments include a
move into video (through the purchase of YouTube
as an outlet for video advertising); audio (by the
acquisition of dMarc, an automated network sell-
ing radio advertising, and a deal with ClearChan-
nel, the world’s largest radio company); and print
(with an agreement to sell advertising on behalf of
66 U.S. newspapers).
• Google is partnering with media companies to sup-
ply video content to affiliated websites—including
MTV. It has formed an alliance with News Corpora-
tion’s MySpace to access social networking.
• Google is now positioning itself as a rival to Microsoft—Google Apps allows users to off-
load their e-mail systems to Google, while keeping their own e-mail addresses, as well as
providing an online office productivity suite to compete directly with Microsoft’s Office
package. Google offers a free e-mail service—Gmail—challenging Microsoft’s Hotmail;
Picasa to allow online photo storage; Google Earth and Google Maps; free Web publish-
ing; and is working on computer security products.
• Plans for e-book digitization—scanning books and making them online searchable—aims
to do the same for books as the iPod did for music.
• Google’s mission is to “organize the world’s information” and not simply to personalize
advertising, but to organize people’s daily lives.
Sources: Tony Allen-Mills, “Search Me?,” The Sunday Times, May 27, 2007, 1–13; Robert D. Hof, “Google
Steps into Microsoft’s Office,” BusinessWeek, February 12, 2007, 62–64; Richard Waters, “Act Two: How
Google Is Muscling Its Way into the Advertising Mainstream,” Financial Times, January 19, 2007, 13; Richard
Waters, “All Eyes on Google Advertising,” Financial Times, April 17, 2007, 22.

Disruptive innovations may impact various technologies and industries. Indications of

these new threats to existing firms can often be identified through perceptive market sens-
ing outside the competitive box. Complacency and management’s hesitancy to consider
options beyond the core business focus are potential problems. When indications are found
that markets are changing, strategic thinking initiatives need to be pursued. The strategic
development of Google is illustrative of the disruptive changes that can be created by an
able competitor. This is described in the STRATEGY FEATURE.
Commoditization Threats
When modularization (products comprised of standardized components) occurs prod-
ucts become commodities, making it difficult to earn anything more than subsistence
returns.5 For example, when the personal computer (PC) market became commoditized the
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52 Part Two Markets, Segments, and Customer Value

opportunity for profits shifted to microprocessors (Intel) and operating system software
(Microsoft). Commoditization was a key factor for IBM’s management in deciding to move
out of the PC market. The business was sold to Lenovo, the leading Chinese PC company.
The potential effect of commoditization in markets highlights the importance of devel-
oping a vision about how the market is likely to change in the future, and deciding what
business strategy initiatives to pursue. Strategies to overcome commoditization threats may
involve competing at a different stage in the value chain or moving into a different product
category that provides attractive growth and profit opportunities.
Creating New Market Space
Kim and Mauborgne offer an interesting and relevant perspective on how companies can
create new market space.6 These actions require finding and pursuing opportunities to offer
potential buyers value in markets and segments that are not being served. The purpose
is to target new opportunities where buyers’ value requirements are not being satisfied
by existing products. For example, unit sales of camera phones were estimated to exceed
400 million units in 2006, over four times digital camera sales.7 Cell phone users have
access to digital photography because the camera is subsidized by wireless carriers. This
creates new market space and new uses by digital camera users. Creating new market space
requires changing management’s traditional strategic perspective of looking for market
opportunities inside the Competitive Box.
Fast Changing Markets
Increasingly, fewer markets are stable, and instead, many are changing rapidly. Fast chang-
ing markets require modifications in management’s strategic thinking. Indications of
changes are signaled by shifting customer value requirements, new technologies, changes
in competitive space, and new business models. Fast changing markets may sometimes
be difficult to predict and strategy initiatives may necessitate trial and error adjustments
guided by market responses. Not acknowledging or responding to the threats and require-
ments of fast changing markets is the real danger. Importantly, even in markets assumed to
be comparatively stable, innovation can quickly alter market space.

Matching Needs with Product Benefits

The term product-market recognizes that a market exists only when there are buyers with
needs who have the ability to purchase goods and services and products are available to
satisfy the needs. There is a compelling logic that competitive strength comes from putting
customer needs at the center of a company’s operations; that this perspective should guide
strategic thinking for markets. For example, Progressive Insurance shows remarkable sales
growth and shareholder value creation by its focus on the most important needs of its cus-
tomers. The INNOVATION FEATURE describes how the company has adapted its opera-
tions to effectively meet customer needs.
Markets are comprised of groups of people who have the ability and willingness to buy
something because they have a need (value requirement) for it.8 The ability to buy and
willingness to buy indicate that there is demand for a particular product. People with needs
and wants buy the benefits provided by a good or service to satisfy either a household
or organizational use situation. A product-market matches people with needs—needs that
lead to a demand for a good or service—to the product benefits that satisfy those needs.
Thus, a product-market combines the benefits of a product with the needs that motivate
people to express a demand for that product.
Accordingly, markets are defined in terms of needs substitutability among different
products and brands and by the different ways in which people choose to satisfy their

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Innovation Feature Progressive Insurance: Customer

Needs at the Center of Strategy

• In the period 1994 to 2004, Progressive Insurance increased sales from $1.3 billion to
$9.5 billion, and ranks high in the BusinessWeek Top 50 U.S. companies for shareholder
value creation.
• The company invents new ways of providing services to save customers time, money,
and irritation, while often lowering costs at the same time.
• Loss adjusters are sent to the road accidents rather than working at the head office, and
they have the power to write checks on the spot.
• Progressive reduced the time needed to see a damaged automobile from seven days to
nine hours.
• Policyholders’ cars are repaired quicker, and the focus on this central customer need has
won much auto insurance business for Progressive.
• These initiatives also enable Progressive to reduce its own costs—the cost of storing a dam-
aged automobile for a day is $28, about the same as the profit from a six-month policy.
Source: Adapted from Adrian Mitchell, “Heart of the Matter,” The Marketer, June 12, 2004, 14.

needs. “A product-market is the set of products judged to be substitutes within those usage
situations in which similar patterns of benefits are sought by groups of customers.”9 The
influence of competing brands becomes stronger the closer the substitutability and the
more direct the competition. The Ford Taurus competes directly with the Toyota Camry,
whereas in a less direct yet relevant way, other major purchases (e.g., vacation travel) com-
pete with automobile expenditures due to the buyer’s budget constraints.
As an example, a financial services product-market for short-term investments may
include money market accounts, mutual funds, U.S. Treasury bills, bank certificates of
deposit, and other short-term investment alternatives. If one type of product is a substitute
for another, then both should be included in the product-market.
By determining how a firm’s specific product or brand is positioned within the product-
market, management can monitor and evaluate changes in the product-market to decide
whether alternate targeting and positioning strategies and product offerings are needed. When
defining a product-market, it is essential to establish boundaries that are broad enough to con-
tain all of the relevant product categories which are competing for the same buyer needs.

Defining and Analyzing Product-Markets

In the remainder of the chapter we discuss the activities involved in defining and analyzing
product-markets. The steps are shown in Exhibit 2.2, beginning with determining product-
market boundaries and structure.
Determining Product-Market Boundaries and Structure
Product-market boundaries and structure provide managers with important information for
developing business and marketing strategies, and alert management to new competition.
Considering only a company’s brands and the direct competitors may mask potential com-
petitive threats or opportunities.
Product-Market Structure
A company’s brand competes with other companies’ brands in generic, product-type, and
product-variant product-markets. The generic product-market includes a broad group of
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54 Part Two Markets, Segments, and Customer Value

EXHIBIT 2.2 Determine the Boundaries

Defining and and Structure of the
Product-Market
Analyzing
Product-Markets

Form the
Product-Market

Describe and
Analyze End Users

Analyze
Competition

Forecast
Market Size and
Rate of Change

products that satisfy a general, yet similar, need. For example, several classes or types of
products can be combined to form the generic product-market for kitchen appliances. The
starting point in determining product-market boundaries is to identify the particular need
or want that a group of products satisfies, such as performing kitchen functions. Since
people with a similar need may not satisfy the need in the same manner, generic product-
markets are often heterogeneous, containing different end-user groups and several types of
related products (e.g., kitchen appliances).
The product-type product-market includes all brands of a particular product type,
such as ovens for use in food preparation by consumers. The product type is a product
category or product classification that offers a specific set of benefits intended to satisfy
a customer’s need or want in a specific way. Differences in the products within a product-
type product-market may exist, creating product-variants.10 For example, electric, gas,
and microwave ovens all provide heating functions but employ different technologies.
Guidelines for Definition
In defining the product-market, it is helpful to indicate (1) the basis for identifying buyers
in the product-market of interest (geographical area, consumer/business, etc.); (2) the mar-
ket size and characteristics; and (3) the brand and/or product categories competing for the
needs and wants of the buyers included in the product-market.
The composition of a product-market can be determined by following the steps shown
in Exhibit 2.3. We illustrate how this process can be used to determine the composition of
the kitchen appliance product-market. Suppose top management of a kitchen appliance
firm is considering expanding its mix of products. The company’s present line of laun-
dry and dishwashing products meets a generic need for the kitchen functions of cleaning.
Other kitchen use situations include heating and cooling of foods. In this example the
generic need is performing various kitchen functions. The products that provide kitchen
functions are ways of satisfying the generic need. The break out of products into specific
product-markets (e.g., A, B, C, and D) would include equipment for washing and drying

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Chapter 2 Markets and Competitive Space 55

EXHIBIT 2.3 Start with the generic need satisfied by

Determining the the product category of interest to
management
Composition of a
Product-Market

Identify the product categories (types)

that can satisfy the generic need

Identify the specific product-markets

within the generic product-market

A B C D

clothing, appliances for cooling food, cooking appliances, and dishwashers. The buyers in
various specific product-markets and the different brands competing in these product-markets
can be identified and analyzed. The process of mapping the product-market structure begins
by identifying the generic need (function) satisfied by the product of interest to management.
Need identification is the basis for selecting the products that fit into the product market.
An example of the product-market structure to meet people’s needs for food is shown in
Exhibit 2.4. A fast-food restaurant chain such as McDonald’s should consider more than its
regular customers and direct competitors in its market opportunity analysis. The consumption
need being satisfied is fast and convenient preparation of food. The buyer has several ways of
meeting the need such as purchasing fast foods, preparing food in the microwave in the home,
patronizing supermarket delis, buying prepared foods in convenience stores, and ordering
take outs from traditional restaurants. The relevant competitive space includes all of these
fast-food sources. It is essential to analyze market behavior and trends in the product-markets
shown in Exhibit 2.4, since competition may come from any of the alternative services.

