1 Confidential - for classroom use only Reminder: The Marketing Imagination Per Theodore Levitt, Marketing is about – gaining differential advantage over.

1 Confidential - for classroom use only Reminder: The Marketing Imagination Per Theodore Levitt, Marketing is about – gaining differential advantage over competitors – getting and keeping customers in some acceptable proportion relative to competitors But getting a customer means he has to do something different than he otherwise would have done – The key is differentiation and segmentation – Because people do not buy things, they buy solutions to problems Your competitors are likely to know the same things as you – The key is being able to take differential advantage of your knowledge – Therefore, you must know your customers, your industry, your business

2 Confidential - for classroom use only The Marketing Plan

3 Confidential - for classroom use only The Marketing Mix Per E. Jerome McCarthy (Michigan State), the four P’s are 1. Product: refers to the specifications of the actual good or service, and how it relates to the end-user's needs and wants 2. Pricing: refers to the process of setting a price for a product, including discounts 3. Promotion: includes advertising, sales promotion, publicity, public relations, and personal selling, and refers to the various methods of promoting the product, brand, or company 4. Placement or distribution: refers to how the product gets to the customer; for example, point of sale placement or retailing. This fourth P has also sometimes been called Place, referring to “where” a product or service is sold, e.g. in which geographic region, industry, or customer segment Bernard Booms and Mary Bitner (Arizona State) extended the four P’s to seven when dealing with services rather than products, including 5. People: All people that are directly or indirectly involved in the consumption of a service are an important part of the Extended Marketing Mix. Knowledge workers, employees, management and consumers often add significant value to the total product or service offering. Whether as part of the original sale or as a supporting service to a product, people are particularly important because, in the customer's eyes, they are generally inseparable from the total service. As a result of this, they must be appropriately trained and motivated. 6. Process: Procedure, mechanisms and flow of activities by which services are provided and consumed, including the behavior of people. 7. Physical evidence: Unlike a product, a service cannot be experienced before it is delivered, which makes it intangible. This, therefore, means that potential customers could perceive greater risk when deciding whether or not to use a service. To reduce the feeling of risk, thus improving the chance for success, it is often vital to offer potential customers the chance to see what a service would be like. This is done by providing physical evidence, such as case studies, or testimonials. And some writers have even added an eighth – Packaging Adapted from http://en.wikipedia.org/wiki/Marketing

4 Confidential - for classroom use only Neil Borden’s Marketing Mix Jonathan Groucutt, et.al., Marketing (Kogan Page: 2004). ActionDescription Product planningPolicies and procedures relating to: product lines to be offered – qualities and design; markets to sell – whom, where, when and in what quantity; new product policy – research and development programmes. PricingPolicies and procedures relating to: price level to adopt; specific prices to adopt; pricing policy – one price or varying price or maintaining a constant price; margins to adopt – for company, for trade. BrandingPolicies and procedures relating to: selection of trade marks and copyrights; brand policy – individualized or family brand; sale as a private label or unbranded. Channels of distributionPolicies and procedures relating to: channels to use between plant and consumer; degree and selectivity among wholesalers and retailers; efforts to gain cooperation of the industry. Personal sellingPolicies and procedures relating to: Burden to be placed on personal selling and the methods to be employed in manufacturer’s organization, wholesale segment of the trade and retail segment of the trade. AdvertisingPolicies and procedures relating to: amount to spend – that is, the burden to be placed on advertising; copy platform to adopt – product image desired and corporate image to be desired; mix of advertising – to the related industry, through the industry, to consumers.

5 Confidential - for classroom use only Neil Borden’s Marketing Mix (contd.) Jonathan Groucutt, et.al., Marketing (Kogan Page: 2004). ActionDescription PromotionsPolicies and procedures relating to: burden to place on special selling plans or devices directed at or through the industry; form of these devices for consumer promotions, for industry (B2B) promotions. PackagingPolicies and procedures relating to: formulation of packaging and labelling. DisplayPolicies and procedures relating to: burden to be placed on display to help create sales; methods to adopt to secure display within point of sale locations: for example, a department store or bookshop. ServicingPolicies and procedures relating to: providing services needed. Physical handlingPolicies and procedures relating to: warehousing; transportation; inventories. Fact finding and analysisPolicies and procedures relating to: securing, analysis, and the use of facts in marketing operations.

6 Confidential - for classroom use only And Another Marketing Mix Per Ken Hudson (University of Technology, Sydney), the marketing mix is comprised of five I's: – ideas, information, imagination, interruptions, interactions 1. Ideas are transformed information with the intention of creating profit. 2. Imagination drives the future of products. "Brand imagination", for example, involves envisioning where a brand could be in 5 years time and the action today to make the vision happen. 3. Interruptions refers to the need to disrupt familiar patterns of thinking and behaving. Growing market share involves bringing customers around to your way of thinking. 4. Interactions involves the crucial importance of listening and understanding what customers want. Adapted from http://www.highperformancethinking.com.au/the-founder.htm

7 Confidential - for classroom use only The Marketing Plan Define the business arena Define the arena within which you will search for attractive opportunities Identify attractive opportunities Segment the market Evaluate market forces Understand the market environment Define market chains Understand buyer choice/rejection behavior Assess resources and competencies Identify resources and competencies Determine fit Understand the competitive challenge Analyze current and potential competitors Understand strategy drivers Make tough strategic choices Review past strategy and identify strategic issues Create options Make choices Plan critical relationships Identify key players Plan relationships Organize relationship teams Complete the winning strategy Detail complete strategy Ensure strategic leverage for market chain members Understand the profit dynamic Estimate market acceptance Develop price, cost, and investment forecast A marketing plan is a detailed and focused strategy for designing a marketing mix to meet consumer needs and wants and to realize a sustainable competitive advantage, and includes the following elements:

8 Confidential - for classroom use only The Marketing Plan William A. Cohen, The Marketing Plan (Wiley: 2005).

9 Confidential - for classroom use only The Marketing Plan (contd.) William A. Cohen, The Marketing Plan (Wiley: 2005).

10 Confidential - for classroom use only The Four P’s: Product

11 Confidential - for classroom use only Introduction: Product Strategy Product Definition Product decisions start with an understanding of what a product is—namely, the product offering is not the thing itself, but rather the total package of benefits obtained by the customer. This idea has had a number of names (e.g., the total product concept, the augmented product, or the integrated product). For marketing strategy development purposes, the product has to be considered from the point of view of value delivered to the customer. Value can be delivered simultaneously by a number of vehicles, for example: The physical product itself Brand name Company reputation Presale education provided by salespeople Post-sale technical support Repair service Financing plans Convenient availability Word-of-mouth references from earlier adopters Reputation of the outlet where the product was purchased Product Line Planning Decisions A taxonomy of product line planning decisions is best developed by considering examples of some product planning decisions firms face: 1. Product line breadth: Product line breadth decisions are how many different lines the company will offer. A guiding principle in answering breadth questions is the company’s position on desired consistency or similarity between the lines it offers. Some firms say, for example, “We market only products that draw on our skills in small-motor technology,” while others are more broad, “We sell products that draw on our superior consumer products marketing skills.” 2. Product line length: that is, how many items there will be in a line providing coverage of different price points. 3. Product line depth: that is, how many types of a given product there will be. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

12 Confidential - for classroom use only Products A product can be defined as anything that is offered to a market for consumption (in one form or another) and that satisfies a need. Products can be classified along a number of dimensions, including: 1.The nature of customers’ buying behavior: Marketers typically speak of convenience goods when products are frequently purchased without much deliberation. Such goods are typically widely available. The purchase of shopping goods involves more planning and some comparison shopping by customers. Specialty goods are characterized by relatively inelastic demand and little or no comparison shopping. They are only available in selected outlets. 2.The level of involvement in the purchase process: A related dimension, products are often characterized as either low involvement, meaning requiring little deliberation by customers, or high involvement, meaning that customers invest significant time and effort in the purchase process. 3.The type of benefit: Some products deliver mostly functional or utilitarian benefits (i.e., have a logical, rational advantage), while other products primarily address an emotional, ego-expressive need. While it is often helpful to think of these product classes, it is important to recognize that different customers may place the same products in entirely different classes. Similarly, different manufacturers competing in the same product category may position their products at opposite sides of the spectrum. Products can be divided into tangible goods (i.e., physical products) and intangible goods (such as services, events, people, places. And ideas). Services are offerings that do not result in the ownership of anything— think of hotels, legal services, or consulting. However, in practice, many products have both a tangible and an intangible component. Examples are everywhere: coffee shops sell coffee in a comfortable atmosphere and often allow customers to stick around as long as they want, car dealers usually sell cars with the promise of free checkups and discounted repair services, and restaurants often offer to box leftovers. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

13 Confidential - for classroom use only Product Mixes It is typically useful to consider critical product policy decisions in the context of a firm’s product mix. A product mix encompasses all product lines. A product line is a group of items that serve a similar function. For example, Snapple’s product mix is made up of five product lines: iced tea, lemonade, juice, water, and Snapple-On-Ice popsicles. Each product line can be described in terms of its length, which refers to the number of items within the product line (e.g., Lemon, Lime Green, Raspberry, and Peach iced tea flavors), and depth, which refers to the number of versions of each product in the line (e.g., Lemon and Diet Lemon). Each firm faces the task of determining the optimal product line length and depth, as well as the optimal number of product lines. It is often also useful to consider the consistency of a product mix (i.e., the extent to which the product lines share relevant characteristics)—for example, that they draw on the same underlying technology or serve the same market segment. Since four or five Snapple product lines are beverages that are consumed in similar ways and, presumably, by similar consumer segments, and its line of popsicles may largely appeal to the same segment, most marketers would describe its product mix as highly consistent. Product lines can stretch out on horizontal and vertical dimensions. Snapple’s offerings differ on a horizontal level in that they do not differ in an objective sense—it is a matter of consumer taste whether Snapple’s cranberry raspberry is better than its Snapple apple or vice versa. In a vertical product line, products are more dearly delineated on a price or performance basis. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

14 Confidential - for classroom use only Types of Products 1.Specialty goods: extensive comparisons with other goods and a lengthy information search. Specialty goods are generally items that would fall into another category, but the seller of these goods has chosen a specific niche market and is extremely narrowly focused. An example would be a cigarette and tobacco shop, or a shop that only sold items with owl pictures on, or a shop that only sells books and magazines. 2.Unsought goods: e.g., cemetery plots, insurance. These are products that we need but which we do not actively seek out to buy. They usually require a hard sell approach by the seller. Example "what will happen to your family if you die and do not have life insurance?" The fear of leaving the family destitute makes us buy almost against our will, even though we know that it is the intelligent thing to do. Certain legal services such as drawing up a will, would also fall into this category. 3.Perishable goods: goods that will deteriorate quickly even without use 4.Durable goods: goods that survive multiple use occasions, often further subdivided into `white goods' (refrigerators and cookers, for example) and `brown goods' (such as furniture, as well as electrical/electronic devices) 5.Non-durable/consumption/consumable goods: goods that are used up in one occasion 6.Capital goods: installations, equipment, and buildings 7.Parts and materials: goods that go into a finished product 8.Supplies and services: goods that facilitate production 9.Commodities: undifferentiated goods (e.g., wheat, gold, sugar) 10.By-products: a product that results from the manufacture of another product http://en.wikipedia.org/wiki/Product_%28business%29

15 Confidential - for classroom use only Core and Augmented Product These examples illustrate that products are often bundles of benefits that satisfy customer needs. As depicted in the figure, marketers distinguish the core product and the augmented product. The core product is what consumers are actually buying—it serves a direct, primary benefit. The augmented product offers additional benefits. For customers who appreciate these added benefits, the augmented product is more valuable than the core product—they are willing to more for grape juice in a Snapple bottle than for the same blend in a generic bottle, even if it comes from the same grapes. Brand associations enhance the core product. Brands are names or symbols that marketers have introduced to make product differentiation concrete. They assert that a firm’s products are different from those offered by competitors. Brand equity is the term used for the positive effect that the brand has on a potential customer of a product—it reflects how much more consumers are willing to pay for a particular brand compared with a competing band (or with a generic product). However, augmentation can come in a variety of ways. Other important tools of differentiation are customer service, installation, repair and delivery services, warranties, and credit possibilities. As products mature and competitors are introducing “me-too” products that efficiently deliver the same core product attributes, firms can use such augmentations to create a sustainable differentiated offering. Intangibles like brands and services are often particularly helpful differentiation tools because they are relatively hard to copy by competitors. Because of the relatively high costs associated with building brands or offering quality customer service, and because of the uncertain pay-off of such investments, competitors are often reluctant to match those expenses in the short run. In sum, when making product policy decisions, marketers must: 1.Recognize the core customer need they intend to satisfy 2.Verify whether their core product is ideally suited to satisfy that need and, if not, how it can be redesigned 3.Understand how they can best augment their core product to create the bundle of benefits that will provide the most satisfying customer experience and shield the company from threats by competitors Alvin J. Silk, What is Marketing? (HBS Press: 2006). core product augmented product

16 Confidential - for classroom use only Reminder: The Total Product Offering Total product offer consists of: Product attributes –Price: offsets to a product’s quality (financial, time, psychological, and social) –Quality: a global evaluative judgment of a product –Features and benefits –Design Brand image –the combination of physical characteristics, psychological value, and all the information embodied by the elements of the marketing mix Packaging Labeling Support services There are three aspects to any product or service: 1.Core benefit –In-use benefits –Psychological benefits (e.g., self- image enhancement, hope, status, self worth) –Problem reduction benefits (e.g., safety, convenience) 2.Tangible product or service –Product attributes and features –benefits and usability of market 3.Intangible product or service

17 Confidential - for classroom use only Key Attributes of Services Intangibility - They cannot be seen, handled, smelled, etc. There is no need for storage. Because services are difficult to conceptualize, marketing them requires creative visualization to effectively evoke a concrete image in the customer's mind. From the customer's point of view, this attribute makes it difficult to evaluate or compare services prior to experiencing the service. Perishability - Unsold service time is "lost", that is, it cannot be regained. It is a lost economic opportunity. For example a doctor that is booked for only two hours a day cannot later work those hours— she has lost her economic opportunity. Other service examples are airplane seats (once the plane departs, those empty seats cannot be sold), and theatre seats (sales end at a certain point). Lack of transportability - Services tend to be consumed at the point of "production" (although this doesn't apply to outsourced business services). Lack of homogeneity - Services are typically modified for each client or each new situation (customized). Mass production of services is very difficult. This can be seen as a problem of inconsistent quality. Both inputs and outputs to the processes involved providing services are highly variable, as are the relationships between these processes, making it difficult to maintain consistent quality. Labor intensity - Services usually involve considerable human activity, rather than precisely determined process. Human resource management is important. The human factor is often the key success factor in service industries. It is difficult to achieve economies of scale or gain dominant market share. Demand fluctuations - It can be difficult to forecast demand (which is also true of many goods). Demand can vary by season, time of day, business cycle, etc. Buyer involvement - Most service provision requires a high degree of interaction between client and service provider. Client-Based Relationships - Is based on creating long-term business relationships. Accountants, attorneys, and financial advisers maintain long-term relationships with their clients for decades. These repeat consumers refer friends and family helping to create a client-based relationship. http://en.wikipedia.org/wiki/Services

18 Confidential - for classroom use only Reminder: What to Sell In a high tech firm, technology itself either is the product or gives rise to the product, which gives rise to the following questions: –Should the firm sell the knowledge itself or possibly license it? –Should the firm commercialize the idea – marketing, distributing, and selling a full solution including service and support –Or, given that final products can be “decomposed” into subsystems and components, should firms manufacture and sell some subsystem or component on an OEM basis Possible options: 1.Sell or license know-how only –Requires the greatest additional expenditures of funds by the customer after the transaction to realize the intended benefit 2.Sell proof-of-concept –Sale may include a prototype or pilot to establish that the know-how can be made to work 3.Sell commercial-grade components to OEMs –Firms may manufacture and sell components that are ready to use in another firm’s manufactured product 4.Sell final products or systems with all essential components, ready for use “out of the box” –For example, Dell computers 5.Sell a complete, end-to-end solution –This whole product solution delivers the intended benefits directly to customers with no need for them to incur additional expenditures on complementary items The decision is based on the amount of required expenditures by customers to drive the intended benefits above and beyond their acquisition costs, and to reduce their uncertainty Jakki Mohr, Marketing of High-Technology Products and Innovation, (Prentice Hall: 2001)

19 Confidential - for classroom use only The Four P’s: Promotion

20 Confidential - for classroom use only Introduction Marketing is the process through which a firm creates value for its chosen customers by meeting those customers’ needs. The firm is then entitled to capture a portion of the created value through pricing. But before this can happen, the consumer not only must be aware of the product’s existence but also must sufficiently value it to choose the firm’s product over competitive products or over not buying at all. This is where marketing promotions come into play. The six Ms model for communications planning can be used for both strategy and implementation: 1.Market:To whom is the communication addressed? 2.Mission:What is the objective of the intervention? 3.Message:What are the specific points to be communicated? 4.Media:Which vehicles will be used to execute on the goals? 5.Money:How much will be spent in the effort? 6.Measurement: How will impact be assessed after the campaign? Alvin J. Silk, What is Marketing? (HBS Press: 2006).