Forming Product-Markets
The factors that influence how product-market boundaries should be determined include
the purpose for analyzing the product-market, the rate of changes in market composition
over time, and the extent of market complexity.
Purpose of Analysis
If management is deciding whether or not to exit from a business, primary emphasis may
be on financial performance and competitive position. Detailed analysis of the product-
market may not be necessary. In contrast, if the objective is finding one or more attractive

EXHIBIT 2.4
Illustrative Fast-Food
Microwave
Product-Market Supermarkets
ovens
Structure
Fast foods

Convenience Traditional
stores restaurants

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56 Part Two Markets, Segments, and Customer Value

market segments to target in the product-market, a much more penetrating analysis is

necessary. When different products satisfy the same need, the product-market boundaries
should contain all relevant products and brands. For example, the photography product-
market should include digital cameras, related equipment and services, and conventional
cameras, film, and services. Product-market boundaries should be determined in a manner
that will facilitate strategic thinking, enabling management to capitalize on existing and
potential opportunities and to avoid possible threats.

Changing Composition of Markets

As discussed earlier product-markets may change as new technologies become available
and new competition emerges. New technologies offer buyers different ways of meeting
their needs. For example, fax technology gave people in need of overnight letter delivery
an alternative way to transmit the information. The entry into the market by new competi-
tors also alters competitive space.
Industry classifications often do not clearly define product-market boundaries. For
example, people may meet their needs for food with products from several industries as
shown in Exhibit 2.4. Industry-based definitions do not consider alternative ways of meet-
ing needs. Industry classifications typically have a product supply rather than a customer
demand orientation. Of course, since industry associations, trade publications, and govern-
ment agencies generate a lot of information about products and markets, information from
these sources should be included in market analysis. However, market analysis activities
should not be constrained by industry boundaries.

Extent of Market Complexity

Three characteristics of markets capture a large portion of the variation in their complexity:
(1) the functions or uses of the product needed by the customer, (2) the technology used in
the product to provide the desired function, and (3) the different customer segments using
the product to perform a particular function.11
Customer function considers the role or purpose of the good or service. It is the value
provided to the customer. Thus, the function provides the capability to satisfy the value
requirements of the customer. In the case of the personal computer, the function performed
may be entertainment for the household, information search, Internet purchasing, or the
performance of various business functions.
Different technologies may satisfy the use situation of the customer. Steel and alumi-
num materials meet a similar need in various use situations. The technology consists of
the materials and designs incorporated into products. In the case of a service, technology
relates to how the service is rendered. For example, voice calls can be sent via the Internet,
traditional phone lines, and wireless phones.
Customer segment recognizes the diversity of the needs of customers in a particular
product-market such as automobiles. A specific brand and model won’t satisfy all buy-
ers’ needs and wants. Two broad market segments for automobile use are households and
organizations. These classifications can be further divided into more specific customer seg-
ments, such as preferences for European-style luxury sedans, sport utility vehicles, and
sports cars.
It is important to focus on the consumer (or organizational) end-user of the product
when defining the market, since the end-user drives demand for the product. When the
end-users’ needs and wants change, the market changes. Even though a producer con-
siders the distributor to which its products are sold to be the customer, the market is
really defined by the consumer and organizational end-users who purchase the product for
consumption.

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Chapter 2 Markets and Competitive Space 57

Illustrative Product-Market Structure

Suppose you are a brand manager for a cereal producer. You know that brands like Life,
Product 19, and Special K compete for sales to people that want nutritional benefits from
cereal. Nonetheless, our earlier discussion highlights the value of considering a more com-
plete picture of how competing brands like Life, Product 19, and Special K also may expe-
rience competition from other ways of meeting the needs satisfied by these brands. For
example, a person may decide to eat a Kellogg’s Nutri-Grain cereal bar instead of a bowl of
cereal, and the consumer may want to vary the type of cereal, eating a natural or regular type
of cereal. Because of the different product types and variants competing for the same needs
and wants, the cereal brand manager should develop a picture of the product-market structure
within which her/his brand is positioned. Exhibit 2.5 provides an illustrative product-market
structure for cereals. The diagram can be expanded to portray other relevant product types
(e.g., breakfast bars) in the generic product-market for food and beverages.

Describing and Analyzing End-Users

After determining the product-market structure it is useful to develop profiles of end-user
buyers for the generic, product-type, and product-variant levels of the product-market

EXHIBIT 2.5
Illustrative Product-
Food and beverages Generic product
Market Structure
for breakfast meal class

Cereals Product type

Ready to eat Variant A

Natural Nutritional Presweetened Regular Variant B

Life Product 19 Special K Brands

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Global Feature Per Capita Income Variations in China

RICH CHINA, POOR CHINA HEILONGJIANG

Incomes vary hugely across the mainland
RURAL PER CAPITA INCOME, 2003 JILIN
URBAN PER CAPITA INCOME, 2003
IN U.S. DOLLARS BEIJING
XINJIANG LIAONING
$691 $1,714 $362 $894

INNER MONGOLIA
TIANJIN
HEBEI
JIANGSU
SHANXI
SHANDONG
QINGHAI NINGXIA $523 $1,144

GANSU SHANGHAI
SHAANXI HENAN
$821 $1,835
HUBEI
ANHUI
SICHUAN
$317 $904 SHANGHAI
TIBET
$275 $869 ZHEJIANG

HUNAN JIANGXI

YUNNAN GUIZHOU FUJIAN

$210 $944

GUANGXI GUANGDONG
$501 $1,528
HONG
KONG
Data: National Bureau of Statistics, China

Source: “Let a Thousand Brands Bloom,” BusinessWeek, October, 17, 2005, 58.

(Exhibit 2.2). Buyers are identified, described, value requirements are indicated, and envi-
ronmental influences (e.g., interest rate trends) determined. Analysis of the buyers in the
market segments within a product-market is considered in Chapter 3.

Identifying and Describing Buyers

Characteristics, such as family size, age, income, geographical location, sex, and occupa-
tion are often useful in identifying buyers in consumer markets. Illustrative factors used
to identify end-users in organizational markets include type of industry, company size,
location, and types of products. Many published sources of information are available for
use in identifying and describing customers. Examples include U.S. Census data, trade
association publications, and studies by advertising media (TV, radio, magazines). When
experience and existing information are not adequate in determining buyers, research stud-
ies may be necessary to identify and describe customers and prospects.
An interesting profile of per capita income variations across China is shown in the
GLOBAL FEATURE.12 Note the huge differences between Rural and Urban income. Rec-
ognizing these income variations, Haier, the leading appliance producer in China, designs
its larger washing machines for Chinese cities, but offers a very small model at $37 for
poorer areas. The Chinese population information is useful in identifying and describing
buyers where income is a relevant predictor of purchases of goods and services such as
automobiles and kitchen appliances.

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Chapter 2 Markets and Competitive Space 59

How Buyers Make Choices

Often, simply describing buyers does not provide enough information to guide market tar-
geting and positioning decisions. We also need to try to find out why people buy products
and specific product brands. In considering how customers decide what to buy, it is useful
to analyze how they move through the sequence of steps leading to a decision to purchase
a particular brand. Buyers normally follow a decision process. They begin by recognizing
a need (problem recognition); next, they seek information; then, they identify and evaluate
alternative products; and finally, they purchase a brand. Of course, the length and complex-
ity of this process varies by product and purchasing situation. Decisions for frequently
purchased products with which a buyer has past experience tend to be routine. One part
of studying buyer decision processes is finding out what criteria people use in making
decisions. For example, how important is the brand name of a product in the purchase
decision?
Illustrations of the buying decision process stages for a consumer purchase and an
organizational purchase are shown in Exhibit 2.6. The consumer purchase involves a porta-
ble CD player purchased by a student, whereas the organizational purchase is for a portable
CD player component from an outside supplier. Both processes move through the major
stages in the buying decision process, but the issues and activities are quite different.

EXHIBIT 2.6 Comparing the Stages in Consumer and Organizational Purchases

Source: Roger A. Kerin, Steve W. Hartley, and William Rudelius, Marketing The Core (Burr Ridge, IL: McGraw-Hill/Irwin, 2004), 129.

STAGE IN THE CONSUMER PURCHASE: ORGANIZATIONAL PURCHASE:

BUYING DECISION PORTABLE CD PLAYER FOR EARPHONES FOR A PORTABLE
PROCESS A STUDENT CD PLAYER

Student doesn’t like the features of the Marketing research and sales departments
portable CD player now owned and observe that competitors are improving the
Problem desires a new portable CD player. earphones on their portable CD models.
recognition The firm decides to improve the earphones
on their own new models, which will be
purchased from an outside supplier.

Student uses past experience, that of Design and production engineers draft
Information friends, ads, the Internet, and Consumer specifications for earphones. The
search Reports to collect information and uncover purchasing department identifies suppliers
alternatives. of portable CD player earphones.