21 Confidential - for classroom use only Goals of Marketing Communication Primary goals 1. To inform 2. To persuade 3. To remind 4. To influence Specifically, to – recruit new users who have never tried the product class – encourage former users of the product to renew purchases – encourage users of competitors’ brands to switch – recruit switchers who are loyal to no brand – increase consumption by current users

22 Confidential - for classroom use only Hierarchy of Effects Resolving the strategic component of the promotions plan begins with a careful analysis of the target consumers’ decision-making process (DMP). Although the ultimate goal of a marketer is to have a consumer buy the firm’s product or service, there is typically a sequence of steps a consumer goes through leading up to the actual purchase. A valid communications goal can be to move the customer from one of these early steps to the next. A general model of the steps that a consumer may go through is called the hierarchy of effects model. 1.Cognitive stage:unaware of productawareness 2.Affective stage:knowledgeliking 3.Behavioral stage:preference The steps presented above can be described in terms of type of response required from consumers to move along in the hierarchy: cognitive, affective, and behavioral. In the cognitive stage, the communications job is to put some facts into the mind of the potential consumer. The first step is to make a consumer aware of the existence of the product and then build knowledge by conveying some information about it. The remaining steps in the affective stage are to move from liking to preferring the product over others and finally having a strong intent or conviction to buy it. The process advances to the behavioral stage that culminates in a repeat purchase of the product. There is no one universally applicable model of the purchase process. The level of involvement and hedonic dimensions of the product will necessarily change the hierarchy of effects through the elimination, addition, or reversal of different stages. In addition, the time between purchases can affect whether the last stage above is relevant. For instance, real estate developers will lot concern themselves with getting the family that just bought one of their properties to purchase from them again when the family moves to another state ten years from now. In contrast, firms may be very concerned about the purchase-repurchase cycle if the Stream of income a customer provides is high relative to any individual purchase (e.g., prescription drugs for chronic conditions or household cleaning supplies). Alvin J. Silk, What is Marketing? (HBS Press: 2006).

23 Confidential - for classroom use only More on Hierarchy of Effects A term summing up the proposition that ADVERTISEMENTS exert their influence on the audience by a simple hierarchical progression of effects. First postulated 70 years ago, it continues to dominate the conceptual frameworks of textbook authors and advertising practitioners alike, despite severe criticism on theoretical and experimental grounds over the years. It is a clearly detectable implicit assumption in much if not most of what is written on both advertising effect and the measurement of ADVERTISING EFFECTIVENESS today. Over the intervening seven decades, a considerable number of 'verbal models' of the hierarchy-of-effects have been published in the academic and practitioner literature- each different, but all clearly closely related. The most familiar four are: 1.Daniel Starch, 1923: 'To be effective, an advertisement must be...seen - read - believed - remembered - acted upon' 2.E.K. Strong, 1925: 'AIDA': attention - interest - desire - action 3.Robert C. Lavidge and G.A. Steiner, 1961: 'Hierarchy of Effects': awareness - knowledge - liking - preference - conviction - action. 4.Russell H. COLLEY, 1961: 'DAGMAR': unawareness - awareness - comprehension - conviction - action. Psychologists would recognise these as a specific example of the generic 'cognitive-affective-conative' or 'C- A-C' pattern of response to stimuli other than advertisements. Cognitive responses are the outcome of thinking about what is happening, affective responses result from an emotional reaction to the stimulus, and conative responses involve consequent actions. Colloquially, the C-A-C model is summed up by the vividly explanatory 'think-feel-do'. http://www.westburnpublishers.com/marketing-dictionary/h/hierarchy-of-effects.aspx

24 Confidential - for classroom use only More on Hierarchy of Effects (contd.) What the hierarchy-of-effects hypothesis does not do is explain how the audience is propelled, or voluntarily progresses, through the levels of the hierarchy of effects. More specific criticisms have also been made by academic theorists over the last 30 years. Most influential among the objectors is KRISTIAN S. PALDA, who published a widely reported evaluation of Lavidge and Steiner's model. The first of his fundamental objections, based on a priori reasoning, is that progression from one rung of a hierarchical ladder to the next does not mean that the probability of eventual action has necessarily been increased. …Their view is that, once the decision to try a new product has been arrived at, probably somewhat arbitrarily, and provided that the first trial is not an unsatisfactory experience, a stable pattern of subsequent re-selection develops. The user then deliberately pays attention to advertising for the product, which in turn reinforces the choice. In other words, 'do' responses trigger 'think' responses and precipitate 'feel' responses aimed at rationalisation of a choice already made. This is certainly not the sequence of the orthodox hierarchies. Despite the serious shortcomings of the conventional hierarchy-of-effects models, we have to recognise and accept that they are still the implicit conceptual underpinning of present-day advertising practice, in the great majority of cases. In particular, this means that the measurement of ADVERTISING EFFECTIVENESS is implicitly based on a learning hierarchy. This must remain the case, of course, until marketing academics are able to produce a better model which practitioners can understand and are willing to use. http://www.westburnpublishers.com/marketing-dictionary/h/hierarchy-of-effects.aspx

25 Confidential - for classroom use only A Communications Model Source – Message – Medium – Receiver Source – the sender. Potential buyers pay the most attention to three specific characteristics of the sender: 1. Credibility – includes expertise, trustworthiness, sincerity, honesty, and consistency – The most credible sources are physically attractive, command respect or sympathy, and exude charisma 2. Attractiveness – in the broadest sense of the word – The more attractive the source, the more likely we are to inflate the utility of the message from that source. Consumers feel more comfortable and less threatened by someone they like 3. Mediation of rewards and punishments – the source must have the ability to dole out rewards and punishments and be willing to use that power and the receiver must understand that the source can and will use that power under the right circumstances

26 Confidential - for classroom use only A Communications Model (contd.) Message – both the content and the structure of the message: 1. Rational appeal – usually contains a set of facts, a conclusion, and an appeal to the receiver’s self-interest and ability to reason. – Emphasizes product attributes and consequences of use 2. Emotional appeal – plays on the feelings of the consumer – Some emotional appeals try to grab our attention so that it can then be focused on cognitive appeals, while some go straight for the heart, stimulating the consumer to act without thinking – Three basic tactics include positive or negative moods, humor, and fear 3. Distraction – an attempt by advertisers to limit the amount of counter-argumentation going on in the consumer’s head – One way is to get the consumer to focus on several things at once, then subtly distract that part of the consumer’s mind that would be formulating counter-arguments, and thereby let the main argument through – For example, advertisements commonly include audio or visual parts that are incidental to the main message 4. Foil – the person in the ad who is learning and absorbing the message, thereby getting the consumer to unconsciously learn and absorb the message Medium – can be personal or non-personal, i.e. the key variable is the distance between the sender and the receiver Receiver – impacted by demographics, personality traits, and past learning

27 Confidential - for classroom use only Issues in Structuring Messages 1. One-sided vs. two-sided appeals – Persuasive communication that presents only one point of view; also called one-sided appeal. Most mass media advertising messages are one-sided. A one-sided message is more appropriate for an audience that is favorably disposed toward the view being presented or is unlikely to be exposed to the other side. A religious fund-raising appeal is usually one-sided on the assumption that the targeted audience is favorably disposed toward the view being expounded and is unlikely to be receptive to other religious beliefs. With a more skeptical audience, a one-sided message is less effective than a two-sided message which presents both points of view and then arguments to counter the opposing view. – Persuasive communication that presents two points of view and then presents arguments to counter the opposing view; also called two-sided appeal. A two-sided message for a service bureau might acknowledge that a competitor is located closer to the prospect and then assert that proximity is irrelevant if the service bureau is doing a good job. A two-sided message is more appropriate to an audience that is favorably disposed toward the opposing view or is likely to be exposed to strong arguments for the other side. An audience that favors another brand or point-of-view must be persuaded to abandon that view before a new view can be accepted. Two-sided messages work best with an educated audience that tends to make informed choices like industrial buyers. The order in which the views are presented in a two-sided appeal can affect the impact of each message depending upon the audience characteristics. 2. Order of presentation of arguments – Should the key arguments be presented in the beginning, middle, or end of the message? – The issue is which order is most likely to attract attention (beginning) and which is most likely to be remembered (end) 3. Amount of information, i.e. the fear of information overload 4. Repetition, which occurs in two ways, within a message and by repeating the same message – As the number of repetitions increases, recall increases, but at a slowing rate, making advertising more expensive over time in relation to increased sales – Repetition means that it is more likely that the message will be remembered when the decision time comes http://www.answers.com/topic/

28 Confidential - for classroom use only Constructing a Persuasive Message Per Steve Booth-Butterfield (West Virginia University): 1. Intent. Forewarned is forearmed. Therefore, simply present the persuasive message without warning. 2. Organization. Structure produces comprehension. Chaos produces confusion. Therefore, make the message clear and organized. 3. Examples versus statistics. Examples are easier to comprehend and generate greater thoughtfulness than statistics. Therefore, prove your points with examples your receivers find compelling. 4. Sidedness. There are two sides to every issue. Messages which defend one side and attack the other are more effective. Therefore, support your position, but make sure you point out weaknesses in other views. 5. Repetition and redundancy. The frequency with which a message is given enhances influence to a balance point. Past that point repetition will annoy and frustrate receivers. Redundancy will delay reaching the balance point, but will not prevent it. Repetition works to improve comprehension. Therefore, expect to repeat your messages several times to make sure everyone gets the word and understands the word. 6. Rhetorical questions. Statements hidden as questions work well when given in advance of the main message. Rhetoricals serve to enhance attention and message processing. Therefore, use rhetoricals to get or regain attention before you make you major points. 7. Fear appeals. Fear also leads to more thinking about the persuasive message. More fear leads to more thinking (except perhaps in extreme, real-world situations). If you feel comfortable with it, use fear appeals to get the attention of your receivers. 8. Evidence. Something created by another person that you use is evidence. Evidence may be the most powerful message variable there is. It produces a simple equation: More good evidence, more influence. Therefore, always include the best evidence for your receivers. http://www.as.wvu.edu/~sbb/wvsbbhp.html

29 Confidential - for classroom use only Types of Marketing Communication Traditional promotional mix includes: 1. Advertising 2. Sales promotions 3. Publicity 4. Personal selling Other forms of marketing communication: – Direct marketing – Sponsorship – Product placement – Exhibitions – Viral marketing (i.e. word of mouth)

30 Confidential - for classroom use only Advertising Per the American Marketing Association, – Paid, non-personal presentation of ideas, goods, and services by an identified sponsor Per Courtland Bovee (Grossmont College), – "Advertising is the nonpersonal communication of information usually paid for and usually persuasive in nature about products, services or ideas by identified sponsors through the various media." Advantages of advertising: – First, advertising has, comparatively speaking, all the time in the world. Unlike personal selling, the sales message and its presentation does not have to be created on the spot with the customer watching. It can be created in as many ways as the writer can conceive, be rewritten, tested, modified, injected with every trick and appeal known to affect consumers. – Second, although advertisers may not see the individual customer, nor be able to modify the sales message according to that individual's reactions at the time, they do have research about customers. The research can identify potential customers, find what message elements might influence them, and figure out how best to get that message to them. Although the research is meaningless when applied to any particular individual, it is effective when applied to large groups of customers. – Third, and perhaps of most importance, advertising can be far cheaper per potential customer than personal selling. Personal selling is extremely labor-intensive, dealing with one customer at a time. Advertising deals with hundreds, thousands, or millions of customers at a time, reducing the cost per customer to mere pennies. In fact, advertising costs are determined in part using a formula to determine, not cost per potential customer, but cost per thousand potential customers. – Thus, it appears that advertising is a good idea as a sales tool. For small ticket items, such as chewing gum and guitar picks, advertising is cost effective to do the entire selling job. For large ticket items, such as cars and computers, advertising can do a large part of the selling job, and personal selling is used to complete and close the sale. Adapted from http://www.wsu.edu:8080/~taflinge/addefine.html

31 Confidential - for classroom use only Some communications options, such as television, are limited to transferring broadcast, one-way messages. Other media alternatives, like telemarketing, allow for instantaneous feedback. There is also a full spectrum of customization of the message. On the one hand, broadcast advertising on network television reaches millions of consumers with the same message. On the other hand, direct mail advertisements can customize or even personalize the message to new homeowners in particular zip codes.… This increases across-the-board competition for the consumer’s attention and makes it more difficult to break through the clutter. Alvin J. Silk, What is Marketing? (HBS Press: 2006). Most broadly defined, advertising refers to the paid placement of announcements and persuasive messages in time or space to inform and/or persuade members of a particular target market or audience about a product, service, organization, or idea. Within advertising, one can distinguish among many tools, which differ on two dimensions: level of feedback and customization.

32 Confidential - for classroom use only Advertising In Media Is Particularly Effective In: 1. Creating awareness of a new product 2. Describing features of the product 3. Suggesting usage situations 4. Distinguishing the product from competitors 5. Directing buyers to the point of purchase 6. Creating or enhancing a brand image Alvin J. Silk, What is Marketing? (HBS Press: 2006).

33 Confidential - for classroom use only Sales Promotion Promotion is communicating information between the seller and potential buyer or others in the channel to influence attitudes and behavior. Objectives include: – Creating, maintaining and reinforcing brand awareness. – Creating, maintaining and reinforcing a positive image of the brand in the mind of the customer. This is equally as important a B2B scenario as it is in a consumer one. – Influencing the views and decisions of key opinion formers. These range from government officials and politicians through to individual consumers or business customers. – Creating the environment for the customer to purchase the product or service. We can include here ease of purchase. – Providing after sales communications in order to create customer retention. Linked to this is the ongoing development of relationship marketing. Sales promotion is the creation of incentives to encourage purchase or selling – Promotion involves disseminating information about a product, product line, brand, or company – Promotion is the act of furthering the growth or development of a business by keeping products or services in the minds of the target market – Promotion helps stimulate demand for a business’ services and involves ongoing advertising and publicity Adapted from Jonathan Groucutt, et. al., Marketing: essential principles, new realities, (Kogan Page: 2004).

34 Confidential - for classroom use only Because most products are sold through independent channels, channel partners can play a crucial role in influencing the consumer’s buying process. Channels not only fulfill demand, but they are also involved in demand generation, after-sale service, and market feedback crucial for marketing strategy development. Manufacturers can use sales promotions to support or supplement channels in their marketing efforts on behalf of the product’s manufacturer. There are two main types of sales promotions: consumer promotions and trade promotions. Consumer sales promotions are designed to accomplish one or more of the following objectives: product trial; repeat usage of product; more, frequent or multiple product purchases; awareness about a new/improved product; new packaging or different size packages; neutralizing competitive advertising or sales promotions; encouraging consumers to trade up to a larger size, more profitable line, or another product in the line. Consumer sales promotions often take the form of coupons, free samples, rebates, or premiums. A rebate returns a portion of the purchase price to the buyer in the form of cash. It commonly requires that a consumer sends proof of purchase and a rebate document to a processing center. A premium is an item of value, other thin the product itself, given s an additional incentive to influence the purchase of a product. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

35 Confidential - for classroom use only Because consumer promotions induce consumers to seek out specific products or brands from the retail channels, they are commonly referred to as “pull strategies.” The definition of pull is also commonly expanded to encompass advertising because that form of promotion is also meant to get the consumer to demand the product at the point of sale. Trade promotions are financial incentives to the channel aimed at gaining support to carry an item, increase its visibility, or lower its price. Ultimately, the trade cares about product margins and the speed with which the product moves off its shelves. These financial incentives either directly increase retail margins or are passed through to consumers in the form of temporary price discounts, coupons, or placement in feature advertising in local Sunday newspapers. If trade promotion dollars are passed on to consumers, the retailer benefits through an increased rate at which the product moves off the shelves. Because trade promotions help the manufacturer to “push” products through the channel, they are commonly referred to as “push strategies.” Alvin J. Silk, What is Marketing? (HBS Press: 2006). Push and Pull Strategies (contd.)

36 Confidential - for classroom use only Publicity Per the American Marketing Association: – Any form of non-paid commercially significant news or editorial comment about ideas, products, or institutions Publicity is the management of product- or brand-related communications between the firm and the general public. It is primarily an informative activity (as opposed to a persuasive one), but its ultimate goal is to promote the client's products, services, or brands. – A basic tool of the publicist is the press release, but other techniques include telephone press conferences, in-studio media tours, multi-component video news releases (VNR’s), newswire stories, and internet releases. For these releases to be used by the media, they must be of interest to the public (or at least to the market segment that the media outlet is targeted to). The releases are often customized to match the media vehicle that they are being sent to. – Getting noticed by the press is all about saying the right thing at the right time. A publicist is continuously asking what about you or your company will pique the reader's curiosity and make a good story? The most successful publicity releases are related to topics of current interest. These are referred to as news pegs. http://en.wikipedia.org/wiki/Publicity

37 Confidential - for classroom use only Public Relations (PR) Public relations is company-influenced publicity directed at building goodwill between an organization and potential customers. – According to two American PR professionals Scott M. Cutlips and Allen H. Center, "PR is a planned effort to influence opinion through good character and responsible performance based upon mutual satisfactory two-way communication". Public relations is the art and science of managing communication between an organization and its key public constituents to build, manage, and sustain its positive image. Public relations involves: – Evaluation of public attitudes and opinions. – Formulation and implementation of an organization's procedures and policy regarding communication with its publics. – Coordination of communications programs. – Developing rapport and good-will through a two way communication process. – Fostering a positive relationship between an organization and its public constituents. One of the earliest definitions of PR was coined by Edward Bernays. According to him, "Public Relations is a management function which tabulates public attitudes, defines the policies, procedures and interest of an organization followed by executing a program of action to earn public understanding and acceptance. " Adapted from http://en.wikipedia.org/wiki/Public_relations

38 Confidential - for classroom use only Personal Selling Personal selling is a promotional tool in which a salesperson communicates one-on-one with potential customers. Personal selling is – personal presentation by the firm’s sales force for the purpose of making sales and building customer relationships – paid personal communication that attempts to inform customers and persuade them to purchase products or services

39 Confidential - for classroom use only The Selling Process 1. Prospecting: Prospecting refers to identifying and developing a list of potential clients. 2. Pre-approach: Before engaging in the actual personal selling process, sales professionals first analyze all the information they have available to them about a prospect to understand as much about the prospect as possible. 3. Approach: The approach is the actual contact the sales professional has with the prospect. This is the point of the selling process where the sales professional meets and greets the prospect, provides an introduction, establishes rapport that sets the foundation of the relationship, and asks open-ended questions to learn more about the prospect and his or her needs. 4. Making the Presentation: During the presentation portion of the selling process, the sales professional tells that product "story" in a way that speaks directly to the identified needs and wants of the prospect. A highly customized presentation is the key component of this step. 5. Overcoming Objections: Professional salespeople seek out prospect objections in order to try to address and overcome them. 6. Closing the Sale: Although technically "closing" a sale happens when products or services are delivered to the customer's satisfaction and payment is received. 7. Followup: Followup is an often overlooked but important part of the selling process. After an order is received, it is in the best interest of everyone involved for the salesperson to followup with the prospect to make sure the product was received in the proper condition, at the right time, installed properly, proper training delivered, and that the entire process was acceptable to the customer. This is a critical step in creating customer satisfaction and building long-term relationships with customers. http://www.davedolak.com/psell.htm

40 Confidential - for classroom use only Reminder: Organizational Buying is Different Organizational buying is usually characterized by these variables: 1.The relative size and concentration of the buyers 2.Multiple decision makers within any organization 3.The relative complexity of reaching decisions in an organizational/group environment 4.The potential existence of close and intricate relations between seller and buyer 5.The leasing of equipment and space rather than ownership 6.The requirement for exact product specifications 7.The existence of professional buyers in most organizations 8.The employment of competitive bidding and negotiations A buying center is a group of employees responsible for purchasing an item for the organization. In a business setting, major purchases typically require input from various parts of the organization, including finance, accounting, purchasing, information technology management, and senior management. Highly technical purchases, such as information systems or production equipment, also require the expertise of technical specialists. Organizational buying roles include: –End users –Gatekeepers: people who control access to members of the decision team, for example secretaries –Influencers: people who influence the buying decision because of their expertise or authority –Deciders: people who make the decision to purchase –Approvers: people who must approve the decision of the deciders –Buyers: people responsible for purchase arrangements Adapted from http://en.wikipedia.org/wiki/Buying_center

41 Confidential - for classroom use only The Four P’s: Place

42 Confidential - for classroom use only Place (Marketing Channels) Strategy The marketing channel is the set of mechanisms or the network which a firm goes to market—that is, is in touch with its customer for a variety of tasks ranging from demand generation to physical delivery of the goods. The customer’s requirements for effective support determine the functions that the members of the channel must collectively provide. V. Kasturi Rangan of Harvard’s Buiness School has identified eight generic channel functions that serve as a starting place for assessing needs in a particular context: 1. Product information 2. Product customization 3. Product quality assurance 4. Lot size (e.g., the ability to buy in small quantities) 5. Product assortment (refers to breadth, length, and width of product lines) 6. Availability 7. After-sale service 8. Logistics Alvin J. Silk, What is Marketing? (HBS Press: 2006).

43 Confidential - for classroom use only The Importance of Place: Examples Place, the marketing channel, is the set of mechanisms or the network via which a firm goes to market. There are four major classes of functions this network typically serves: 1.The channel first must generate demand for a product or service 2.and then fill that demand 3.and then provide for after-the-sale service, and 4.finally, the channel often serves a useful function in transmitting feedback from the customer base back to the manufacturer. When a company thinks about going to market it must consider what each of the functions will specifically entail and who will do them—the manufacturer or a chosen partner such as a distributor or retailer. Very different go-to-market systems can be found in the marketplace. For example:  Knoll Furniture, a leading maker of high-end office furniture systems, uses its own sales force to generate demand from the accounts. Demand fulfillment takes place through a dealer network.  Avon Products generated $5 billion in sales in 1997, selling through 2.6 million sales representatives worldwide. Selling mostly cosmetics and fragrances, these reps are independent agents, not employees of Avon, who work part-time selling to female customers on a door-to-door basis.  Tupperware follows a similar direct selling model for its food Storage containers, utilizing 950,000 independent Tupperware consultants worldwide. These consultants sell via the “party plan” in which potential customers gather at the home of a hostess for refreshments, product demonstration, and product ordering.  The Gap, Inc. designs all its own products, which it sells through more than 2,000 company-owned retail stores. It also deals in electronic retailing, opening the Gap Online ore at www.gap.com. It outsources manufacturing, purchasing from 1,200 suppliers, but manages the going-to-market phase entirely itself.  BMW, on the other hand, goes to market through partners. About 300 franchised dealers selling its automobiles in the United States. The dealers and BMW share responsibility for demand generation. BMW designs and implements national advertising. Dealers provide for product display and convenient testing by customers. Dealers fulfill demand, delivering vehicles to customers, and provide local after-the-sale service.  Compaq Computer sells primarily through third-party resellers. A systems integrator may obtain a Compaq computer and package it with other equipment to sell a system to a customer. Like the Gap, Compaq has a direct online selling capability. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

44 Confidential - for classroom use only Two Major Decisions in Designing Channels An important point with respect to channel design is that while there are options about whether a particular institution (e.g., a distributor) is included in the channel or not, the setting implicates specific tasks that must be accomplished by someone in the channel. One can eliminate a layer in the chain but not the tasks that performed. The popular phrase “we’ve cut out the middleman and passed the savings on to you” seems to indicate that the middleman represents all costs but no value added. The functions done by the middleman now have to be done by someone else. Thus, the recommended approach is to develop customer-driven systems assessing the channel structure and management mechanisms that will best perform the needed functions. The two major decisions in channels are: 1. Channel design, which involves both a length and breadth issue 2. Channel management—that is, what policies and procedures will be used to have the necessary functions performed by the various parties Alvin J. Silk, What is Marketing? (HBS Press: 2006).

45 Confidential - for classroom use only Channel Length Issues In addition to customer requirements, the major considerations in channel length issues are: 1. Account concentration: If a few customers represent the bulk sales opportunities (e.g., jet engines), a direct selling approach can be cost effective. If the target group is larger in number and more diffuse (e.g., toothpaste), then the services of someone like a retailer who can spread the costs of an account relationship over many products is warranted. 2. Degree of control and importance of direct customer contact: One reason to go direct may be the lack of intermediaries from whom the firm could secure adequate attention—that is, the firm lacks the power to gain some control over the intermediaries to ensure the necessary tasks are performed. Also, direct customer contact may be seen as a critical way to gain market understanding as an input into future product development efforts. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

46 Confidential - for classroom use only Channel Breadth The second part of the channel design issue is channel breadth (i.e., how intense should the firm’s presence be in a market area?). Does the firm wish to intensively distribute its product, making for maximal customer convenience (e.g., placing the product “within arm’s reach of desire/’ as Coca-Cola terms it), or does it wish to be more selective? More selectivity may be warranted if there is a market education or development task to be done. Thus, some automobile manufacturers, typically high-end (e.g., Infiniti), limit the number of dealers in an area to reduce the dealer’s concern that benefits of developing potential customers in a given area would accrue to another dealer free-riding on these efforts. In general, the strength of the argument for limiting distribution to selective or exclusive levels increases with: 1. The customer’s willingness to travel and search for the good 2. The unit cost of stocking the good 3. The amount of true “selling” or market development that must be done As a product becomes more well known, there is a tendency to become less selective in distribution. For example, personal computers moved from computer specialty stores to mass merchants and warehouse clubs over time as customer education requirements decreased. Thus, the right channel structure changes over time. This presents a significant challenge as the firm seeks to maintain flexibility in channels while complex legal and other relationship elements tend to cement distribution arrangements. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

47 Confidential - for classroom use only Three Types of Channel Breadth The basic alternatives with respect to channel breadth or intensity of market coverage are: 1.Exclusive distribution 2.Selective distribution 3.Intensive distribution In exclusive distribution, the manufacturer establishes only one reseller in each region to carry the product. The cost is that, with an exclusive policy, consumers must be willing to seek out the one outlet in their area carrying the brand. The middle ground between exclusivity and seeking the maximum coverage possible is selective distribution. In selective distribution, there is more than one reseller, but a limited number, in each market. The purposive limiting of the number of outlets is intended to increase the support the reseller provides the brand over the case of intensive distribution. Having more than one outlet is intended to increase shopping convenience over exclusive distribution. Finally, many manufacturers try to place their products with as many resellers as possible. For some markets, it is believed that “share of space” (i.e., retail shelf space) delivers “share of market,” and, thus, the objective is to be as widely and intensively distributed as possible. Note that it is not necessarily the case that the more outlets the product is in, the better off the manufacturer is. Moving from exclusive to intensive trades off reseller support in return for easier availability of goods for the consumer. Shaving cream, television, and exotic car represent categories of goods known as a “convenience good,” a “shopping good,” and a “specialty good,” respectively. Of course, no item can be definitely classified as any one of these three types for all consumers. However, the following is a useful guideline: Convenience good —> Intensive distribution Shopping good > Selective distribution Specialty good > Exclusive distribution Alvin J. Silk, What is Marketing? (HBS Press: 2006).