Alternative portable CD players are Purchasing and engineering personnel visit

evaluated on the basis of important with suppliers and assess (1) facilities,
Alternative
attributes desired in a portable CD player, (2) capacity, (3) quality control, and
evaluation
and several stores are visited. (4) financial status. They drop any suppliers
not satisfactory on these factors.

A specific brand of portable CD player is They use (1) quality, (2) price, (3) delivery,
Purchase selected, the price is paid, and the student and (4) technical capability as key buying
decision leaves the store. criteria to select a supplier. Then they
negotiate terms and award a contract.

Student reevaluates the purchase They evaluate suppliers using a formal

Postpurchase decision, may return the portable CD vendor rating system and notify a supplier
behavior player to the store if it is unsatisfactory. if earphones do not meet their quality
standard. If the problem is not corrected,
they drop the firm as a future supplier.

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60 Part Two Markets, Segments, and Customer Value

EXHIBIT 2.7 Percent

–2.9 to 1.4
Population Trends for AK 1.5 to 2.4
the 50 States in the 2.5 to 3.4
United States: 1995 3.5 to 4.5
4.6 to 14.1
to 2025
WA NH
MT VT ME
Source: U.S. Bureau of the ND
Census, Population Division, OR MN
MA
PPL-47. ID
SD WI NY
MI RI
WY
CT
IA PA
NE NJ
NV OH DE
IL IN
UT MD
CO WV VA
CA KS MO
KY
NC DC
AZ TN
OK
NM AR SC
HI MS AL GA

TX LA

FL

Environmental Influences
The final step in building customer profiles is to identify the external environmental factors
that influence buyers and thus impact the size and composition of the market over time.
These influences include government actions (e.g., tax cuts), social change, economic
shifts, technology, and other factors that may alter buyers’ needs and wants. Typically, these
factors are not controlled by the buyer or the firms that market the product, and substantial
changes in environmental influences can have a major impact on customers’ purchasing
activities. Therefore, it is important to identify the relevant external influences on a product-
market and to estimate their future impact. During the past decade various changes in
market opportunities occurred as a result of uncontrollable environmental factors. Illustra-
tions include the shifts in population age-group composition, changes in tax laws affecting
investments, and variations in interest rates. Consider, for example, the population trends
for the 50 states in the United States from 1995 to 2025. Note that some states (Exhibit 2.7)
display high growth rates while others are declining in size. Residential construction rates
and various other product-markets will be impacted by differences in population growth
across regions and states in the U.S.
Building Customer Profiles
Describing customers begins with the generic product-market. At this level customer pro-
files are likely to describe the size and general composition of the customer base. For
example, the commercial air travel customer profile for a specified geographical area
(e.g., South America) would include market size, growth rates, mix of business and pleas-
ure travelers, and other general characteristics. The product-type and variant profiles are
more specific about customer characteristics such as needs and wants, use situations, activ-
ities and interests, opinions, purchase processes and choice criteria, and environmental
influences on buying decisions. Normally, product-type analysis considers the organiza-
tion’s product and closely related product types.
In developing marketing strategy, management is concerned with deciding which buy-
ers to target within the product-market of interest and how to position to each target. The
customer profiles help to guide these decisions. The profile information is also useful in
deciding how to segment the market. More comprehensive customer analyses are neces-
sary in market segmentation analysis, which we discuss in Chapter 3.

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Chapter 2 Markets and Competitive Space 61

Analyzing Competition
Competitor analysis considers the companies and brands that compete in the product-
market of interest. Analyzing the competition follows the five steps shown in Exhibit 2.8. In
Step 1 we determine the competitive arena in which an organization competes and describe
the characteristics of the competitive space. Steps 2 and 3 identify, describe, and evaluate
the organization’s key competitors. Steps 4 and 5 anticipate competitors’ future actions and
identify potential competitors that may enter the market.

Defining the Competitive Arena

Competition often includes more than the firms that are direct competitors, like Coke
and Pepsi. For example, the different levels of competition for diet colas are shown in
Exhibit 2.9. The product variant is the most direct type of competition. Nevertheless, other
product categories of soft drinks also compete for buyers, as do other beverages. A com-
plete understanding of the competitive arena helps to guide strategy design and imple-
mentation. Since competition often occurs within specific industries, study of the industry
structure is useful in defining the competitive arena, recognizing that more than one indus-
try may be competing in the same product-market, depending on the complexity of the
product-market structure. For example, the digital photography product-market includes
traditional camera and film competitors and electronics industry competitors.
Industry Analysis
Competitor analysis is conducted from the point of view of a particular firm. For example,
a soft drink firm such as Coca-Cola should include other beverage brands in its industry
analysis. Two kinds of information are needed: (1) a descriptive profile of the industry;
and (2) an analysis of the value chain (distribution) channels that link together the various
organizations in the value-added system from suppliers to end-users. Thus, the industry
analysis is horizontal and covers similar types of firms (e.g., soft drink producers), whereas
the value chain analysis considers the vertical network of firms that supply materials and/
or parts, produce products (and services), and distribute the products to end-users.
The industry analysis includes: (1) industry characteristics and trends, such as sales,
number of firms, and growth rates; and (2) operating practices of the firms in the industry,
including product mix, service provided, barriers to entry, and geographical scope. Many
industries provide information in publications and websites that is useful in the analysis.
Industry associations also publish research reports which typically include growth forecasts.

EXHIBIT 2.8
1 Define the competitive arena for the generic, specific, and variant product-markets.
Analyzing the
Competition

2 Identify key competitors.

3 Evaluate key competitors.

4 Anticipate actions by competitors.

5 Identify and evaluate potential competitors.

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62 Part Two Markets, Segments, and Customer Value

EXHIBIT 2.9
Examples of Levels
of Competition
Source: Donald R. Lehmann
and Russell S. Winer, Analysis Ice
for Marketing Planning, 4th ed. cream
(Burr Ridge, IL: Richard D. Beer
Irwin, 1997), 22. Copyright ©
The McGraw-Hill Companies.
Used with permission. Regular
colas

Wine Diet
Diet-Rite lemon-
Cola limes
Fast Diet Diet Juices
food Coke Pepsi

Fruit Product form

flavored competition:
colas diet colas
Lemon- Video
Bottled limes rentals
Product
water
category
competition:
soft drinks
Coffee
Generic
competition:
beverages
Baseball
cards
Budget
competition:
food and
entertainment

First, we need to identify the companies that comprise the industry and develop descrip-
tive information on the industry and its members. It is important to examine industry
structure beyond domestic market boundaries, since international industry developments
often affect regional, national, and international markets. It is also necessary to include all
relevant industries in the analysis. For example, as shown in Exhibit 2.10, including only
the firms providing traditional long distance phone services would provide an incomplete
assessment of the industries and firms that provide services. The traditional boundaries
between phone companies, cable providers, and other tech firms are changing rapidly. Note
the large differences in revenue growth.
The industry identification is based on product similarity, location at the same level
in the value chain (e.g., manufacturer, distributor, retailer) and geographical scope. The
industry analysis considers:
• Industry size, growth, and composition.
• Typical marketing practices.
• Industry changes that are anticipated (e.g., consolidation trends).
• Industry strengths and weaknesses.
• Strategic alliances and potential mergers/acquisitions among competitors.

Analysis of the Value-Added Chain

The study of supplier and distribution channels is important in understanding and serv-
ing product-markets. While some producers may go directly to their end-users, many work
with other organizations through distribution channels. The extent of vertical integration
by competitor backward (supply) and forward toward end-users is also useful information.

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Chapter 2 Markets and Competitive Space 63

EXHIBIT 2.10 The Shifting Telecom Landscape

Source: “The Shifting Telecom Landscape,” BusinessWeek, February 28, 2005, 36.

Revenue in Billions
Compound
Annual
2003 2004 2005 2006 2007 2008 Growth Rate
• Video $ 0.2 $ 0.3 $ 0.5 $ 1.0 $ 1.6 $ 2.5 65.7%
• Consumer
broadband 2.8 3.5 4.0 4.2 4.6 4.8 11.4
• Consumer
long distance 20.7 18.2 16.0 13.6 11.3 9.2 ⴚ15.0
• Business local 26.3 26.7 26.4 26.1 25.8 25.5 ⴚ0.6
• Business long
distance 26.1 24.5 23.0 21.3 19.7 18.2 ⴚ7.0
• Business data* 44.8 45.6 46.6 47.1 46.8 45.4 0.3
• Consumer local 46.9 42.2 39.0 36.2 34.0 32.3 ⴚ7.25
• Wireless 91.5 108.7 119.2 132.8 144.5 153.6 10.9
Total $260.7 $271.5 $277.0 $285.0 $291.3 $294.9 2.5%

*Includes Internet access, private data lines, ATM traffic, and frame relay data: In-Stat/MDR

The types of relationships (collaborative or transactional) in the distribution channel should

be identified and evaluated. The extent of outsourcing activities in the value chain is also
of interest. Different channels that access end-user customers should be included in the
channel analysis. By looking at the distribution approaches of industry members, we can
identify important patterns and trends in serving end-users. Value chain analysis may also
uncover new market opportunities that are not served by present channels of distribution.
Finally, information from various value chain levels can help in forecasting end-user sales.
The use of outsourcing manufacturing and other business functions expanded rapidly in
the United States and Europe during the last decade. By outsourcing an organization may
gain strategic advantage by focusing on its core competencies, while outsourcing other
necessary business functions to independent partners. Thus, analysis of outsourcing activi-
ties may be an important aspect of competitor analysis.

Competitive Forces
Different competitive forces are present in the value-added chain. The traditional view
of competition is expanded by recognizing Michael Porter’s five competitive forces that
impact industry performance:
1. Rivalry among existing firms.
2. Threat of new entrants.
3. Threat of substitute products.
4. Bargaining power of suppliers.
5. Bargaining power of buyers.13
The first force recognizes that active competition among industry members helps deter-
mine industry performance, and it is the most direct and intense form of competition. The
aggressive competition between General Motors and Toyota is illustrative. Rivalry may
occur within a market segment or across an entire product-market. The nature and scope of
competition may vary according to the maturity of the industry.