48 Confidential - for classroom use only Channel Conflict In a general sense, all parties in the marketing system want the product to do well. But conflicts can arise from: 1. Lack of congruence in goals—for example, the manufacturer’s number one priority may be to “build the consumer franchise,” while the distributor’s is to make money this quarter 2. Lack of consensus on who is doing what—for example, who is to perform certain functions such as after-the-sale service; who handles small accounts; who handles global or national accounts when assignments were originally made along a smaller geographic basis Channel management is a day-to-day “work-on-it” task rather than a “solve-it-once” situation. Attention to proper design of contracts and other explicit understandings can help to reduce the potential for conflict. Good communications (for example, through dealer panels that are comprised of a sample of respondents from dealerships whose feedback is measured repeatedly over time) can help facilitate development of understanding and trust that will almost always be necessary to resolve issues since contracts cannot typically anticipate all the situations that may arise. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

49 Confidential - for classroom use only Direct or Indirect Distribution? With an understanding of customer requirements in place, a primary question in channel design is whether distribution will be direct, indirect, or both (i.e., some customers served one way and others another). In direct distribution, there is no independent party between the firm and its customers…. In indirect distribution, there is a third party. This party may operate under contract to the firm (e.g., as in a franchise system), or it may act independently (e.g., as in a situation where a retailer pays for and takes title to the firm's goods and then is free to sell them at whatever price and in whatever fashion it desires). Through the 1960s, the conventional wisdom was that a firm should go to market either direct or indirect, but not both, because of the channel conflict that would result. The bias was toward going direct as soon as sales volume justified it, because direct distribution provided more control and direct contact with customers. By the early 1980s, more firms began simultaneously serving different target markets, each requiring different channel functions (e.g., one segment needed intense presale education; another did not). Thus there came a need to manage dual distribution, wherein different systems are used to reach each market segment efficiently and effectively. A firm’s sales force served some segments; a distributor served others. This move away from only one method of going to market has accelerated. Now a firm may sell through retail outlets and via direct mail; use its own sales force to call on some accounts; rely on distributors to call smaller ones; and rely on other customers to find the company’s 800 number or Web site, or to submit an order directly to the firm through some electronic data interchange system. In many firms, the economics of reaching the full set of its chosen target segments are such that a single approach for all customers simply won’t work. Thus, rather than making one decision, the firm must make a coordinated set of decisions by market segment, recognizing and preparing to manage the conflicts that may arise across the different channel types. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

50 Confidential - for classroom use only Determining the Most Appropriate Sales and Distribution Model As mentioned previously, companies must determine the most effective sales and distribution model for sustaining value based on their chosen business model; the complexity, value, and anticipated sales volume of the unique product offering; the customer being targeted; and the desired interaction between the customer, the company, and the product. In practice, however, there are other considerations that must be taken into account, including the size and financial resources of the company, degree of market complexity, and the extent of competition in the market space. If a company lacks the resources and/or access to capital necessary to build a sales force, then it has no choice but to use a distributor or enter into a third-party partnership with another manufacturer, at least in the short term. When an indirect sales and distribution model is determined to be the best option, then the company should assess the characteristics of its product to determine which type of indirect approach makes the most sense. For low-complexity or undifferentiated products, distribution through large national distributors is typically the best strategy (either under a private label or the manufacturer’s brand name). For a higher complexity product with strong competitive attributes, the company can either sell though specialized distributors or via a partnership agreement with a larger, well-established manufacturer. If the company has the resources to build a sales force, then a direct sales and distribution model becomes a possibility. A direct sales force is appropriate for complex, high-value products that can command high profit margins, but that will require significant support and training in return. When limited funding for a sales force exists, a hybrid model can be an effective strategy for moving a company from an indirect to direct sales and distribution model as shown below. Adapted from the Stanford Casebook

51 Confidential - for classroom use only The Four P’s: Pricing

52 Confidential - for classroom use only Introduction Understanding customers’ wants and needs is the foundation for building customer value. In turn, capturing that value falls to the marketing mix, commonly referred to as “the four P’s”: 1.Developing a product that satisfies those wants and needs 2.Designing a promotion program that conveys the value of that product to customers 3.Choosing a distribution program (i.e., place) that makes that product readily available 4.Designing a pricing strategy that simultaneously creates a consumer’s incentive to buy that product and the firm’s incentive to sell that product The first three of these marketing mix variables represent costs to the firm. Pricing’s role in the marketing mix is to tap into the value created and generate revenues (1)to fund the firm’s current value-creation activities, (2)to support research that will lead to future value creation, and (3)to generate a profit from the firm’s activities. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

53 Confidential - for classroom use only Two Primary Strategies The price is what consumers give up to obtain a product or service. There are two primary strategies: 1.Maximize profit 2.Maximize unit sales and market share A well chosen price should do three things: 1.achieve the financial goals of the firm (e.g. profitability) 2.fit the realities of the marketplace (will customers buy at that price?) 3.support a product's positioning and be consistent with the other variables in the marketing mix Price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product –price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising and promotional campaigns –a low price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors From a marketing perspective, an efficient price is a price that is very close to the maximum that customers are prepared to pay. Adapted from http://en.wikipedia.org/wiki/Pricing

54 Confidential - for classroom use only Determining Prices To set prices decisions must be made regarding: 1.Pricing strategy (skim, penetration, etc.) 2.Suggested retail price 3.Volume discounts and wholesale pricing 4.Schedule of payments 5.Cash and early payment discounts 6.Seasonal pricing 7.Bundling 8.Price flexibility 9.Price discrimination http://www.netmba.com/marketing/mix/

55 Confidential - for classroom use only The Value-Pricing Approach The value-pricing approach to product pricing is driven by a small handful of factors. One of these factors is the objective value the product delivers to the consumer. Also called true economic value, this is a measure of the benefits that the product delivers to the consumer, regardless of whether the consumer recognizes those benefits. A critical second factor is the perceived value of the product to a consumer. Perceived value is the value the consumer understands the product to deliver. Sometimes, a product’s benefits are readily apparent to the consumer, and perceived value approaches objective value with little effort by the firm. Other times, a product’s benefits are less obvious and need to be communicated by the firm to the consumer (e.g., via advertising or personal selling). In such cases, the perceived value of a product typically falls well below its objective value. The perceived value of a product also can be influenced by the price of competing products or substitutes. Company A may develop a product that creates great objective value for consumers. Consumers may recognize this value and be willing to pay a high price to obtain the product. However, if Company B introduces an identical product at a much lower price, the perceived value of Company A’s product will be reduced to the price of Company B’s product. The last major component to the economic approach to pricing involves the firm’s COGS. Just as the consumer requires an incentive to purchase a product, the firm requires an incentive to sell the product. To stay in business and make a positive return, a firm must charge a price that covers its cost of production. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

56 Confidential - for classroom use only Alvin J. Silk, What is Marketing? (HBS Press: 2006). By pricing above the COGS and below perceived value, the firm has an incentive to sell the product, measured as price – COGS, and the consumer has an incentive to purchase the product, measured as perceived value – price. In value-pricing terminology, the firm has “created” value by offering a product that the consumer values at a price greater than the firm’s COGS. In turn, by pricing between perceived value and COGS, the firm has “captured” some of that value for itself and has allowed consumers to capture the remainder. All of these economic factors come together to form the value pricing approach to pricing. In optimally pricing a product, a firm is bound at the upper end by the consumers’ perceived value for the product. This perceived value is influenced by the objective value of the product to the consumer, by the firm’s marketing effort to communicate that objective value, and by the price of substitute products. T the same time, the firm is bound on the lower end by its COGS.

57 Confidential - for classroom use only Assessing a Product’s Value to Customers But how does a firm determine the objective and perceived value of a product to a customer? For determining objective value, firms often rely upon an understanding of the potential buyer’s cost structure. For determining perceived value, firms often employ surveys in which potential buyers are asked directly about value. The following sections take a look at each, in turn. Determining Objective Value Through Cost-Structure Studies In a cost-structure study, one assesses the objective value or true economic value (TEV) of a product to a customer by understanding the competitive alternatives, the price and performance of those alternatives, and the buyer’s costs. TEV has two major components: TEV = Cost of the Next-Best Alternative + Value of Performance Differential … if the buyer has several alternatives, the calculation has to be relative to the best alternative. For example, what is the objective value of a flight on the Delta Shuttle to a busy banking executive who needs to get from Boston to New York? One could calculate the TEV relative to going on the bus—but this leads to an irrelevant number, as the best alternative is the US Airways Shuttle, flying essentially the same schedule as Delta from the same airport. In this case, the value of the performance differential is likely to be very small, as there is little product differentiation. Hence, in this situation, the executive’s TEV for Delta will be very close to US Air’s price. This approach is more useful when there is a performance differential to consider. A firm’s product may be superior to the next- best alternative in some dimensions but inferior in others. Alvin J. Silk, What is Marketing? (HBS Press: 2006). Next best alternativeNew product Operating cost/hour$10$15 Probability of system crash20% over one year1% over one year Price$75,000To be determined

58 Confidential - for classroom use only Example of Assessing a Product’s Value to Customers Consider a customer who needs such a system for a single year (after which it will be scrapped) and plans to use it for 2,500 hours over the course of that year. If the cost of a system crash to the buyer is $100,000 (e.g., the selling firm will bear the cost of any system crash after the first), the TEV for the new product can be calculated as: TEV = Price of Next-Best Alternative + System Crash Savings – Added Operating Cost = $75,000 + [.2(100,000) -.01 (100,000)] – [(2,500 hrs x $15/hr) – (2,500 hrs x $10/hr)] = $75,000 + $19,000 - $12,500 = $81,500 Thus, the objective value or TEV of this new product is $81,500, meaning a fully informed, rational consumer should be indifferent between the next-best alternative priced at $75,000 and the new product priced at $81,500. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

59 Confidential - for classroom use only Using Surveys to Determine Perceived Value While it is important to understand the objective value a new product delivers, it is equally important to understand the value of that product as perceived by potential consumers. One common way to assess perceived value relies on survey methods. The most common of these is a direct-response survey, in which the respondent answers such questions as: 1. What is the likelihood you would buy this product at a price of $25? 2. At what price would you definitely buy this product? 3. How much would you pay for this product? 4. How much of this product would you buy at a price of $0.99? 5. At which price difference would you switch from product A to product B? Consider a major camera maker that used this method to set the price for a new camera. In a survey, a set of respondents were provided a description of the new camera and were asked to indicate their purchase intention on a seven-point scale, from “definitely not buy” to “definitely would buy,” One-third of the respondents were told the camera would cost $150, one- third were told it would cost $80, and one-third were told it would cost $40. The fact that 47 percent of people responded with a 1, 2, or 3 (“probably would buy”) for the $40 price (as opposed to only 19 percent for the $80 price) was instrumental in the firm’s introducing the camera at a suggested retail price of $39.95. Note that there are potential problems with direct-response surveys. For instance, they often induce an unrealistically high level of price consciousness in consumers. Similarly, given that consumers are only asked about their willingness to buy or to pay, and not actually required to spend their money, the results often paint an overly optimistic picture of a product’s potential. Nevertheless, such surveys are often a good first step in assessing perceived value. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

60 Confidential - for classroom use only Assessing Price Sensitivity Another key element in determining price is price sensitivity, with that sensitivity varying across customers, across time, and across products. Consider an interventional cardiologist preparing to do surgery on a heart patient with a blocked artery. The best solution may be to insert a stent to hold back the plaque blocking the artery, allowing blood to again flow freely. – Given that there are three different stent manufacturers, how sensitive to price will the typical doctor be in this situation? Contrary to some expectations, the answer is “not very.” – First, given that this is a life-or-death procedure for the patient, product performance will be key. – Second, the doctor is (hopefully) a very knowledgeable, sophisticated decision maker, aware of each stent’s advantages and disadvantages for various types of blockages. – Third, the doctor may have more experience inserting one type of stent and would prefer not to shift from the usual brand. Finally, since the doctor is not paying for the stent, the doctor’s sensitivity to price may be lower. Price sensitivity tends to be far greater in high-cost than in low-cost product categories. Thus, a 10 percent price differential on a sports car will be a far bigger deal than a 10 percent price differential on a tube of toothpaste. More broadly, price sensitivity is likely to increase as: 1. The absolute dollar cost of the product increases. 2. The aggregate cost of ongoing usage increases. 3. The cost of that product increases as a percentage of the total cost. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

61 Confidential - for classroom use only More on Price Sensitivity Some products are paid for by the customer. Some are not. In the case of an automobile for personal use, for instance, the user of the car is also the payer. When the car is a company car, however, the user may bear none of the cost of that car. In some situations, the user of the product pays some, but not all, of the cost of a good, as is often the case with health insurance, where the employee pays some portion of the insurance and the company pays the remainder. Not surprisingly, to the extent that the user is responsible for the costs, the greater is that user’s price sensitivity. Competitive factors also impact price sensitivity. Price sensitivity is higher to the extent that: 1. The customer does not perceive significant differences in alternative products. 2. It is easy to compare products and their prices. 3. It is easy for the decision maker to switch products. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

62 Confidential - for classroom use only Price Customization Given the value-pricing framework and the discussion of price sensitivity, one realizes that the perceived value of a product can vary significantly between individuals. For example, the latest golf-club innovation is more highly valued by someone trying to make a living as a professional than it is by an amateur. A number of factors cause value variation across potential customers, such as: 1. Taste: Some people think Godiva chocolates are the greatest, while others would just as soon have a Hershey bar. 2. Importance of performance: The experienced computer user values speed and storage more than the novice user. 3. Ability to pay: A millionaire has more resources to pay for a high-definition television than a true television fan of lesser economic means. 4. Intensity of use: A hands-free cell phone is more highly valued by a person using the device regularly as compared with those in “emergency-use-only” mode. 5. Category knowledge: The experienced car buyer who has searched the market views the invoice price of a car as the appropriate benchmark, while the novice buyer views the sticker price of a car as the appropriate benchmark. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

63 Confidential - for classroom use only Ways of Customizing Price When value varies across customers, a pricing program should consider whether to customize price according to the value received, thereby charging a higher price to those who value the product more. Several means to customize price are: 1. Through the product line: Firms can offer a high-end product with many features for the high-value customers and more basic models for the lower- value customers. 2. By controlling availability: For example, a mail-order clothes company can send different catalogs (with different prices) to different customers depending on their past purchasing behavior. 3. Through demographics: Here, one looks for some characteristic of buyers that correlates with willingness to pay. 4. Through transaction characteristics: Price is tied to the particular features of the transaction, such as how far in advance of consumption the product is purchased. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

64 Confidential - for classroom use only Strategic Pricing

65 Confidential - for classroom use only Pricing Strategy To a large extent, the combination of product, place (channel), and promotion (communications mix) determine the target customer’s perception of the value of the firm’s product in a given competitive context. Conceptually, this perceived value represents the maximum price that the customer is willing to pay. This should be the primary guide to pricing the product. Once the firm has created value for customers, it is entitled to capture some of that value for itself to fund future value-creation efforts. This is the role of effective pricing. In most situations, cost should act as a floor on pricing. In some circumstances, a firm intentionally sells at a loss for a time to establish a position in the market, but it is often difficult to increase prices later due to the customer’s use of the introductory price as a reference point. With perceived value in mind, the first question is, what is the marketing objective, and how does the pricing objective derive that? For example, the perceived value of the product typically varies by customer. Thus, the higher the price, the lower the sales rate, and vice versa. The price that would maximize short-term profit is thus typically higher than the one that would maximize market penetration, subject even to making some profit on each item. Some have described this as a choice between a skim and a penetration pricing strategy. In a skim strategy, the focus is on those customers with high value—skimming the cream off the top of the market. The classic example of this is hardcover books at $30 initially for the impatient and dropping to $7 for the identical book in softcover about a year later. In penetration pricing, the firm sets a lower price to generate lots of sales quickly. This “leaves money on the table” with the high-value customers but is designed to preempt competition and gain a significant number of customers early on. The appeal of a penetration strategy increases to the extent that (1) customers are sensitive to price, (2) economies of scale are important, (3) adequate production capacity is available, and (4) there is a threat of competition. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

66 Confidential - for classroom use only Pricing Strategy (contd.) Since customers typically place different values on the product, the firm should consider whether it is worth trying to capitalize on these value variations by charging different customers different prices. In some cases, legal constraints and logistical practicalities can make this infeasible. However, many firms owe their economic ell-being to their ability to customize prices. For example, the yield management systems used by airlines and car rental companies have been a major source of profit, as prices are varied depending on when the buyer is booking, for how long, for which days of week, and so forth. These characteristics are used as indicators of the value the customer places on the product. Price customization can be achieved by: 1. Developing a product line—such as the hardcover/softcover book situation just described 2. Controlling the availability of lower prices—for example, by making them available only in certain locations 3. Varying prices based on observable buyer characteristics—for example, software suppliers charge lower prices to “upgraders” than to new customers (the logic in new customers paying a higher price is they value the product more highly since they do not have the option of sticking with the current version; upgraders identify themselves by turning in some proof of ownership, such as support manuals) 4. Varying prices based on observable characteristics of the transaction—for example, quantity discounts could be offered if the situation were that big-volume buyers valued the product less than small-volume buyers Some industries feature a large degree of pricing interdependence in an industry. That is, competitors react to pricing moves. Thus, any pricing decision has to reflect anticipated competitive reaction. Some industries, legal and effective price leadership has been displayed as firms avoided price cutting in pursuit of share gains. In other industries, price wars have destroyed the profitability of nearly all the players. The tendency toward excessive price competition is particularly acute when: 1. Firms have high fixed but low variable costs. 2. There is little differentiation among competitor’s products, and thus consumers largely buy on price. 3. Industry growth rate is low. 4. There are barriers to capacity adjustment, and economies of scale are important. Thus, a key decision is how to ensure that the firm’s actions do not have a negative impact on industry profitability by setting off a round of price cuts. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

67 Confidential - for classroom use only Key Pricing Factors All pricing methods begin with understanding costs and what kind of price is necessary to break even on an item. New venture owner/managers may reduce the price and try to cut losses on a particular line; however, that should only happen as a result of careful analysis of certain key factors. Three basic factors to consider when setting a price are as follows: 1. The cost of goods 2. Competitive prices 3. Market demand Donald F. Kuratko and Jeffrey S. Hornsby, New Venture Management (Pearson Prentice Hall: 2009).

68 Confidential - for classroom use only Pricing Strategies New ventures employ a wide variety of pricing strategies. However, they all have two common objectives: (1) to earn a profit for the firm and (2) to garner and maintain market demand for the product. The specific pricing strategy is dictated by a number of considerations. For example, some companies tie their pricing to the product life cycle of the good. When the product is first introduced, they use one type of pricing strategy. When the product begins to mature, they employ another pricing strategy. As the good begins moving into the declining phase, they implement a third strategy. Regardless of whether this strategy is used, a host of pricing techniques typically serves as the basis for pricing decisions. Skimming pricing is the technique of selling at a high price to skim off of the strongest demand in the marketplace. This strategy particularly helps a new venture generate high profit per unit. However, the strategy is often maintained for only a short time because the conditions that allow for skimming usually do not last very long. Skimming also is used profitably when customers perceive a major difference between the high-priced good or service and lower-priced ones. For example, many patients prefer to stay with their current dentist rather than go to a university dental clinic or a large dental facility located in a shopping center despite the fact their current dentist often charges higher prices. These patients are convinced that the dental care they receive from their dentist is superior to what they would get in a shopping center. Whether or not this is true, it helps explain dentists in small offices are able to attract and maintain clientele in the face of lower-priced competition. Penetration pricing is the strategy of employing a low price that is competitive designed both to stimulate demand and to discourage competition. Penetration pricing most typically is used for low-priced goods where the firm’s objective is to trade profit per unit for gross sales. Many new ventures, for example, have found that when charging a high price for an item—$2.99, for example— they will sell 100 units a month, but at $2.49 they will sell 500 units a month. If the cost of 3 unit is $2, the business will make a total profit of $99 at the high price and $245 at the lower price. Another benefit of penetration pricing is that it discourages new competitors because the profit per item is low, and these firms often are unwilling to compete or the necessary market share. (This is in contrast to a skimming strategy, which often attracts competitors who see the opportunity for large profit per unit.) Penetration pricing also helps a new venture build an image as a place Penetration pricing also helps a new venture build an image as a place where merchandise can be purchased at reasonable prices. Another term used here is parity pricing, which means that the entrepreneur will charge at or near what the competitors are charging. Marketing researchers charge at or near what the competitors are charging. Marketing researchers Kotler and Armstrong claim that the choice of strategy affects the competition that entrepreneurs might face. A strategy with high margins may draw in others who would like to take advantage; however, a low margin strategy may drive competitors out. To decide what to do, ask the following questions: 1. Does the company’s product or service compare to the competition? 2. How strong are current competitors? 3. How does the competitive landscape influence customer price sensitivity? Donald F. Kuratko and Jeffrey S. Hornsby, New Venture Management (Pearson Prentice Hall: 2009).

69 Confidential - for classroom use only Pricing Strategies (contd.) Many new ventures use penetration or parity pricing because they are better able control their costs than larger competitors. Thus, they can afford to earn lower profit per unit and still remain viable. However, penetration pricing must be closely coordinated with inventory ordering to ensure that the business neither runs out of merchandise nor overstocks. Many companies feel this is a small price to pay for the potentially large profit they can generate using penetration pricing. A sliding price strategy is a method of moving prices in relation to demand. This strategy involves a combination of skimming and penetration pricing. In most cases, goods are priced high and demand at this level is skimmed off. Then, as demand weakens, the firm will lower its price and continue to generate demand. The move into penetration pricing will continue until the company drops the product line or freezes the price at the lowest level it can go. In some cases, a sliding price strategy involves fluctuations both up and down…. In most cases, however, a sliding price strategy follows a skimming and then penetration pattern with progressively lower prices. One of the main reasons for this pattern is competition from new product offerings. For example, the price of microcomputers has continued to fall—machines that cost $2,200 ten years ago ire now being purchased, with more advanced systems, for less than half that price. As technology causes old products to become outmoded, sellers must lower their prices to maintain demand. New venture owners who sell these units know that the longer they have these units on hand, the greater the likelihood that they will have to lower prices in order to create the necessary demand. At this point, the pricing emphasis is more on penetration than skimming. Odd pricing is the setting of a price just below a round number. Examples include pricing a good at $1.99 rather than $2.00, or $299 rather than $300. This strategy is based on the belief that customers perceive the odd price as much than the round number price. Obviously, the price is not significantly lower, as perceived, but the phenomenon helps account for why odd pricing often is referred to as psychological pricing. The major question for new venture owners is, how much of an impact on sales will an odd price generate? The answer depends on the price. For example, razor blades that sell at $2.99 are often more attractive than similar offerings at $3.00, but few people would be influenced to buy refrigerator for $999.99 rather than $1,000 because the penny difference is not regarded as a sufficient savings. Recent research shows that odd pricing tactics can be helpful to new venture owners, but the approach has to vary depending on the level. Following are four guidelines that have been recommended: 1. Product selling for under $1: Prices for these goods should end in 9. 2. Product selling for $1 to $10: The two best numbers in this price category are 9 and 5. 3. Products selling above $10 and up to $100: At these higher levels, the effect of prices ending in 9 diminishes significantly. Instead, new venture owners should use prices ending in 25 cents, 50 cents, or 75 cents. 4. Products selling above $100: At this level, only whole-dollar prices should be used. Donald F. Kuratko and Jeffrey S. Hornsby, New Venture Management (Pearson Prentice Hall: 2009).

70 Confidential - for classroom use only Pricing Strategies (contd.) Leader pricing is the marking down of a popular product to attract more customers. The objective of this pricing strategy is to build customer traffic. One of the most popular forms of leader pricing has been the use of loss leaders, which are products sold below cost in an effort to generate increased overall sales for all products in a store. In many states, loss leaders have been outlawed because they are viewed as unfair competition. However, the basic idea of attracting customers through lower-than-usual prices continues to be a mainstay of most new venture pricing strategies. The logic behind leader pricing is that customers may come to buy one extremely low-priced product but end up buying normally priced products as well. The objective of the strategy is to increase the number of people coming into the business. Price lining is the process of offering merchandise in several different price ranges. Some experts call this price flexibility and relate it to the decision to apply the same price to all segments or to differentiate based on different customers or regions. One-price policies work best in mass-selling markets, and variable pricing is usually applied when individual bargaining is involved. Price bundling is a type of pricing in which customers acquire a “host of goods or services” along with the products they purchase. A good example of bundled pricing is the purchase of a cell phone and a calling plan. In order to get the Special price on a desired cell phone, you must also sign up for a calling plan that bundles minutes, weekend calling, e-mail, text messaging, insurance, and so forth, all at one cost. Geographic pricing is the technique of charging customers based on where they live. Simply stated, this pricing strategy passes on the cost of transporting goods to buyers. In some cases, this is handled merely by charging customers the of the products “plus shipping.” If the company is located in New Jersey, the product’s final cost will be greater for customers in San Francisco than for those in Philadelphia. Donald F. Kuratko and Jeffrey S. Hornsby, New Venture Management (Pearson Prentice Hall: 2009).

71 Confidential - for classroom use only Discounts A discount is a reduction in the list price. Many new ventures find that they can boost sales profitably by deviating from a fixed-price strategy. In some cases, this is a result of selling experience; in other cases, it is mandated by competitive practices, and the business has no alternative but to grant discounts. A recent tide in the Harvard Business Review by Jim Geisman and John Maruskin suggests that a firm ask itself several questions when deciding to offer a discount: – Are discount dollars being invested in the market segment that offers the best strategic value for the company? – Do discount levels vary widely, and, if so, what is the basis for this variation? – Are discounts consistent over time, or do they increase at the end of a quarter? – Is widespread discounting a uniform problem across the company? Some experts suggest that a company monitor its discount practices to ensure that pricing fits the firm’s competitive place in the market and overall marketing strategy. A seasonal discount is a price reduction given during particular times of the year. These typically occur before or after peak buying periods. For example, swimsuit manufacturers offer discounts to retailers in the Midwest who buy before peak summer months. Because most bathing suits are sold between May and August, these discounts are given in March and April. Manufacturers use discounting to help increase sales as well as to minimize their cost of warehousing inventory. Retailers, in turn, offer seasonal discounts in the late summer and early fall in an effort to sell merchandise that soon will have no market demand and have to be warehoused. Another common strategy is special group discounting, such as 25 percent off of list price for all senior citizens. This strategy has been very helpful in recent years in building and maintaining a loyal customer base among seniors, who are often retired and are careful about how they spend their money. Other groups often targeted include educators, students, police, and firefighters. A third type of discount is the quantity discount, which offers a lower cost per A third type of discount is the quantity discount, which offers a lower cost per one shirt, $60 for two shirts, $75 for three shirts, and $20 for each additional shirt. Another variation of the strategy is to offer shirts for $35 each, or three for $90. In this case, the company encourages people to buy three shirts rather than trying to entice them up the sales ladder one shirt at a time. A fourth variation of this strategy is a cash discount. Although this can take a variety of forms, one of the most important among new ventures is to offer a price reduction of 3 to 5 percent on purchases if the individual will pay with cash 3r check rather than a credit card.. Simply stated, the store owner offers to pass fee that the credit-card company charges the store back to the customer as an added inducement to buy. This discount tactic is legal and is gaining popularity because of current competitive retailing practices that emphasize discount buying. Donald F. Kuratko and Jeffrey S. Hornsby, New Venture Management (Pearson Prentice Hall: 2009).

72 Confidential - for classroom use only Summary: Generic Pricing Strategies 1. Cost plus: cost plus some markup, assuming the firm actually knows what its costs are 2. Penetration pricing: a low price is set with the idea of quickly gaining a foothold in the market, usually set by the industry’s price leader, with everyone else soon following 3. Market skimming: the opposite of penetration pricing, and very common where the firm intends to either leave the market quickly or reduce the price over time and the course of the product life cycle 4. Customary pricing: the practice of using a single well-known price for an extended period of time, often set by the industry leader 5. Non-linear pricing: the practice of setting prices in a way that the second and third purchases have a lower value than the initial purchase 6. Price bundling: involves selling two or more products as a package 7. Price lining: the tactic of offering a number of variations of a product with each variation priced at a different level, for example Starbucks coffee 8. Life cycle pricing: setting the price at appropriate levels over the course of the entire life cycle to maximize revenue and profit not at each stage or for each accounting period but over the entire cycle, thereby achieving the highest return on investment 9. Conspicuous consumption pricing: otherwise known as charm pricing, where a high price is thought to convey a particular lifestyle 10. Price reductions: tactic of overcoming consumer resistance to buying by offering sales, specials, and discounts (including quantity discounts)

73 Confidential - for classroom use only Alternative: Systemic Pricing Model StagesDescription/action Market opportunity analysis It is necessary to select the specific market segments that the organization wishes to target. As we have already seen, different segments expect different levels of price. Therefore a clear policy on which market segments are to be targeted is crucial to ensure that an acceptable pricing strategy is developed. Company imageThe second stage is to consider the sort of image the organization wishes to portray, for both itself and the product or service in question. The image and reputation will have a direct effect on the price that can be charged and it must, of course, be compatible with the chosen segment or segments. Marketing mix strategy It is then necessary to develop the marketing mix strategy for what is being offered. The price is affected by and in turn affects all the other elements of the marketing The price is affected by and in turn affects all the other elements of the marketing blend and portray a consistent image in the minds of potential customers. Pricing and the marketing plan Once you have worked through the initial stages of this model, it is then possible to start considering the most suitable overall pricing policy. This must, of course, fit with the overall marketing plan. Develop and implement pricing strategy The next stage is to develop and implement a pricing strategy. We have seen that prices are likely to change during the various stages in the product life cycle, so it is important that this is planned in advance. The other elements of the marketing mix will also change, so care must be taken to ensure that consistency of the overall image of the product or service is maintained. Specific price for product or service The final stage is to choose a specific price that will be charged for the benefits that The final stage is to choose a specific price that will be charged for the benefits that undertaken, this price will be the market price and will result in the optimum sales for the product. Oxenfeldt, A. R., Multistage Approach to Pricing, (Harvard Business Review: 1960).

74 Confidential - for classroom use only Alternative: Offensive Pricing Model PrinciplesDescription/action Know the price dynamics of the market It is important to get a feel for what might influence price. Consideration of such factors as frequency of purchase, degree of necessity, unit price, degree of comparability and degree of fashion or status all contributes to the price sensitivity of the company’s product or service. Choose price segments Price bracket segments of all markets. In general the strong brands are in the upper pricing segments while the commodity products and less known brands are in the lower segments. It is important that an organization can clearly define the segments in which it operates. Achieve clarity of pricing Potential customers must understand a company’s pricing system. If it is not logical then they will not trust the brand or organization. Always consider the alternatives Pricing is often considered as a rather mechanical aspect of marketing. It is necessary to be more creative. Price is only one part of the marketing mix, therefore the whole mix must be considered when analyzing the pricing strategy. Target price changes Remember that price elasticity varies by type of consumer, shopping environment and occasion of use. Companies must make sure that they understand the way price elasticity works and use price promotions, not only to stimulate new sales but also to reward loyal customers. Avoiding profit cannibalization when pricing new products Companies should ensure that new products take profits from their competitors, and not from other products in their own product lines. Using pricing to optimize return on capacity This is especially the case with perishable products such as fresh food. It means using all the available demand forecasting tools, and having a good understanding and being able to act upon price elasticities of different customer types. It also involves analyzing capacity utilization and using price to maximize it. A company must also make sure its cost allocations are efficient. Pricing mistakes/errors If a company makes a mistake on pricing, it must admit it and remedy it fast. It is easy If a company makes a mistake on pricing, it must admit it and remedy it fast. It is easy efficiently and effectively adjusted. Davidson, H., Even More Offensive Marketing: An exhilarating action guide to winning in business, (London: Penguin, 1997).