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64 Part Two Markets, Segments, and Customer Value

The second force highlights the possibility of new competitors entering the market.
Existing firms may try to discourage new competition by aggressive expansion and other
types of market entry barriers. The entry of Wal-Mart into the supermarket business has
substantially expanded and intensified the competitive arena in this market.
The third force considers the potential impact of substitutes. New technologies that sat-
isfy the same customer value requirement are important sources of competition. Including
alternative technologies (e.g., disruptive innovations) in the definition of product-market
structure identifies substitute forms of competition.
The fourth force is the power that suppliers may be able to exert on the producers in an
industry. For example, the high costs of labor exert major pressures on the commercial air-
line industry. Coke and Pepsi exert important influences on their independent bottlers and
encourage collaboration. Companies may pursue vertical integration strategies to reduce
the bargaining power of suppliers. Collaborative relationships are useful to respond to the
needs of both partners.
Finally, buyers may use their purchasing power to influence their suppliers. Wal-Mart,
for example, has a strong influence on the suppliers of its many products. Understand-
ing which organizations have power and influence in the value chain provides important
insights into the structure of competition.

Key Competitor Analysis

Competitor analysis is conducted for the firms directly competing with each other
(e.g., Nike and Reebok) and other companies that management may consider important in
strategy analysis (for example, potential market entrants). The rapid expansion of competi-
tor intelligence activities by many companies in the last decade highlights the high priority
executives place on monitoring competitors’ activities. Many companies around the world
have developed very effective intelligence units. Nonetheless, there are important ethical
and legal issues to consider in competitive intelligence gathering. These issues are illus-
trated in the ETHICS FEATURE.
We now look at two major aspects of competitor analysis: (1) preparing a descriptive
profile for each competitor; and (2) evaluating the competitor’s strengths and weaknesses
(Steps 2 and 3 of Exhibit 2.8).

Describing and Evaluating the Competitor

A key competitor is any organization going after the same market target as the firm con-
ducting the analysis. American and Southwest Airlines are key competitors on many U.S.
routes. Key competitors are brands that compete in the same product-market or segment(s)
within the market (Motorola, Nokia, and Samsung cell phones). Different product types
that satisfy the same need or want may also actively compete against each other. Thus,
microwave dinners may compete with fast-food operators.
Information which is typically included in the competitor profile is shown in Exhibit 2.11.
Sources of information include annual reports, industry studies by government and pri-
vate organizations, business magazines and newspapers, industry trade publications and
websites, reports by financial analysts (e.g., Value Line Investment Survey), government
reports, standardized data services (e.g., Information Resources, Inc. and Nielsen), data-
bases, suppliers, customers, company personnel, and salespeople. Direct contact with the
research directors of trade publications is often a useful source of information about the
industry and key competitors.
It is important to gain as much knowledge as possible about the background, experience,
qualifications, and tenure of key executives for each major competitor. This information

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Ethics Feature Competitor Intelligence Gathering

Most competitive intelligence gathering relies on publicly available information and the
views of distributors and customers. However, there are important limits to the behavior of
intelligence gatherers. The Society of Competitive Intelligence Professionals outlaws mis-
representation by intelligence gatherers in its code of ethics. Nonetheless, there are grey
areas, which raise serious ethical dilemmas:
• What if intelligence researchers pose as something else—conference organizers, head-
hunters, students, or journalists to tease information out of intelligence targets?
• Is it acceptable if competitor staff members are interviewed for phantom jobs which do
not exist, to see what they reveal when questioned?
• Is it reasonable for researchers to pose as customers to collect competitor information?
Unethical intelligence gathering practices carry substantial risks if discovered, and are
completely unacceptable to reputable companies. Many organizations now operate eth-
ics compliance systems, and report corporate citizenship actions to shareholders and
investors.
Direct contact with competitors to gather intelligence may be interpreted as “inappro-
priate conversations” associated with anti-competitive behavior, and attract investigation
and punishment by regulatory bodies.
Source: Stephen Overell, “Agents Who Shed Light on Hidden Corporate Life,” Financial Times, Monday,
March 19, 2001, p. 14; Joseph Weber, “The New Ethics Enforcers,” BusinessWeek, February 13, 2006, 76–77.

EXHIBIT 2.11
Describing and
• Business scope and objectives
Evaluating Key • Management experience, capabilities, and weaknesses
Competitors • Market position and trends
• Market target(s) and customer base
• Positioning strategy for each target
• Distinctive capabilities
• Financial performance (current and historical)

includes the executives’ performance records, their particular areas of expertise, and the
firms where they were previously employed. These analyses may suggest the future strate-
gic initiatives of a key competitor.
Market targets and customer base analyses center on the market segments targeted by
the competitor and the competitor’s actual and relative market-share position. Relative
market position is measured by comparing the share of the firm against the competitor with
the highest market share in the segment. All segments in the product-market that could be
targeted by the firm should be included in the competitor evaluation.
The competitor’s past performance offers a useful basis for comparing competitors. The
customer value proposition offered by the competitor for each segment is important infor-
mation. This may indicate competitive opportunities as well as a possible threat. The com-
petitor’s distinctive capabilities need to be identified and evaluated.
An analysis of each competitor’s past sales and financial performance indicates how
well the competitor has performed on a historical basis. Competitor ratings are also use-
ful in the comparisons (e.g., Consumer Reports). A typical period of analysis is three to
five years or longer depending on the rate of change in the market. Performance informa-
tion may include sales, market share, net profit, net profit margin, cash flow, and debt.

65

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66 Part Two Markets, Segments, and Customer Value

Additionally, for specific types of businesses other performance information may be use-
ful. For example, sales-per-square-foot is often used to compare the performance of retail
stores. Operating cost per passenger mile is a relevant measure for airline performance
comparisons.
Assessing how well competitors meet customer value requirements requires finding out
what criteria buyers use to rate each supplier. Customer-focused assessments are more
useful than relying only on management judgments of value delivery. Measurement meth-
ods include customer comparisons of value attributes of the firm versus its competitors,
customer surveys, loyalty measures, and the relative market share of end-use segments.14
Customer value assessment is further considered in Chapter 4.
Using the competitor information, we can develop an overall evaluation of the key com-
petitor’s current strengths and weaknesses. Additionally, the summary assessment of dis-
tinctive capabilities includes information on the competitor’s management capabilities and
limitations, technical and operating advantages and weaknesses, marketing strategy, and
other key strengths and limitations. Since competitors often display different capabilities,
it is important to highlight these differences.

Anticipating Competitors’ Actions

Steps 4 and 5 in competitor analysis (Exhibit 2.8) consider what each key competitor may
do in the future, and identify potential new competitors. The information obtained in the
previous steps of the analysis should be helpful in estimating future trends, although pos-
sible strategy shifts by competitors may occur.

Estimating Competitors’ Future Strategies

Competitors’ future strategies may continue the directions that they have established in the
past, particularly if no major external influences require changing their strategies. Nev-
ertheless, assuming an existing strategy will continue is not wise. Competitors’ current
actions may signal probable strategy shifts that may create future threats.
An interesting development in the telecommunication market is the growth in the use
of Internet calling. First introduced in 1995, Voice-Over Internet Protocol (VOIP) experi-
enced start-up problems but by 2003, the technology was a rapidly growing share of home
and business markets.15 Industry authorities expect the technology to become a significant
competitive threat. VOIP subscribers are estimated to increase to over five times the 2003
level by 2006.
Relatedly, the acquisition strategy at eBay is a strong indicator of the company’s goal
to move from being an online auction site to an e-commerce engine that sells Web tools
to small businesses. Current developments at eBay are illustrated in the INTERNET
FEATURE, and are indicative of the areas in which eBay will be a competitor in the
future.

Identifying New Competitors

New competitors may come from four major sources: (1) companies competing in a related
product-market; (2) companies with related technologies; (3) companies already targeting
similar customer groups with other products; and/or (4) companies competing in other
geographical regions with similar products. Market entry by a new competitor is likely
under one or more of these conditions:
• High profit margins are being achieved by market incumbents.
• Future growth opportunities in the market are attractive.
• No major market-entry barriers are present.

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Internet Feature EBay’s Strategic Direction

The online auction site eBay.com has become one of the Web’s most successful sites with
233 million registered users. The impact on many areas of conventional retailing has been
substantial.
EBay executives believe future growth depends on evolving the company beyond a des-
tination site into a provider of tools and services that power e-commerce across the Web.
The company is making considerable efforts to break out of its current business model, and
has spent $6 billion in five years. Key acquisitions include:
• PayPal—payment processor for eBay and other websites - $1.5 billion (July 2002).
• Rent.com provides property rental and roommate search services—$415 million
(December 2004).
• Kurant/Pro—helps sellers set up online storefronts separate from eBay (January 2005).
• Shopping.com runs a comparison-shopping website—$620 million (June 2005).
• Skype—its Internet telephone service can connect sellers with shoppers—$2.5 billion
(September 2005).
• Stubhub—a ticket reselling site that is promoted on eBay—$310 million (January 2007).
• Stumbleupon—recommends websites based on user interests - $75 million (May 2007).
Source: Catherine Holahan, “Going, Going . . . Everywhere,” BusinessWeek, June 18, 2007, 62–64.

• Competition is limited to one or a few competitors.

• Gaining an equivalent (or better) competitive advantage over the existing firm(s) serv-
ing the market is feasible.
If one or more of these conditions are present in a competitive situation, new competi-
tion will probably appear.