75 Confidential - for classroom use only The Dead Zone: A Cautionary Tale

76 Confidential - for classroom use only Effective Distribution It’s better to think of distribution as something essential to the design of your product. If you’ve invented something new but you haven’t invented an effective way to sell it, you have a bad business— no matter how good the product. Superior sales and distribution by itself can create a monopoly, even with no product differentiation. The converse is not true. No matter how strong your product— even if it easily fits into already established habits and anybody who tries it likes it immediately— you must still support it with a strong distribution plan. Two metrics set the limits for effective distribution. 1.The total net profit that you earn on average over the course of your relationship with a customer (Customer Lifetime Value, or CLV) 2.must exceed the amount you spend on average to acquire a new customer (Customer Acquisition Cost, or CAC). In general, the higher the price of your product, the more you have to spend to make a sale— and the more it makes sense to spend it. Distribution methods can be plotted on a continuum: Peter Thiel, From Zero to On (Crown Business : 2014)

77 Confidential - for classroom use only The Dead Zone Continuum Peter Thiel, From Zero to On (Crown Business : 2014)

78 Confidential - for classroom use only Complex Sales If your average sale is seven figures or more, every detail of every deal requires close personal attention. It might take months to develop the right relationships. You might make a sale only once every year or two. Then you’ll usually have to follow up during installation and service the product long after the deal is done. It’s hard to do, but this kind of “complex sales” is the only way to sell some of the most valuable products. Complex sales works best when you don’t have “salesmen” at all…. Our deal sizes range from $1 million to $100 million. At that price point, buyers want to talk to the CEO, not the VP of Sales. Businesses with complex sales models succeed if they achieve 50% to 100% year-over-year growth over the course of a decade. This will seem slow to any entrepreneur dreaming of viral growth. You might expect revenue to increase 10x as soon as customers learn about an obviously superior product, but that almost never happens. Good enterprise sales strategy starts small, as it must: a new customer might agree to become your biggest customer, but they’ll rarely be comfortable signing a deal completely out of scale with what you’ve sold before. Once you have a pool of reference customers who are successfully using your product, then you can begin the long and methodical work of hustling toward ever bigger deals. Peter Thiel, From Zero to On (Crown Business : 2014)

79 Confidential - for classroom use only The Dead Zone Most sales are not particularly complex: average deal sizes might range between $10,000 and $100,000, and usually the CEO won’t have to do all the selling himself. The challenge here isn’t about how to make any particular sale, but how to establish a process by which a sales team of modest size can move the product to a wide audience. In between personal sales (salespeople obviously required) and traditional advertising (no salespeople required) there is a dead zone. Suppose you create a software service that helps convenience store owners track their inventory and manage ordering. For a product priced around $1,000, there might be no good distribution channel to reach the small businesses that might buy it. Even if you have a clear value proposition, how do you get people to hear it? Advertising would either be too broad (there’s no TV channel that only convenience store owners watch) or too inefficient (on its own, an ad in Convenience Store News probably won’t convince any owner to part with $1,000 a year). The product needs a personal sales effort, but at that price point, you simply don’t have the resources to send an actual person to talk to every prospective customer. This is why so many small and medium-sized businesses don’t use tools that bigger firms take for granted. It’s not that small business proprietors are unusually backward or that good tools don’t exist: distribution is the hidden bottleneck. Peter Thiel, From Zero to On (Crown Business : 2014)

80 Confidential - for classroom use only Marketing and Advertising Marketing and advertising work for relatively low-priced products that have mass appeal but lack any method of viral distribution. Procter & Gamble can’t afford to pay salespeople to go door-to-door selling laundry detergent. (P& G does employ salespeople to talk to grocery chains and large retail outlets, since one detergent sale made to these buyers might mean 100,000 one-gallon bottles.) To reach its end user, a packaged goods company has to produce television commercials, print coupons in newspapers, and design its product boxes to attract attention. Advertising can work for startups, too, but only when your customer acquisition costs and customer lifetime value make every other distribution channel uneconomical. Peter Thiel, From Zero to On (Crown Business : 2014)

81 Confidential - for classroom use only Viral Marketing A product is viral if its core functionality encourages users to invite their friends to become users too. This is how Facebook and PayPal both grew quickly: every time someone shares with a friend or makes a payment, they naturally invite more and more people into the network. This isn’t just cheap— it’s fast, too. If every new user leads to more than one additional user, you can achieve a chain reaction of exponential growth. The ideal viral loop should be as quick and frictionless as possible. Whoever is first to dominate the most important segment of a market with viral potential will be the last mover in the whole market. At PayPal we didn’t want to acquire more users at random; we wanted to get the most valuable users first. The most obvious market segment in email-based payments was the millions of emigrants still using Western Union to wire money to their families back home. Our product made that effortless, but the transactions were too infrequent. We needed a smaller niche market segment with a higher velocity of money— a segment we found in eBay “PowerSellers,” the professional vendors who sold goods online through eBay’s auction marketplace. There were 20,000 of them. Most had multiple auctions ending each day, and they bought almost as much as they sold, which meant a constant stream of payments. And because eBay’s own solution to the payment problem was terrible, these merchants were extremely enthusiastic early adopters. Once PayPal dominated this segment and became the payments platform for eBay, there was no catching up— on eBay or anywhere else. Peter Thiel, From Zero to On (Crown Business : 2014)

82 Confidential - for classroom use only The Power Law of Distribution One of these methods is likely to be far more powerful than every other for any given business: distribution follows a power law of its own. This is counterintuitive for most entrepreneurs, who assume that more is more. But the kitchen sink approach— employ a few salespeople, place some magazine ads, and try to add some kind of viral functionality to the product as an afterthought— doesn’t work. Most businesses get zero distribution channels to work: poor sales rather than bad product is the most common cause of failure. If you can get just one distribution channel to work, you have a great business. If you try for several but don’t nail one, you’re finished. Peter Thiel, From Zero to On (Crown Business : 2014)

83 Confidential - for classroom use only The Product Life Cycle

84 Confidential - for classroom use only The Product Life Cycle Introduction Stage At the Introduction (or development) Stage market size and growth is slight. it is possible that substantial research and development costs have been incurred in getting the product to this stage. In addition, marketing costs may be high in order to test the market, undergo launch promotion and set up distribution channels. It is highly unlikely that companies will make profits on products at the Introduction Stage. Products at this stage have to be carefully monitored to ensure that they start to grow. Otherwise, the best option may be to withdraw or end the product. Growth Stage The Growth Stage is characterized by rapid growth in sales and profits. Profits arise due to an increase in output (economies of scale) and possibly better prices. At this stage, it is cheaper for businesses to invest in increasing their market share as well as enjoying the overall growth of the market. Accordingly, significant promotional resources are traditionally invested in products that are firmly in the Growth Stage. Maturity Stage The Maturity Stage is, perhaps, the most common stage for all markets. it is in this stage that competition is most intense as companies fight to maintain their market share. Here, both marketing and finance become key activities. Marketing spend has to be monitored carefully, since any significant moves are likely to be copied by competitors. The Maturity Stage is the time when most profit is earned by the market as a whole. Any expenditure on research and development is likely to be restricted to product modification and improvement and perhaps to improve production efficiency and quality. Decline Stage In the Decline Stage, the market is shrinking, reducing the overall amount of profit that can be shared amongst the remaining competitors. At this stage, great care has to be taken to manage the product carefully. It may be possible to take out some production cost, to transfer production to a cheaper facility, sell the product into other, cheaper markets. Care should be taken to control the amount of stocks of the product. Ultimately, depending on whether the product remains profitable, a company may decide to end the product. http://www.tutor2u.net/business/marketing/products_lifecycle.asp

85 Confidential - for classroom use only Stages of the Product Life Cycle and the Marketing Mix Introduction Stage In the introduction stage, the firm seeks to build product awareness and develop a market for the product: Product branding and quality level is established, and intellectual property protection such as patents and trademarks are obtained. Pricing may be low penetration pricing to build market share rapidly, or high skim pricing to recover development costs. Distribution is selective until consumers show acceptance of the product. Promotion is aimed at innovators and early adopters. Marketing communications seeks to build product awareness and to educate potential consumers about the product. Growth Stage In the growth stage, the firm seeks to build brand preference and increase market share. Product quality is maintained and additional features and support services may be added. Pricing is maintained as the firm enjoys increasing demand with little competition. Distribution channels are added as demand increases and customers accept the product. Promotion is aimed at a broader audience. Maturity Stage At maturity, the strong growth in sales diminishes. Competition may appear with similar products. The primary objective at this point is to defend market share while maximizing profit. Product features may be enhanced to differentiate the product from that of competitors. Pricing may be lower because of the new competition. Distribution becomes more intensive and incentives may be offered to encourage preference over competing products. Promotion emphasizes product differentiation. Decline Stage As sales decline, the firm has several options: –Maintain the product, possibly rejuvenating it by adding new features and finding new uses. –Harvest the product - reduce costs and continue to offer it, possibly to a loyal niche segment. –Discontinue the product, liquidating remaining inventory or selling it to another firm that is willing to continue the product. –The marketing mix decisions in the decline phase will depend on the selected strategy. For example, the product may be changed if it is being rejuvenated, or left unchanged if it is being harvested or liquidated. The price may be maintained if the product is harvested, or reduced drastically if liquidated. http://www.quickmba.com/marketing/product/lifecycle/

86 Confidential - for classroom use only PLC Characteristics & Responses

87 Confidential - for classroom use only Product Life Cycle Concept: Summary Product development is only the first step in the so-called product life cycle, which includes five stages: 1.Development: In the period before the product is introduced, investments increase, while sales are nonexistent. 2.Introduction: When the product is launched in the marketplace, initial sales growth is typically slow, but marketing expenses and other costs are high, leading to negative profits. Customers that enter in this stage can be characterized as “innovators.” The firm’s primary marketing objective in this stage is to create product awareness and trial. 3.Growth: Sales rapidly rise in the growth stage. The early adopters now join the firm’s customer base, and this growing market acceptance goes along with economies of scale and rising profits. In this stage, amid a growing number of competitors, the firm is primarily focused on maximizing its market share. 4.Maturity: Sales levels peak in the maturity stage, but sales growth slows down as the market saturates and competition further increases. It becomes less efficient to reach new customers and more difficult to effectively market the product. As a result, profits level off. The firm’s primary marketing objective is to maximize profits while defending market share. 5.Decline: In the final stage, sales fall, and profitability virtually disappears. Some competitors may exit the market at this stage. The firm’s objective is to reduce expenditures and milk the brand. Naturally, in practice, product life cycles show a great deal of variety, as a result of both decisions taken by the marketer and other factors. For example, some products are characterized by fashion or fads that lead to a sharp peak in sales irrespective of the stage of the product life cycle. The context of the product introduction also a role. When a firm introduces an original product in a new market with a strong need for the product, the adoption process lay be relatively quick. However, when firms must invest heavily in educating customers—for example, because significant competition exists, or because the product benefits are difficult to grasp—sales may not take off slower and profitability may be difficult to achieve. Nevertheless, the product life cycle is a helpful tool for marketers seeking to understand the challenges and opportunities ace in managing a product. For each stage, they can map out the desired strategy regarding the marketing mix elements. As far the product strategy is concerned, for instance, it is often useful to focus on offering a basic product in the introduction stage, add elements of the augmented product (such as customer service) and product extensions in the growth stage, extend and diversify the brand in the maturity stage, and prune the product or brand mix in the decline stage. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

88 Confidential - for classroom use only Challenges to the Product Life Cycle Concept The PLC concept, as developed by its proponents, is fairly simple. Like human beings or animals, everything in the marketplace is presumed to be mortal. A brand is born, grows lustily, attains maturity, and then enters declining years, after which it is quietly buried. Even a cursory analysis shows flaws in this picture. In the biological world the length of each stage in the cycle is fixed in fairly precise terms; moreover, one stage follows another in an immutable and irreversible sequence. But neither of these conditions is characteristic of the marketing world. The length of different stages tends to vary from product to product. Some items move almost directly from introduction to maturity and have hardly any growth stage. Other products surge to sudden heights of fashion, hesitate momentarily at an uneasy peak and then quickly drop off into total oblivion. Their introductory and maturity stages are barely perceptible. What is more, it is not unusual for products to gain “second lives” or even “reincarnation.” Thanks to brilliant promotion, many brands have gone from the maturity stage not to decline and death but to a fresh period of rapid growth. Despite the lack of correspondence between the marketing and the biological worlds, PLC advocates continue to remain dogmatic and proclaim that their concept has wide applications in different areas of planning and policy formulation. Narriman K. Dhalla and Sonia Yuseph, Forget the product life cycle concept! (Harvard Business Review: Jan 1976).

89 Confidential - for classroom use only When it comes to brands, the PLC model has even less validity. Many potentially useful offerings die in the introductory stage because of inadequate product development or unwise market planning, or both. The much-expected ebullient growth phase never arrives. Even when a brand survives the introductory stage, the model in most cases cannot be used as a planning or a predictive tool. Of course, a company may not be able to extend the maturity phase indefinitely. When a brand passes “over the hill” in sales, no marketing strategies are effective anymore. Such a drop may be due to changes in consumer tastes and values, or to the fact that users have shifted their preference to and improved competitive product. In these instances, euthanasia has to be quietly performed so that the company’s capital resources can be used profitably in other ventures. Unfortunately, in numerous cases a brand is discontinued, not because of irreversible changes in consumer values or tastes, but because management, on the basis of the PLC theory, believes the brand has entered a dying stage. In effect, a self-fulfilling prophecy results. Narriman K. Dhalla and Sonia Yuseph, Forget the product life cycle concept! (Harvard Business Review: Jan 1976). Challenges to the Product Life Cycle Concept (contd.)

90 Confidential - for classroom use only Challenges to the Product Life Cycle Concept (contd.) A major disservice of the PLC concept to marketing that it has led top executives to overemphasize new product introduction. This route is perilous. Experience shows that nothing seems to take more time, cost more money, involve more pitfalls, or cause more anguish than new product programs. The PLC concept has little validity. The sequence of marketing strategies typically recommended for succeeding stages of the cycle is likely to cause trouble. In some respects, the concept has done more harm than good by persuading top executives to neglect existing brands and place undue emphasis on new products. Marketing-communications models can be of great help. They measure quantitatively the influence of different elements on sales, permit the evaluation of different options, and provide advance warning signals so that remedial action can be taken before a crisis occurs. The management that uses them will lot be misled by minor sales aberrations into believing erroneously that a brand has entered a declining stage. Narriman K. Dhalla and Sonia Yuseph, Forget the product life cycle concept! (Harvard Business Review: Jan 1976).