Market Size Estimation

An important part of market opportunity analysis is estimating the present and potential
size of the market. Market size is usually measured by dollar sales and/or unit sales for a
defined product-market and specified time period. Other size measures include the number
of buyers, average purchase quantity, and frequency of purchase. Three key measures of
market size are: market potential, sales forecast, and market share.
Market Potential
Market potential is the maximum amount of product sales that can be obtained from a defined
product-market during a specified time period. It includes the total opportunity for sales by
all firms serving the product-market. Market potential is the upper limit of sales that can be
achieved by all firms for a specified product-market over an indicated time period. Often,
actual industry sales in a specified year fall somewhat below market potential because the
production and distribution systems are unable to completely meet the needs of all buyers
who are both willing and able to purchase the product during the period of interest.
Useful information for considering market potential and growth rates for various prod-
uct categories in Russia is shown in Exhibit 2.12. The share of household ownership per-
centages and share increases provide an indication of where the market potential appears
promising. Not surprisingly, cell phone and computer penetration is expanding rapidly.
Household income is increasing fast and 70 percent of all income is disposable in Russia
compared to 40 percent in Western countries.16 Market potential is exploding for many
product categories including tourism and financial services.
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68 Part Two Markets, Segments, and Customer Value

EXHIBIT 2.12 Ownership by Share of Households

Market Penetration
and Growth Rates for 2001 2005
Selected Consumer Mobile phone 6% 50%
Product Categories Computer 5 20
in Russia Washing machine 16 35
Stereo 15 31
Source: Jason Bush, “Shoppers
Gone Wild,” BusinessWeek, Video recorder 39 50
February 20, 2006, 46. Car 25 31
Imported TV 58 71
Apartment or house 71 82
August 2001 vs. August 2005 Data: GfK Rus.

Sales Forecast
The sales forecast indicates the expected sales for a defined product-market during a speci-
fied time period. The industry sales forecast is the total volume of sales expected by all
firms serving the product market. The sales forecast can be no greater than market poten-
tial and typically falls short of potential as discussed above. A forecast can be made for
total sales at any product-market level (generic, product type, variant) and for specific
subsets of the product-market (e.g., market segments). A company sales forecast can also
be made for sales expected by a particular firm.
Several sales forecasting methods are described in Exhibit 2.13. The advantages of each
technique are indicated. Time-series analysis is popular for projecting future sales but is
very dependent on the stability of historical trends.

Market Share
Company sales divided by the total sales of all firms for a specified product-market deter-
mines the market share of a particular firm. Market share may be calculated on the basis of
actual sales or forecasted sales. Market share can be used to forecast future company sales
and to compare actual market position among competing brands of a product. Market share
may vary depending on the use of dollar sales or unit sales due to price differences across
competitors.
It is essential in preparing forecasts to specify exactly what is being forecast (defined
product-market), the time period involved, and the geographical area. Otherwise, compari-
sons of sales and market share with those of competing firms will not be meaningful.

Evaluating Market Opportunity

Since a company’s sales depend, in part, on its marketing plans, management’s forecasts
and marketing strategy are closely interrelated. Forecasting involves “what if ” analyses.
Alternative positioning strategies (product, distribution, price, and promotion) need to be
evaluated for their estimated effects on sales. Because of the marketing effort/sales rela-
tionship, it is important to consider both market potential (opportunity) and planned mar-
keting expenditures in determining the forecast. The impact of different sales forecasts
must be evaluated from a total business perspective, since these forecasts affect production
planning, human resource needs, and financial requirements.
Sales forecasts of target markets are needed so that management can estimate the finan-
cial attractiveness of both new and existing market opportunities. The market potential and
growth estimates gauge the overall attractiveness of the market. The sales forecast for the
company’s brand in combination with cost estimates provide a basis for profit projections.
The decision to enter a new market or to exit from an existing market depends heavily on

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Chapter 2 Markets and Competitive Space 69

EXHIBIT 2.13 Summary of Advantages and Disadvantages of Various Forecasting Techniques

Source: Mark W. Johnston and Greg W. Marshall, Sales Force Management, 7th ed. (New York: McGraw-Hill/Irwin, 2003), 131.

Sales Forecasting
Method Advantages Disadvantages
User expectations 1. Forecast estimates obtained 1. Potential customers must be few and
directly from buyers well defined
2. Projected product usage informa- 2. Does not work well for consumer goods
tion can be highly detailed 3. Depends on the accuracy of user’s
3. Insightful method aids planning estimates
marketing strategy 4. Expensive, time-consuming,
4. Useful for new product forecasting labor-intensive
Sales force 1. Involves the people (sales 1. Estimators (sales personnel) have a
composite personnel) who will be held vested interest and therefore may be
responsible for the results biased
2. Is fairly accurate 2. Elaborate schemes sometimes are
3. Aids in controlling and directing necessary to counteract bias
sales effort 3. If estimates are biased, process to
4. Forecast is available for individual correct the data can be expensive
sales territories
Jury of executive 1. Easily done, very quick 1. Produces aggregate forecasts
opinion 2. Does not require elaborate statistics 2. Expensive
3. Utilizes “collected wisdom” of the 3. Disperses responsibility for the
top people forecast
4. Useful for new or innovative 4. Group dynamics operate
products
Delphi technique 1. Minimizes effects of group 1. Can be expensive and time-consuming
dynamics
Market test 1. Provides ultimate test of consumers’ 1. Lets competitors know what firm is
reactions to the product doing
2. Allows assessment of the effec- 2. Invites competitive reaction
tiveness of the total marketing 3. Expensive and time-consuming to set
program up
3. Useful for new and innovative 4. Often takes a long time to accurately
products assess level of initial and repeat demand
Time-series analysis 1. Utilizes historical data 1. Not useful for new or innovative products
2. Objective, inexpensive 2. Factors for trend, cyclical, seasonal, or
product life-cycle phase must be
accurately assessed and included
3. Technical skill and good judgment
required
Statistical demand 1. Great intuitive appeal 1. Factors affecting sales must remain
analysis 2. Requires quantification of assump- constant and be identified accurately to
tions underlying the estimates produce an accurate estimate
3. Allows management to check results 2. Requires technical skill and expertise
4. Uncovers hidden factors affecting 3. Some managers reluctant to use
sales method due to the sophistication
5. Method is objective

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70 Part Two Markets, Segments, and Customer Value

financial analyses and projections. Alternate market targets under consideration can be
compared using sales and profit projections. Similar projections of key competitors are
also useful in evaluating market opportunities.

Developing a Strategic Vision About the Future

Market development and competitive space may not follow clearly defined and predictable
paths. Nonetheless, signals can be identified that are useful in pointing to possible market
changes. Answers to the questions shown in Exhibit 2.14 are needed in Developing a Stra-
tegic Vision concerning the firm’s market(s). These issues need to be addressed for each
product-market.
Phases of Competition
It is useful to distinguish between different phases in the development of competition. In
the initial stage, companies compete in identifying product concepts, technology choices,
and building competencies.17 This phase involves experimentation with ideas, and the path
to market leadership is not clearly defined. Phase 2 may involve partnering of companies
with the objective of controlling industry standards, though these firms eventually become
competitors. Finally, as the market becomes clearly defined and the competitive space
established, the competitors concentrate on market share for end products and profits. The
personal computer market is currently in this stage.
Anticipating the Future
Increasingly, we find that change and turbulence, rather than stability, characterize many
product-markets. Moreover, as discussed above, it is often possible to determine the forces
underway that will alter product-market structure. Though these influences are not easily
identified and analyzed, the organizations that choose to invest substantial time and effort in
anticipating the future create an opportunity for competitive advantage. Fuji appears to have
done a better job of anticipating the future of digital photography than did Kodak. Executives
in market-driven companies recognize the importance of developing these capabilities.
Hamel and Prahalad offer a compelling blueprint for analyzing the forces of change.
While the details of their process cannot be captured in a few pages of discussion, the fol-
lowing questions are examples of the information needed to anticipate the future:18
• What are the influences (discontinuities) present in the product-market that have the
potential to profoundly transform market/competitor structure?
• Investigate each discontinuity in substantial depth.

EXHIBIT 2.14 • Are product-market boundaries and composition of the product-market undergoing
Developing a
Strategic Vision
transformation?
• How and to what extent is the end-user customer base changing?
• Are the scope and structure of competitor space changing due to market and industry
transformation and entry/exit of competitors?
• Are there potential threats from disruptive technologies and/or commoditization?
• Are the composition and structure of the value chain(s) serving the end-user market(s)
changing?
• Do other influences operating in the product-market have the potential to significantly
transform the product?
• At what life-cycle stage is the product-market (new, growth, maturity, decline), and
how fast is the life cycle advancing?

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Chapter 2 Markets and Competitive Space 71

• How will the trend impact customers?

• What is the likely economic impact?
• How fast is the trend developing?
• Who is exploiting this trend?
• Who has the most to gain/lose?
• What new product opportunities will be created by this discontinuity?
• How can we learn more about this trend?
Following the blueprint requires looking in depth at the relevant forces of change in a
product-market and other markets that are interrelated. Anticipating the future requires
searching beyond the existing competitive arena for influences that promise to impact
product-market boundaries. The process requires the involvement of the entire organiza-
tion and it demands a substantial amount of time. A company with a market orientation
and cross-functional processes should be able to utilize these processes for anticipating the
future. Importantly, developing a vision about the future needs to be an ongoing process.

Summary Analyzing markets and competition is essential to making sound business and marketing
decisions. The uses of product-market analyses are many and varied. An important aspect
of market definition and analysis is moving beyond a product or industry focus by incorpo-
rating market needs into the analysts’ viewpoint.
Business strategies and markets are interrelated and companies which do not understand
their markets and how they are likely to change in the future are at a competitive disadvan-
tage. Effective market sensing is essential in guiding business and marketing strategies. Dis-
ruptive innovation, the process of customers shifting their purchases to new products that
better meet their needs, should be anticipated and counterstrategies developed. An essential
part of becoming market-oriented is identifying future directions of market change.
This chapter examines the nature and scope of defining and analyzing product-market
structure. By using different levels of aggregation (generic, product-type, and product-
variant), products and brands are positioned within more aggregate categories, thus
helping to better understand customers, product interrelationships, industry structure, dis-
tribution approaches, and key competitors. This approach to product-market analysis offers
a consistent guide to needed information, regardless of the type of product-market being
analyzed. Analyzing market opportunity includes (1) determining product-market bounda-
ries and structure; (2) forming the product-market; (3) describing and analyzing end-users;
(4) analyzing competition; and (5) estimating market size and growth rates.
After determining the product-market boundaries and structure, information on various
aspects of the market is collected and examined. First, it is useful to study the people or
organizations who are the end-users in the product-market at each level (generic, product
type, and variant). These market profiles of customers help to evaluate opportunities and
guide market targeting and positioning strategies. Next, we identify and analyze the firms
that market products and services at each product-market level to aid strategy develop-
ment. Industry and key competitor analysis considers the firms that compete with the com-
pany performing the market opportunity analysis. Thus, industry analysis for a personal
computer producer would include the producers that make up the industry. The analysis
should also include firms operating at all stages (levels) in the value-added chain, such as
suppliers, manufacturers, distributors, and retailers.
The next step is a comprehensive assessment of the major competitors. The competitor
analysis should include both actual and potential competitors that management considers
important. Competitor analysis includes: (1) describing the company; (2) evaluating the

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72 Part Two Markets, Segments, and Customer Value

competitor; and (3) anticipating the future actions of competitors. It is also important to
identify possible new competitors. Competitor analysis is an ongoing activity and requires
coordinated information collection and analysis.
An important part of product-market analysis is estimating potential and forecasting sales.
The forecasts often used in product-market analysis include estimates of market potential,
sales forecasts of total sales by firms competing in the product-market, and the sales fore-
cast for the firm of interest. This information is needed for various purposes and is prepared
for different units of analysis, such as product category, brands, and geographical areas. The
forecasting approach and techniques should be matched to the organization’s needs.
The mounting evidence about markets points to the critical importance of understand-
ing and anticipating changes in markets by developing a strategic vision about the future.
In gaining these insights, it is useful to view competition as a three-stage process of experi-
mentation, partnering to set industry standards, and then pursuing market share and profits.
Analyzing the forces of change provides a basis for anticipating how product-markets will
change in the future.

Questions for 1. Discuss the important issues that should be considered in defining the product-market for a
totally new product.
Review and 2. Under what product and market conditions is the end-user customer more likely to make an
Discussion important contribution to product-market definition?
3. What recommendations can you make to the management of a company competing in a rapid
growth market to help it identify new competitive threats early enough so that counterstrategies
can be developed?
4. There are some dangers in concentrating product-market analysis only on a firm’s specific brand
and those brands that compete directly with a firm’s brand. Discuss.
5. Using the approach to product-market definition and analysis discussed in the chapter, select a
brand and describe the generic, product type, and brand product-markets of which the brand is a
part.
6. For the brand you selected in Question 5, indicate the kinds of information needed to conduct a
complete product-market analysis. Also suggest sources for obtaining each type of information.
7. Select an industry and describe its characteristics, participants, and structure.
8. A competitor analysis of the 7UP soft drink brand is being conducted. Management plans to
position the brand against its key competitors. Should the competitors consist of only other non-
cola drinks?
9. Outline an approach to competitor evaluation, assuming you are preparing the analysis for a
regional bank holding company.
10. Discuss how a small company (less than $1 million in sales) should analyze its competition.
11. Many popular forecasting techniques draw from past experience and historical data. Discuss
some of the more important problems that may occur in using these methods.
12. What are the relevant issues a cross-functional team should consider in developing a strategic
vision about the future for the organization’s product-market(s)?

Internet A. Visit the website of Project 2000 (www2000.ogsm.Vanderbilt.edu), founded at the Owen Graduate
School of Vanderbilt University to determine if the Web provides useful information for market
Applications and competitor analysis. Describe the various types of market information available on the Web.
B. Visit Hoover’s website (www.hoovers.com). Investigate the different options for competitive and
market analysis provided. How can these online tools best be utilized? What limitations apply?

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Chapter 2 Markets and Competitive Space 73

C. Johnson & Johnson is currently competitive in the surgical stent market (a device inserted surgi-
cally in an artery to enable blood flow). Perform an Internet analysis of the stent market indicat-
ing past and current unit sales levels and forecasts for 2006–2010.
D. Samsung Electronics is one of the top producers of cell phones. Draw from Internet sources to
prepare an analysis of the global cell phone market.

Feature A. Select a product-market where new types of competition and/or new business models are
developing. Discuss how and to what extent “opportunities outside the competitive box are
Applications developing.”
B. Review the GLOBAL FEATURE concerning China’s geographical income distributions. Dis-
cuss how this information could be useful to a company planning to enter the Chinese market
with water purification treatment units for use in residences.

Notes 1. This illustration is based on William M. Bulkeley, “Kodak’s Loss Widens as Revenue Declines
8.8%,” The Wall Street Journal, August 2, 2006, B10; “A Tense Kodak Moment,” BusinessWeek,
October 17, 2005, 84–85; “Another Kodak Moment,” The Economist, May 14, 2005, 69.
2. Diane Brady, “A Thousand and One Noshes,” BusinessWeek, June 14, 2004, 44.
3. This discussion is based on David W. Cravens, Nigel F. Piercy, and Artur Baldauf, “Strategic
Thinking for Changing Markets,” Working Paper, October 15, 2007.
4. Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution (Boston: Harvard
Business School Press, 2003), Chapter 1.
5. Ibid., Chapter 6.
6. W.C. Kim and R. Mauborgne, Blue Ocean Strategy (Boston: Harvard Business School Press,
2005).
7. Pui-Wing Tam, “Entreaty to Camera-Phone Photographers: Please Print,” The Wall Street
Journal, December 28, 2004, B1 and B3.
8. This discussion is based upon suggestions provided by Professor Robert B. Woodruff of the
University of Tennessee, Knoxville.
9. Rajendra K. Srivastava, Mark I. Alpert, and Allan D. Shocker, “A Customer-Oriented Approach
for Determining Market Structures,” Journal of Marketing, Spring 1984, 32.
10. George S. Day, Strategic Marketing Planning: The Pursuit of Competitive Advantage (St. Paul,
MN: West Publishing, 1984), 72.
11. Derek F. Abell, Defining the Business: The Starting Point of Strategic Planning (Englewood
Cliffs, NY: Prentice Hall, 1980).
12. “Let a Thousand Brands Bloom,” BusinessWeek, October 17, 2005, 58 and 60.
13. Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), 5.
14. George S. Day and Robin Wensley, “Assessing Advantage: A Framework for Diagnosing Com-
petitive Superiority,” Journal of Marketing, April, 1988, 12–16.
15. Peter Grant and Almar Latour, “Circuit Breaker,” The Wall Street Journal, October 9, 2003, A1
and A9; “Net Phones Start Ringing Up Customers,” BusinessWeek, December 29, 2003, 45–46.
16. Jason Bush, “Shoppers Gone Wild,” BusinessWeek, February 20, 2006, 46.
17. C. K. Prahalad, “Weak Signals Versus Strong Paradigms,” Journal of Marketing Research,
August 1995, iii–vi.
18. Gary Hamel and C. K. Prahalad, Competing for the Future (Boston: Harvard Business School
Press, 1994), 101.

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74 Part Two Markets, Segments, and Customer Value

Appendix 2A

Financial Analysis for Marketing To evaluate a firm’s financial condition and perform-
ance, the financial analyst needs certain yardsticks.
Planning and Control The yardstick frequently used is a ratio or index,
relating two pieces of financial data to each other.
Several kinds of financial analyses are needed for Analysis and interpretation of various ratios should
marketing analysis, planning, and control activities. Such give an experienced and skilled analyst a better
analyses represent an important part of case preparation understanding of the financial condition and perform-
activities. In some instances it will be necessary to ance of the firm than he would obtain from analysis of
review and interpret the financial information provided the financial data alone.1
in the cases. In other instances, analyses may be
As we examine the financial analysis model in the
prepared to support specific recommendations. The
next section, note how the ratio or index provides a
methods covered in this appendix represent a group
useful frame of reference. Typically, ratios are used to
of tools and techniques for use in marketing financial
compare historical and/or future trends within the firm
analysis. Throughout the discussion, it is assumed that
or to compare a firm or business unit with an industry
accounting and finance fundamentals are understood.
or other firms.
Several financial ratios often used to measure busi-
Unit of Financial Analysis ness performance are shown in Exhibit 2A.2. Note
that these ratios are primarily useful as a means of
Various units of analysis that can be used in marketing
comparing:
financial analysis are shown in Exhibit 2A.1. Two factors
often influence the choice of a unit of analysis: (1) the 1. Ratio values for several time periods for a particular
purpose of the analysis and (2) the costs and availability business.
of the information needed to perform the analysis. 2. A firm to its key competitors.
3. A firm to an industry or business standard.
Financial Situation Analysis There are several sources of ratio data. These in-
Financial measures can be used to help assess the clude data services such as Dun & Bradstreet, The
present situation. One of the most common and best Value Line Investment Survey, industry and trade asso-
ways to quantify the financial situation of a firm is ciations, government agencies, and investment advi-
through ratio analysis. These ratios should be analyzed sory services.
over a period of at least three years to discern trends. Other ways to gauge the productivity of marketing
activities include sales per square feet of retail floor
space, occupancy rates of hotels and office buildings,
Key Financial Ratios
and sales per salesperson.
Financial information will be more useful to manage-
ment if it is prepared so that comparisons can be made. 1
James C. Van Horne, Fundamentals of Financial Management,
James Van Horne comments upon this need. 4th ed. (Englewood Cliffs, NJ: Prentice-Hall, 1980), 103–4.