91 Confidential - for classroom use only Summary: Managing Product and Brand Portfolios The product life cycle concept indicates that it is critical for firms to manage its product and brand portfolios and to assess the manner in which its products interact within and across product lines. Effective firms have a detailed product development plan and a vision of where they want to be over time. That is not to say, of course, that plans should not be adjusted, but there must be a guiding philosophy on the desired extent of product proliferation, and how products will be added or deleted over time. In many industries, it is particularly useful to develop a product platform or template from which a family of products can be developed at low incremental cost. The key reason to have a product line rather than a single product is to be able to better serve multiple market segments concurrently. In the ideal case, different products in the line or mix clearly map onto different target market segments. Firms must avoid a situation in which little (or no) forward planning takes place and product lines evolve opportunistically. A lack of planning frequently results in a proliferated product line with poor coverage of the market segments. In addition, it often leads to a high level of competition between the company's own product offerings. Product planning should consider the extent to which demand for a new product will be truly incremental or will cannibalize the firm’s existing products. Obviously, the relative profitability of the new and cannibalized items is a key factor in that analysis. If the unit margin on the new product is better than that of the cannibalized item (as is often the case when a company discovers a lower-cost way to bring the same level of functionality to market), this may not be as serious an issue. However, if the new item is less profitable than items it threatens to cannibalize (as is often the case when a company “trades down” its product line to reach more of the mass market), then careful consideration must be given to ways to limit the rate of cannibalization. Over time, product lines typically proliferate, as it is usually more difficult for firms to delete an item from a line than to add one. Firms may expect strong negative reactions from customers and channel partners when a product is placed on the to-be-discontinued list. There is a real danger: customers may feel abandoned or poorly served by the company, and may even pressure the firm to take back previously sold items. Similarly, channel partners may “punish” the firm by allocating less shelf space to the firm’s remaining products. However, a strong product line planning process includes a systematic investigation of deletion opportunities to ease customers’ decision making and improve the overall economics of the firm. Alvin J. Silk, What is Marketing? (HBS Press: 2006).

92 Confidential - for classroom use only Appendix: Product for MedTech

93 Confidential - for classroom use only Example: MedTech Products Disposables – Disposables generally fall into two categories: (1) Low-value products (as measured by sales price in this context), such as lab supplies, syringes, or gloves—all of which rely on high sales, high volume, and low overhead to be profitable. These also tend to be low-complexity, non-differentiated products (meaning that physicians do not typically express a preference for which brand of the product they use). As a result, low-value disposables often require limited sales effort beyond the initial product launch, assuming that prices are kept low and quality remains consistent. Marketing and product-related information sharing is generally accomplished via supplier catalogs or online sources, with customer service representatives (reps) available by phone to handle more specific product inquiries and sales. (2) High-value products, such as ablation catheters used in the treatment of atrial fibrillation or the automated anastomosis systems for cardiac artery bypass graft (CABG) surgery. These high-value disposables command relatively high prices, tend to be complex, and may be more appropriately handled through a direct sales model. Reusables – Many reusable products, such as surgical instruments, tend to be lower-value offerings that provide relatively low margins and depend on moderate to high volumes to be profitable. Like disposables, they can be marketed through supplier catalogs and/or Internet resources. However, some reusable products, if they are sufficiently complex, have a slightly higher value and/or command somewhat higher prices such as ambulatory cardiac rhythm monitors (e.g. Holter monitors),, which can be reused among many patients before requiring replacement. As a result, they may be sold and distributed by a third-party distributor that carries a complete line of complementary products. Implants – When considering the characteristics of implantable products, it is useful to separate higher value implants from those with moderate or lower relative value. High-value, complex implants, such as pacemakers and artificial joints, often require a knowledgeable and involved sales force in order to complete a sale and ensure proper device usage (through training, etc.). They usually have a somewhat longer sales cycle. As well. Depending on expected sales volume, high-value implants typically lend themselves to either a direct sales force or a specialized third-party distributor. Moderate and lower-value implants, on the other hand, may have characteristics that more closely resemble reusable products, as described above. As a result, it may be more appropriate to distribute them without the involvement of a direct sales force. Capital Equipment – Capital equipment products, such as MRI machines and ultrasound equipment, are often highly complex. They provide high value to the user and, in turn, command high margins. These products tend to have a particularly long sales cycle that requires a prolonged, dedicated effort in order to make the sale. For this reason, the associated business model favors a direct sales force. Facilities generally act as buyers for capital equipment, with or without broad provider input. Because volume is low, the sales team is usually small, although auxiliary field personnel are required to provide servicing of the equipment. Stanford Casebook

94 Confidential - for classroom use only Appendix: Promotion for MedTech

95 Confidential - for classroom use only Example: Communication Vehicles for Medtech Stanford Casebook VehicleDescriptionIssues to Consider Peer Reviewed Publications Peer review is the process of subjecting an author’s scholarly who of others (peers) who are experts in the same field. Peer reviewed publications are considered more credible than other sources because they aggregate, filter, and validate author submissions independent of any outside influence or interested third party. Submitted data must be based on clear evidence Publication can take anywhere from three months to two years from the time of submission, depending on the publication, topic, and strength of the data; as a result, it makes planning difficult Revisions/rewrites may be required prior to publication Publication is not guaranteed Any potential conflicts of interest between the company and the authors must be disclosed May cost between $15,000 and $25,000 to support the research that leads to the publication (conflicts of interest caused by the relationship between the research sponsor and the investigator that may undermine the scientific validity of any studies will need to be managed and disclosed properly) Abstracts and Conferences An abstract provides a concise statement of the major elements of a research project. It states the purpose, methods, and findings of the research project and is submitted to conference organizers to inform them of work-in-progress or completed work that is available to be presented. Abstracts are reviewed against other submissions, with some subset being chosen for presentation based on their fit with conference criteria. Submitted data must be based on clear evidence Abstract requirements vary from conference to conference and should be well understood before a submission is made Conference presentations are typically brief, so a company should plan to present only a portion of its data Abstracts must be submitted an average of 6 to 8 months prior to the conference Continuing Medical Education (CME) CME is required by physicians in most U.S. states to maintain their licenses. It provides a way for physicians to stay informed and learn about new developments in their field. Content for CME programs is typically developed, reviewed, and delivered by faculty who are experts in their individual clinical areas. CME programs must be certified by the Accreditation Council for Continuing Medical Education Any potential conflicts of interest Any potential conflicts of interest must be disclosed CME programs can be sponsored directly by companies or through professional societies The costs are significant: a professional conference attended by 200 people for two days could be $100,000 or more; an academic conferences for 50 people for one to two days could be more than $50,000 tart with speaker honoraria of $5,999 to $15,000 for 10 speakers, then add room and board, food, etc.) Reimbursement Dossier Reimbursement dossiers typically serve as the official source for all key information about the product, including the place of product in the diagnostic and therapeutic chain, results from key clinical and economic studies, disease management strategies, modeling report, product value and overall cost, and references. Must be based on well-established and tested facts about the product Can be time-consuming and resource intensive to prepare, requiring specialized expertise and significant lead-time Must be customized to meet the needs and interest of each target audience Cost can range from $50,000 (for a simple dossier) to as much as $250,000 (for a more complete deliverable) Direct-to- Consumer (DTC) Advertising DTC advertising refers to the promotion of medical dew patients through newspapers, magazines, television, and the Internet. Companies also use brochures, videos, and other materials that are made available to patients in doctors’ offices. One recent trend is to focus on direct-to-patient (DTP) advertising (i.e., advertising in channels accessed more exclusively by patients, such as the Diabetes Digest for diabetic patients) DTC advertising is only legal in two developed countries: the U.S. and New Zealand Not all medical technologies are well suited to DTC advertising and this approach is rarely used in the industry (exceptions: elective Lasik surgery, Botox, drug eluting stents, Lap Band for bariatric surgery). DTC advertising is considered somewhat controversial among regulators, some physicians, and some regulators, some DTC advertising is complicated and expensive

96 Confidential - for classroom use only Sales Force Training: Example of MedTech Any direct sales force requires extensive training to effectively represent and sell a complex product to the target audience. Such training should be delivered directly by the company that developed the device such that the sales people gain a deep understanding of the product’s attributes, the disease state that it treats, how it is used in practice, how it compares to competitive products and/or the standard of care, and its core value proposition. In cases where sales reps will be asked to educate, train, and/or coach providers on the use of the device, even more in-depth training is required to prepare the sales force for the field. Reps should be prepared to answer detailed and often technical questions related to clinical benefit, economic benefit, and billing and reimbursement. At sales meetings, reps will often be asked to “role play” so they gain experience in addressing the many challenging questions that can arise in the sales process. At times, sales reps are also given the opportunity to shadow doctors while learning about a new procedure or field of medicine. Stanford Casebook

97 Confidential - for classroom use only Appendix: Place for MedTech

98 Confidential - for classroom use only Sales and Distribution for Medtech Sales and distribution channel considerations form important input into an entrepreneur’s decision regarding the selection of a business model for s/her company. Some business models lend themselves better to specific sales and distribution approaches than others. The differences arise primarily from the characteristics of the innovation or product offering. The four most common medtech business models are 1.Disposables – Disposables generally fall into two categories: (1) Low-value products (as measured by sales price in this context), such as lab supplies, syringes, or gloves—all of which rely on high sales, high volume, and low overhead to be profitable. These also tend to be low-complexity, non-differentiated products (meaning that physicians do not typically express a preference for which brand of the product they use). As a result, low-value disposables often require limited sales effort beyond the initial product launch. Assuming that prices are kept low and quality remains consistent. Marketing and product-related information sharing is generally accomplished via supplier catalogs or online resources, with customer service representatives (reps) available by phone to handle more specific product inquiries and sales. (2) High-value products, such as ablation catheters used in the treatment of atrial fibrillation or the automated anastomosis systems for cardiac artery bypass graft (CABG) surgery. These high-value disposables command relatively high prices, tend to be complex, and may be more appropriately handled through a direct sales model. 2.Reusables – Many reusable products, such as surgical instruments, tend to be lower-value offerings that provide relatively low margins and depend on moderate to high volumes to be profitable. Like disposables, they can be marketed through supplier catalogs and/or Internet resources. However, some reusable products, if they are sufficiently complex, have a slightly higher value and/or command somewhat higher prices such as ambulatory cardiac rhythm monitors (e.g. Holter monitors),, which can be reused among many patients before requiring replacement. As a result, they may be sold and distributed by a third-party distributor that carries a complete line of complementary products. 3.Implants – When considering the characteristics of implantable products, it is useful to separate higher value implants from those with moderate or lower relative value. High-value, complex implants, such as pacemakers and artificial joints, often require a knowledgeable and involved sales force in order to complete a sale and ensure proper device usage (through training, etc.). They usually have a somewhat longer sales cycle, well. Depending on expected sales volume, high-value implants typically lend themselves to either a direct sales force or a specialized third-party distributor. Moderate and lower-value implants, on the other hand, may have characteristics that more closely m resemble reusable products, as described above. As a result, it may be more appropriate to distribute them without the involvement of a direct sales force. 4.Capital Equipment – Capital equipment products, such as MRI machines and ultrasound equipment, are often highly complex. They provide high value to the user and, in turn. Command high margins, these products tend to have a particularly long sales cycle that requires a prolonged, dedicated effort in order to make the sale. For this reason, the associated business model favors a direct sales force. Facilities generally act as buyers for capital equipment, with or without broad provider input. Because volume is low, the sales team is usually small, although auxiliary field personnel are required to provide servicing of the equipment. Stanford Casebook

99 Confidential - for classroom use only Sales and Distribution for Medtech (contd.) As implied within these descriptions, there are two fundamental approaches to sales and distribution: the indirect and the direct models. In an indirect model, one or more sales teams from distributors or third-party manufacturers serve as the primary point of contact with the end user to manage product sales and delivery. They typically ar not dedicated exclusively to any le product from a single company, but instead represent a portfolio of complementary products from multiple companies. That said, while some distributors carry a broad range of products across multiple fields, others may be more specialized, targeting products in a particular field, specific types of physicians, and/or a narrowly defined geographic territory. In a direct model, the company builds its own internal sales force to handle all sales functions, and establishes a separate customer support division to manage distribution of the product to the end user. A third, hybrid model is becoming increasingly common in the medtech industry, in which a combination of direct sales force and distributors is employed. The business model, product characteristics, and preferred sales and distribution approach come together as shown below: While this view represents what is often found with medical devices, the decision regarding an approach is never “black and white.” As previously emphasized, companies must determine the most effective sales and distribution model for capturing and sustaining value based on their chosen business model, their unique product offering, the customer being targeted, and the desired interaction with the customer. Customer accessibility and receptiveness are two important factors that play into the desired interaction that a company seeks to create with its target audience. For example, a direct sales model requires a high-touch relationship with physicians. Such a model is only appropriate if a company can reliably gain access to those physicians through a direct channel and they are generally willing to engage in the sales process based on how they have traditionally been contacted by other device manufacturers. Each medical specialty tends to have its own “personality” regarding how receptive physicians are to experimenting with new innovations curious they are to learn about new products, and how loyal they are to established treatments. Understanding the psyche of the doctors in the field where the company is trying to establish a foothold is essential to deciding on an optimal sales and distribution model. Examining the models used by competitors can be a source of invaluable insights. Stanford Casebook Direct Sales Force or Specialized Distributor (e.g. spine implants) Direct Sales Force (e.g. drug eluting stents, disposable anastomosis systems) National Distributor or Specialized Distributor (e.g. orthopedic screws) National Distributor (e.g. syringes) Number of Users Product Value

100 Confidential - for classroom use only Indirect Distribution Models: National Distributors In the medtech field, there are several common approaches to adopting an indirect model for sales and distribution. These include entering into a sales and distribution agreement with a national or specialized distributor, or forming a third-party partnership with another manufacturer. The first approach works especially well for disposables, reusables, and simple implants that have a relatively low unit price and low to moderate complexity. In these cases, the sales and distribution process is largely managed by a large national distributor or wholesaler. The company generally sells to the distributor at a discount. The distributor, in turn, passes along the product at full price, keeping the difference as a form of compensation. The company maintains its own brand, while the distributor maintains the right to represent other products (i.e., the sales and distribution agreement is not exclusive). While this model is almost always adopted for commodity products, such as syringes, surgical gloves, and other such medical equipment, it can also be effective for somewhat higher-end disposables and reusables. For example, Acclarent, a company that manufactures and markets endoscopic, catheter-based tools to perform balloon sinuplasty (a procedure in which a balloon is used to dilate various areas of the sinuses) uses this kind of indirect model to sell and distribute its product to surgeons. In most cases, the customer for the products sold and delivered through a national distributor is not the physician or other end user of the device. Instead, these entities tend to interact with the purchasing departments of hospitals or clinics, or they interface with intermediaries, such as global purchasing organizations (GPOs) or buyers for integrated delivery networks (IDNs). Once a contract is in place, buyers commonly place orders by telephone or online through systems managed by the distributor. Products are then delivered from the distributor’s warehouse(s) via courier, with the distributor often managing inventory on behalf of the company. Stanford Casebook