EXHIBIT 2A.1 Market Product/Service Organization

Alternative Units for
Financial Analysis Market Industry Company
Market niche(s) Product mix Segment/division/unit
Geographic area(s) Product line Marketing department
Customer groups Specific product Sales unit:
Individual customers Brand Region
Model District branch
Office/store

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 EXHIBIT 2A.2 Summary of Key Financial Ratios
Source: Adapted from Arthur A. Thompson, Jr., and A. J. Strickland III, Strategy and Policy, 4th ed. (Homewood, IL: Richard D. Irwin, 1987), 270–1.

cra81004_ch02_047-082.indd 75
Ratio How Calculated What It Shows
Profitability ratios:
1. Gross profit margin Sales ⫺ Cost of goods sold An indication of the total margin available to cover operating
expenses and yield a profit.
Sales
2. Operating profit margin Profits before taxes and before interest An indication of the firm’s profitability from current operations
es
Sale without regard to the interest charges accruing from the capital
structure.
3. Net profit margin Profits after taxes Shows after-tax profits per dollar of sales. Subpar profit margins
(or return on sales) Sales indicate that the firm’s relatively low, its costs are relatively high,
or both.
4. Return on total assets Profits after taxes A measure of the return on total investment in the enterprise.
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Total assets It is sometimes desirable to add interest to after-tax profits to

or form the numerator of the ratio, since total assets are financed
Profits after taxes ⫹ Interest by creditors as well as by stockholders; hence, it is accurate to
Total assets measure the productivity of assets by the returns provided to
both classes of investors.
5. Return on stockholders’ equity Profits after taxes A measure of the rate on stockholders’ investment in the
(or return on net worth) Total stockholders’ equity enterprise.

6. Return on common equity Profits after taxes

⫺ Preferred stock dividen ds A measure of the rate of return on the investment which the
Total stockholders’ equity owners of common stock have made in the enterprise.
⫺ Par value of preferred stock
7. Earnings per share Profits after taxes
⫺Preferred stock dividen ds
Shows the earnings available to the owners of common stock.
Number of shares of common
stock outstandiing
Liquidity ratios:
1. Current ratio Indicates the extent to which the claims of short-term credi-
Current assets tors are covered by assets that are expected to be converted to
Current liabilities cash in a period roughly corresponding to the maturity of the
liabilities.
2. Quick ratio (or acid-test ratio) Current assets ⫺ Inventory A measure of the firm’s ability to pay off short-term obligations
without relying on the sale of its inventories.
Current liabilities
3. Cash ratio Cash & Marketable securities An indicator of how long the company can go without further

75
Current liabilitties inflow of funds.
(continued)

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 EXHIBIT 2A.2—(concluded)

76
4. Inventory to net working capital Inventory A measure of the extent to which the firm’s working capital is
tied up in inventory.
Current assets ⫺ Current liabilities
Leverage ratios:

cra81004_ch02_047-082.indd 76
1. Debt to assets ratio Total debt Measures the extent to which borrowed funds have been used
Total assets to finance the firm’s operations.

2. Debt to equity ratio Total debt Provides another measure of the funds provided the creditors
Total stockholders’ equity versus the funds provided by owners.

3. Long-term debt to equity ratio Long-term debt A widely used measure of the balance between debt and
equity in the firm’s overall capital structure.
Total stockholders’ equity
4. Times-interest-earned Profits before interest and taxes Measures the extent to which earnings can decline without the
(or coverage ratios) firm’s becoming unable to meet its annual interest costs.
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Total interrest charges

5. Fixed-charge coverage Profits before taxes
and interest ⫹ Lease obligations A more inclusive indication of the firm’s ability to meet all of its
Total interest charges fixed-charge obligations.
⫹Lease obliga tions
Activity ratios:
1. Inventory turnover Cost of goods sold When compared to industry averages, it provides an indica-
tion of whether a company has excessive inventory or perhaps
Inventory
inadequate inventory.
2. Fixed-assets turnover* Sales A measure of the sales productivity and utilization of plant and
Fixed assets equipment.

3. Total-assets turnover Sales A measure of the utilization of all the firm’s assets; a ratio below
Total assets the industry average indicates the company is not generating a
sufficient volume of business given the size of its asset investment.
4. Accounts receivable turnover Annual credit sales A measure of the average length of time it takes the firm to
Accounts receivable collect on the sales made on credit.

5. Average collection period Accounts receivable Indicates the average length of time the firm must wait after
Total sales ⫼ 365 making a sale before it receives payment.

or
Accounts receivable
Average daily sales

*The manager should also keep in mind the fixed charges associated with noncapitalized lease obligations.

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Chapter 2 Markets and Competitive Space 77

EXHIBIT 2A.3 Illustrative Contribution Margin performance. Increasing either ratio will increase net
Analysis for Product X ($000) worth. The values of these ratios will vary consider-
ably from one industry to another. For example, in
Sales $300
grocery wholesaling, profit margins are typically very
Less: Variable manufacturing costs 100
Other variable costs traceable
low, whereas asset turnover is very high. Through effi-
to product X 50 cient management and high turnover, a wholesaler
Equals: Contribution margin 150
can stack up impressive returns on net worth. Further-
Less: Fixed costs directly traceable more, space productivity measures are obtained for
to product X 100 individual departments in retail stores that offer more
Equals: Product net income $ 50 than one line, such as department stores. The measures
selected depend on the particular characteristics of the
business.
Contribution Analysis
When the performance of products, market segments, Evaluating Alternatives
and other marketing units is being analyzed, manage-
ment should examine the unit’s profit contribution. As we move through the discussion of financial analy-
Contribution margin is equal to sales (revenue) less sis, it is important to recognize the type of costs being
variable costs. Thus, contribution margin represents used in the analysis. Using accounting terminology,
the amount of money available to cover fixed costs, and costs can be designated as fixed or variable. A cost is
contribution margin less fixed costs is net income. An fixed if it remains constant over the observation period,
illustration of contribution margin analysis is given in even though the volume of activity varies. In contrast,
Exhibit 2A.3. In this example, product X is generating a variable cost is an expense that varies with sales over
a positive contribution margin. If product X were elim- the observation period. Costs are designated as mixed
inated, $50,000 of product net income would be lost, or semivariable in instances when they contain both
and the remaining products would have to cover fixed fixed and variable components.
costs not directly traceable to them. If the product is
retained, the $50,000 can be used to contribute to other Break-Even Analysis
fixed costs and/or net income. This technique is used to examine the relationship
between sales and costs. An illustration is given in
Financial Analysis Model Exhibit 2A.5. Using sales and cost information, it
is easy to determine from a break-even analysis how
The model shown in Exhibit 2A.4 provides a useful many units of a product must be sold in order to break
guide for examining financial performance and identi- even, or cover total costs. In this example 65,000 units
fying possible problem areas. The model combines sev- at sales of $120,000 are equal to total costs of $120,000.
eral important financial ratios into one equation. Let’s Any additional units sold will produce a profit. The
examine the model, moving from left to right. Profit break-even point can be calculated in this manner:
margin multiplied by asset turnover yields return on
assets. Moreover, assuming that the performance target Break-even units ⫽
is return on net worth (or return on equity), the product Fixed costs
of return on assets and financial leverage determines Price per unit ⫺ Variable cost per unit

EXHIBIT 2A.4 Profit Asset Return Financial Return on

Financial Analysis margin turnover on assets leverage net worth
Model
↓ ↓ ↓ ↓ ↓
Net Net Net
profits Net profits Total profits
(after taxes) ⫻ sales (after taxes) ⫻ assets ⫽ (after taxes)
↓

Net sales Total Total Net Net

assets assets worth worth

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78 Part Two Markets, Segments, and Customer Value

Price in the illustration shown in Exhibit 2A.5 is must be sold in order to break even or achieve a target
$1.846 per unit, and variable cost is $0.769 per unit. profit. Some important assumptions that underlie the
With fixed costs of $70,000, this results in the break- above break-even analysis include the use of constant
even calculation: fixed and variable costs, a constant price, and a single
product.
$ 70, 000 In addition to break-even analysis, several other
BE units ⫽ ⫽ 65, 000 units financial tools are used to evaluate alternatives. Net
$ 1 . 846 ⫺ $ 0 . 769
present value of cash flow analysis and return on invest-
To determine how many units must be sold to ment are among the most useful. For example, assume
achieve a target profit (expressed in before-tax dollars), there are two projects with the cash flows shown in
the formula is amended as follows: Exhibit 2A.6.
Though return on investment is widely used, it is lim-
ited by its inability to consider the time value of money.
Target profit units ⫽
This is shown in Exhibit 2A.7. Return on investment for
Fixed costs ⫹ Target profit ( before tax )
both projects X and Y is 10 percent. However, a dollar
Price per unit ⫺ Variable cost per unit today is worth more than a dollar given in three years.
Therefore, in assessing cash flows of a project or invest-
Using the same illustration as above and including ment, future cash flows must be discounted back to the
a target before-tax profit of $37,700, the target profit present at a rate comparable to the risk of the project.
calculation becomes:
EXHIBIT 2A.6 Cash Flow Comparison ($000s)
$ 70, 000 ⫹ $ 37, 700
Target profit units ⫽ Project X Project Y
$ 1 . 846 ⫺ $ 0 . 769
⫽ 100, 000 units Start-Up Costs <1,000 > <1,000 >
Year 1 500 300
Year 2 500 400
Break-even analysis is not a forecast. It indicates
Year 3 300 600
how many units of a product at a given price and cost

EXHIBIT 2A.5 250

Illustrative Break-
Even Analysis

200 Sales
Net profit
Sales and costs ($000s)

Profit

150
Total costs
120 Variable costs
Break-even point
100

Fixed costs

50 Loss
Fixed costs

0
25 50 65 75 100 125
Number of units (000s)

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Chapter 2 Markets and Competitive Space 79

EXHIBIT 2A.7 Time Cash Flow PV Factor NPV of Cash Flow

Present Value of Cash
Flows Project X
0 <1,000> 1/(1 ⫹ .12)⬚ ⫽ 1 <1,000>
1 500 1/(1 ⫹ .12)1 ⫽ 0.8929 ⫽ 446.45
2 500 1/(1 ⫹ .12)2 ⫽ 0.7972 ⫽ 398.60
3 300 1/(1 ⫹ .12)3 ⫽ 0.7118 ⫽ 213.54
Present value ⫹ 58.59
Project Y
0 <1,000> 1/(1 ⫹ .12)0 ⫽ 1 <1,000>
1 300 1/(1 ⫹ .12)1 ⫽ 0.8929 ⫽ 267.87
2 400 1/(1 ⫹ .12)2 ⫽ 0.7972 ⫽ 318.88
3 600 1/(1 ⫹ .12)3 ⫽ 0.7118 ⫽ 427.08
Net present value ⫹ 13.83

Discounting cash flows is a simple process. Assume selection of performance measures to be used in gaug-
that the firm is considering projects X and Y and that ing marketing performance. The objective is to indicate
its cost of capital is 12 percent. Additionally, assume the range of possibilities and suggest some of the more
that both projects carry risk comparable to the normal frequently used financial analysis.
business risk. Under these circumstances, the analyst Pro forma income statements can be very useful
should discount the cash flows back to the present at when one is projecting performance and budgeting.
the cost of capital, 12 percent. Present value factors can Usually, this is done on a spreadsheet so that assump-
be looked up or computed using the formula 1/(1 ⫹ i)n, tions can be altered rapidly. Usually, only a few assump-
where i equals our discounting rate per time period and tions need be made. For example, sales growth rates
n equals the number of compounding periods. In this can be projected from past trends and adjusted for new
example, the present value of cash flows would be as information. From this starting point, cost of goods
shown in Exhibit 2A.7. can be determined as a percentage of sales. Operating
Because both projects have a positive net present expenses can also be determined as a percentage of
value, both are good. However, if they are mutually sales based on past relationships, and the effective tax
exclusive, the project with the highest net present value rate as a percentage of earnings before taxes. However,
should be selected. past relationships may not hold in the future. It may
be necessary to analyze possible divergence from past
Financial Planning relationships.
In addition, pro forma income statements can be
Financial planning involves two major activities: used to generate pro forma cash flow statements. It is
(1) forecasting revenues and (2) budgeting (estimat- then possible to compare alternative courses of action
ing future expenses). The actual financial analyses by employing a uniformly comparable standard cash
and forecasts included in the strategic marketing plan flow.
vary considerably from firm to firm. In addition, inter-
nal financial reporting and budgeting procedures vary Supplemental Financial Analyses
widely among companies. Therefore, consider this
approach as one example rather than the norm. The preceding sections of this appendix detailed the var-
The choice of the financial information to be used ious forms of traditional financial analysis useful in mar-
for marketing planning and control will depend on keting decision making. There are supplemental forms
its relationship with the corporate or business unit of analysis that can also be helpful in different types
strategic plan. Another important consideration is the of marketing decisions. These supplemental techniques

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80 Part Two Markets, Segments, and Customer Value

draw mainly from the management accounting disci- and include activity-based costing, attribute costing,
pline and rely on data that are available only to internal benchmarking, brand valuation budgeting and moni-
decision makers. Many of the financial analyses in the toring, competitor cost assessment, competitive posi-
earlier sections employed data from published financial tion monitoring, competitor performance appraisal,
statements. integrated performance measurement, life cycle cost-
Only recently have marketing decision makers been ing, quality costing, strategic costing, strategic pricing,
able to look to management accounting to provide an target costing, and value-chain costing.4
additional set of quantitative tools to aid in the decision Exhibit 2A.8 also provides a description of the vari-
process.2 These tools may be referred to collectively as ous marketing applications of strategic management
strategic management accounting practices. Simmonds accounting practices in terms of specific decision-
is generally credited with originating the term strate- making situations. Most of these practices require
gic management accounting, which he defines as “the the marketing decision maker to gather information
provision and analysis of management accounting data additional to that normally used for the preparation of
about a business and its competitors for use in devel- external financial statements. In most cases, this infor-
oping and monitoring the business strategy.” 3 Although mation is already available in the accounting informa-
academic researchers may disagree about the specific tion system of the firm. However, it may be necessary
techniques which constitute strategic management to compile data from outside the firm in a more formal-
accounting, a wide selection of management account- ized manner to perform analysis using some of these
ing practices available for use in marketing decision strategic management accounting practices.
making. These practices are described in Exhibit 2A.8 4
For a comprehensive description of strategic management
2 accounting techniques and differences in attitudes toward
George Foster and Mahendra Gupta, “Marketing, Cost
the use of these techniques between accounting and market-
Management and Management Accounting,” Journal of
ing managers, see Karen S. Cravens and Chris Guilding, “An
Management Accounting Research 6 (1994), 43–77.
Empirical Study of the Application of Strategic Management
3
K. Simmonds, “Strategic Management Accounting,” Accounting Techniques,” Advances in Management Accounting
Management Accounting (UK) 59, no. 4 (1981), 26–29. 10 (2001), 95–124.

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 EXHIBIT 2A.8 Supplemental Financial Analyses Using Management Accounting Practices

cra81004_ch02_047-082.indd 81
Strategic Management
Accounting Practice Description of the Practice Description of Marketing Application
Activity-based costing Indirect costs are assigned to a product or service in This technique is particularly useful in determin-
relation to the activities used to produce the product ing the costs of customization or the provision of
or provide the service. Decision making focuses on additional services to customers. Since the activities
the collection of activities necessary to produce the are the central focus for costing, decision makers
product or service rather than the costs in a specific can evaluate customers and markets in terms of the
category. activities required to serve their needs.
Attribute costing Products or services are costed in terms of attributes The nature of the cost object can be modified
that appeal to customers. Thus, the cost object is to support different strategic decision-making
not the entire product but a collection of features situations. As customers modify their preferences,
that respond to customer needs. decision makers can consider how particular
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product attributes satisfy their needs relative to

marketing positioning strategies.
Benchmarking Benchmarking is improving existing processes by Benchmarking provides an opportunity to assess
looking to an ideal standard. The standard may processes for improvement and strategic advantage
be established from an external source such as a in terms of operational effectiveness. Critical lapses
competitor, a partner, or an unrelated industry or in customer service or customer contact situations
company or by another area of the same firm. can be remedied.
Brand valuation—budgeting Brand valuation assesses the current and future Current spending on brand promotion activities
and monitoring potential of a brand in quantitative terms. A can be evaluated in terms of future benefits. This
“capitalized” value for internally developed brands can assist with budgeting decisions relative to a
can be created even though in the United States this portfolio of brands or products and in monitoring
value may not be included on a balance sheet. the mix and potential of existing products.
Competitive position This type of analysis is used in evaluating the Since this technique requires an external focus, it
monitoring market strategy of a competitor. Overall competitor allows decision makers to assess the position of a
positions in the market and industry are assessed, product in terms of existing and future strategy
including sales and trend information, along with relative to competitors. Situations allowing a firm
market share and cost estimates. to improve competitive position can be identified
and acted upon.
Competitor performance This form of analysis is a detailed part of competitive Decision makers can identify the key areas of a
appraisal position monitoring and focuses on preparing a competitor’s market advantage and relate areas of
quantitative analysis of the competitor’s external advantage to strategic decisions.
financial statements.
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EXHIBIT 2A.8—(concluded)
Integrated performance This form of analysis uses performance appraisal Measures focusing on the customer can be linked
measurement based on measures that are developed in terms of a to overall strategic objectives throughout the
customer focus. Integrated measures may be linked organization. Decision makers can get a clear

cra81004_ch02_047-082.indd 82
to customer satisfaction and may include nonfi- picture of how their decisions (and performance)
nancial measures monitored at the individual and affect overall corporate performance.
departmental levels.
Life cycle costing A product or service is costed based on stages in Decision makers can adopt a longer-term perspec-
the life of a product rather than financial reporting tive to evaluate the performance of a product with-
periods. out the constraints of annual reporting periods.
Quality costing Accounting measures support determining the cost Decision makers can evaluate the impact on
of quality and the cost of a quality failure. customers and market position when choices are
made regarding quality issues.
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Strategic costing Strategic costing involves recognizing that the Long-term strategy and strategic objectives
ultimate objective of expenditures related to a considering product positioning and market
product or service may be more long-term in penetration can be evaluated more completely.
perspective. Thus, cost minimization is not the The long-term implications of a decision receive
prime objective. Choices involving costs are precedence over the short-term effect.
evaluated in terms of long-term issues and the
future potential of strategies.
Strategic pricing Strategic pricing adopts a more long-term and Pricing decisions can be evaluated more in terms of
demand-focused approach to pricing rather than competitive and market choices.
considering a cost-based and historical foundation.
Target costing A market-based approach is used to determine the Since the product is designed to meet the target
target cost for a future product. The target cost cost, decision makers know that the product will
is the remainder after a desired profit margin is be able to enter the market at a price that allows
subtracted from the estimated market price of a new an adequate level of profits. External rather than
product. internal factors determine the price.
Value-chain costing The cost of a product is evaluated over the entire Operational efficiencies and competitive
value chain of production from research and positioning can be evaluated at all stages of the
development to customer service. This value chain value chain, not merely from the costs incurred
may include multiple functional areas within the during production. Links to suppliers, customers,
organization and cover different financial accounting and competitors can be considered at all points of
reporting periods. the value chain.

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