101 Confidential - for classroom use only The Role of GPOs and IDNs in a National Distributor Model GPOs and IDNs both seek to leverage the purchasing power of a group of participants to negotiate for more favorable sales and distribution terms. Both groups have formed partly in response to rising healthcare costs. GPOs, such as Novation and Premier, organize multiple hospital groups, large clinics, and medical practices into buying cooperatives. Integrated delivery networks (IDNs) take the idea of consolidation one step further by aggregating hospitals, physicians, allied health professionals, clinics, outpatient facilities, home care providers, managed care, and suppliers into a single, closed network. Kaiser, Tenet, and Intermountain Health are examples of IDNs. Companies and/or their distributors may have the opportunity to negotiate sole source contracts with GPOs and large IDNs, giving greater pricing and delivery concessions in exchange for this preferred status. Large GPOs may represent as many as 1,000 to 2,000 hospitals. As a result, they have a high degree of negotiating power with companies. Approximately 72 percent of all medical system purchases go through a GPO. On average, GPOs are able to secure 10-15 percent discounts on supplies, devices, capital equipment, services, Pharmaceuticals, and more, which they pass on to their members. In return, GPOs earn a 2-3 percent contracting administration fee (CAF) per contract. In the medical device field, this fee is typically paid for by the manufacturer. Many GPOs also provide value-added services to their members, such as product evaluation, training. And service and inventory management. IDNs are becoming sufficiently large to gain buying clout and act as their own GPO. A 2002 study from the American Hospital Association (AHA) reported that there are approximately 455 IDNs in the U.S., averaging eight hospitals each. Approximately half of these IDNs are large enough to be able to negotiate independently and competitively with manufacturers. In addition to size, IDNs also gain negotiating power as they include several healthcare venues (hospital, nursing home, etc.) across the continuum of care, offering an attractive place for companies (or their distributors) to contract a full line of products. Additionally, the integrated, single ownership nature of IDNs greatly improves compliance with purchasing contracts, ensuring that the targeted sales volume is reached in exchange for the discount granted. Stanford Casebook

102 Confidential - for classroom use only Indirect Distribution Models: Specialized Distributors Another indirect model that is widely used in the medtech field is to work with specialized distributors. This approach is best suited to devices that are somewhat differentiated, relatively more complex, and offer at least moderate value to the user (as measured by physician preference for a brand name device, e.g., certain types of implants). Alternatively, it works well for low- complexity products that complete a complex product line carried by the specialized distributor. With a specialized distributor model, a company gains access to sales reps who are specialists in a particular type of product or therapeutic area. The sales personnel that support this model may be employed by a central company. However, they often work as independent reps, contracting directly to the company on a salary and/or commission basis without actually becoming employees. In either scenario, these reps have strong customer relationships within a particular region, and are able to leverage these relationships to sell whatever product they are carrying at the time. Sole source distributors carry one company’s products while multiple source distributors carry a few lines of product, ideally with clear differentiation along product characteristics and price. While it is in the best interest of distributors to carry as many brands as possible, manufacturers prefer exclusivity and can demand this if they are large enough. Invivo Surgical Systems is an example of a multi-source franchise distributor that carries spinal fixation implant product lines and equipment. Invivo Surgical Systems limits its coverage to the Northeast and New England, and recruits its own sales personnel to sell product. Specialized distributors can be set up as master resellers or agents. The primary distinction lies in whether the specialized distributor takes ownership of the product. This distinction has important ramifications on the economics of the sale. Specialized distributors who are master resellers purchase the product from the company in anticipation of orders coming in from customers and resell it to the end user. Because master resellers take title of the product, they have more power to negotiate contracts and discounts with the end user. Specialized distributors act as agents, on the other hand, sell product on consignment and negotiate the sale on behalf of the manufacturer, earning a commission. They have limited pricing flexibility and can only contract and discount at terms that are acceptable to the manufacturer. Although master resellers have more flexibility to negotiate the price than agents, they also take on more financial risk. They purchase goods from the manufacturer at a discount that is roughly equal to their target margin, but have no guarantee that the end user will buy at the retail price, or buy at all. Agents, on the other hand, receive a 20-30 percent commission on each sale and are not responsible for product that does not sell. However, they do risk losing part of their commission if they accept a lower price from the end user. Stanford Casebook

103 Confidential - for classroom use only Indirect Distribution Models: Third-Party Partnerships A third indirect approach is to manage sales and distribution through a partnership with a third-party company or manufacturer. Such partnerships involve another, often larger or more established medical device company to handle sales and distribution on behalf of the smaller company. This model, while widely used in the pharmaceutical industry, is relatively new to medical devices. Lifescan’s 2007 announcement that it planned to distribute its glucose monitor through Medtronic provides one example of this kind of partnership. Another example is seen in Israel-based Medinol’s decision to sell and distribute its drug eluting stent through Boston Scientific in the late 1990s. Sometimes worldwide sales and distribution rights are awarded as part of the deal. In other scenarios, the smaller company maintains local rights (e.g., in the U.S.), while essentially “outsourcing” sales and distribution in other markets (e.g., Europe). Third-party sales and distribution partnerships are generally only available to companies whose products can be clearly differentiated, have at least moderate perceived value, and/or complete a complex system. The most common reason for small companies to enter into these partnerships is to avoid the large financial burden associated with building and maintaining a direct sales force. Companies may also consider such a deal if they lack the breadth in their product lines to sell to entities that wish to purchase a complete line of products. Established manufacturers also have more leverage with GPOs and other important buyers and provide smaller companies with access to these relationships. There are two primary financial arrangements for forming these partnerships. The distinction is driven by whether or not the distributing company will manufacture the product. If the smaller company will be the manufacturer, a transfer fee is awarded each time product is shipped to the distributing company. If the distributing company will be the manufacturer, then a royalty is paid (usually 5-8 percent) to the smaller company based on net revenues. In both scenarios, an upfront payment may be awarded to the smaller company to provide the financial means to bring the product to market. While third-party sales and distribution partnerships can ensure the resources, infrastructure, relationships, and experience to quickly help get a product into practice, entering into such a relationship can be risky for a small device company, particularly if it is a single-product company. Because the larger company controls all of the customer relationships and manages pricing, training, and usage of the product, the smaller company is essentially putting its fate into the hands of its partner. Partnerships such as these are best employed only when some terminal event is spelled out in the partnership agreement toward which the company is working (e.g., an acquisition) or the company has another flagship product over which it exercises significantly greater control,. Another scenario in which a third party partnership might be appropriate is when the company is facing financial difficulties, which leave it with few other alternatives. Stanford Casebook

104 Confidential - for classroom use only Hybrid Models A hybrid distribution model that combines both a direct and indirect approach is a good sales and distribution choice for some medtech companies, particularly in their early stages (a hybrid approach can also be called a 2/4 tiered model). The time, cost, and other resources associated with establishing a direct sales force can be daunting to a young company. However, if a product is at least moderate in its complexity, value, and anticipated volume, the company would be well advised to consider launching a small direct sales team whose efforts are complemented by an independent distributor. The direct sales force can target a narrow segment of the company’s highest-value customers, while distributors or third-party partnerships with larger manufacturers are leveraged to give the company breadth in the total available market. Often hybrid models are based on geography, with a company deploying a direct sales force in concentrated markets but relying on regional specialized distributors in diffuse or closed markets. In these scenarios, the company may have the ability to gradually “take back” markets from distributors as its product gains momentum and revenues increase. Osteotech, which makes bone implants that partially utilize donated tissue, is one example of a start-up company ;hat utilized a hybrid model in order to rapidly gain a presence in a relatively large market. To address territories that extended beyond the capabilities of its small direct sales team, Osteotech worked with multisource agents to promote its product. However, over time, the company had plans to move toward a more direct model, investing $4 million in its sales and distribution channel in 2007 to make more “OsteoBiologic Specialists” available to drive the sales process. Stanford Casebook

105 Confidential - for classroom use only Direct Sales and Distribution Models For more complex and expensive devices, such as capital equipment and high-value disposables or implants, a direct sales model is often required. The primary customer in these sales is generally the physician or the medical facility (hospital, clinic, ambulatory surgical center, etc). Often, both the physician and the facility must be considered customers as they each have a role in the purchase process: physicians evaluate and endorse the performance of a product, while the facilities evaluate the economic ramifications of the purchase. More often than not, to convince these stakeholder groups to buy a product requires information, relationships, and interactions that only a direct sales force can provide. A direct sales force, a company hires its own sales people to engage providers (physicians and facilities) in a six-step process: Step 1: Account Prospecting Focusing sales efforts on targets that will eventually lead to consummated business is a two-stage process. First, initial sales targets are set by the company based on the amount of calculated potential business a target can generate in the future. Next, sales reps visit or “call on” these targets. Over time, they identify and focus on the subset of providers who are most receptive. Sales reps may also identify additional providers not included on the original list of targets through networking and other professional activities. Step 2: Relationship Building Forming partnerships and developing trust with providers requires extensive formal and informal relationship building activity. During this stage of the selling process, the sales rep is constantly evaluating providers’ needs and seeking to convince them of the product’s value on addressing those needs. The off-site social meetings popularized by the drug industry (such as dinners, sporting events, and company-sponsored weekend advisory board meetings) have become relatively commonplace in the medical device field as one vehicle for gaining access to providers. Educational events are also used as a mechanism for building relationships as part of the sales process. Providers often decide to enter into a relationship with a company based on their evaluation of a product’s attributes, the sales rep’s medical expertise and personal characteristics (such as honesty and integrity), and the commitment of the company to the account (demonstrated through time, special attention given to providers, and the future potential for research partnerships). The process of building a relationship with a provider can be time consuming. It is not unusual for new sales reps to be given months (or even years in some highly complex, specialized fields) to identify and develop productive relationships before they must generate sales. Building relationships can be especially challenging in crowded therapeutic areas, where physicians may have deep loyalties to the products and sales personnel of established competitors. For example, orthopedics, most reps are expected to have convinced only 10 physicians to try their products within the first two years of selling. Step 3: Pitching and Closing Ongoing product sales begin once the relationship has become adequately established and the product benefits are clear to the provider. Sales reps are extensively trained to handle this stage of the sales process. With a particular patient or patient-type in mind, the rep uses product, competitor, and disease state information as well as an understanding of the provider’s unmet needs in order to make a case for his/her company’s product. Materials are often customized to each provider’s specific circumstances and interests. Sales reps must be prepared to handle objections from providers (such as doubts about performance, safety, or value). The actual close” takes place when the rep asks for the product to be purchased for a specific patient or within a defined time frame, and the provider agrees. Stanford Casebook

106 Confidential - for classroom use only Direct Sales and Distribution Models (contd.) Step 4: Pricing and Contract Negotiations Pricing and contract negotiations may occur in parallel with pitching and closing the sale. Some providers want to address these issues before any final agreement is reached, while others prefer to address them after the product has been tested and found acceptable in a few patients. Within a single facility, price and contract negotiations for capital equipment and high-value implants are generally conducted between the sales reps and contacts from purchasing and/or administration. While physicians are integral to making the recommendation to procure the product, they do not directly participate in the purchasing negotiations, which include agreeing on a price for the product and the negotiation of all relevant deal terms (delivery, training, usage, service, etc.). Outside a hospital or other larger facility setting (e.g., for products sold into doctors’ offices), the physician is much more likely to serve as the primary point of contact for the end-to-end sales process, including pricing and contract negotiations. As an integral part of the purchasing negotiation, especially for high-cost items, companies generally develop a business case model that can be customized by the sales reps to provide a tailored demonstration to the buyer regarding how the product will improve outcomes and enable future profit in the buyer’s environment (e.g., through billing the insurance company for the product and procedure, by expanding the provider's market, or through repeated use of capital equipment). In the case of strategic customers, such as large IDNs, major hospitals, or GPOs, contract negotiations are usually handled by the most experienced sales reps or by higher level company executives (the VP of sales and marketing or the chief medical officer). Such negotiations can be complicated and time consuming. Additionally, they are often strategic in nature and the buying decisions tend to involve large sums of money (e.g., in the form of pricing concessions). Step 5: Provider Training Once a sale has been made or promised, sales reps help the provider use and integrate the device into practice. For example, with an implant, they first train the provider on how to select the appropriate model and size of the device and then how to perform the procedure. If appropriate, sales reps are commonly present in the first few procedures to assist the provider in selecting the model or size of device for each individual patient and help troubleshoot problems and issues as they arise. For highly complex devices, it is not unusual for device companies to restrict the use of a device until physicians have completed appropriate training by a representative of the company. Step 6: Account Management Post-sale account servicing includes everything that happens after the sale to support all servicing included in the contract (e.g., service for a piece of equipment, answering product questions, and assisting with reimbursement issues). Additionally, it is focused on customer retention and the development of future sales with the same account. By proactively addressing customer concerns, a sales force can understand what issues might cause a customer to try another product and, in many cases, make adjustments to the offering to circumvent the problem. Examples of common concerns in the medtech field that must be managed on an ongoing basis include difficulties with the device and/or procedure, lower than anticipated patient outcomes, and suboptimal customer service. Importantly, account management is also intertwined with the development of new product ideas. As sales reps assist providers with the use of the device and address product questions and concerns, they gather feedback that can be used by engineers and other technical experts within the company to improve and/or expand the company's offerings. Stanford Casebook

107 Confidential - for classroom use only Direct Sales and Distribution Models (contd.) As this brief description of the direct sales process illustrates, there is a sizable investment of time and resources to make each sale. However, once physicians and facilities start reliably engaging the sales reps and using the company’s products, a strong bond is often formed that can be leveraged to make sales easier and less time-consuming in the future. Direct sales teams are typically organized geographically, with each individual territory manager reporting into a regional manager who, in turn, reports to a national sales director. The territory sales reps have limited freedom in choosing which doctors and hospitals they target, as much of this direction comes from company management. Responsibility for the sale is shared somewhat between the regional manager and the territory manager. They take a team approach closing the sale, after which the regional manager handles the contract negotiations and the territory manager handles account maintenance and customer retention in collaboration with the sales rep. Any contracts and discounts are typically managed centrally by the company. In a direct model, the physical delivery of the device is typically made by the sales reps or via a courier service (capital equipment requiring a major installation is, of course, one exception to this rule). The provider completes and submits an order form, calls the company’s customer service department, or places the order directly through the sales rep. In turn, the product is shipped or hand-delivered. In some cases, multiple sizes or models of the product are left with the provider on consignment so that, during procedures, the device with the correct specifications is always available. Because the physical delivery of a device is not as complex as the underlying sales process, the manufacturer may engage a third-party distributor to take charge of deliveries, even as it maintains a direct sales force. Although manufacturers of high-value devices traditionally have not entered into contracts with GPOs and IDNs, groups that aggregate the purchasing power of multiple entities must still be viewed as important customers. Healthcare providers sometimes organize themselves into purchasing groups for buying complex, high-value medical devices. Similar to GPOs, these groups take individual physician input into account, but also rely heavily on pooled criteria for making buying decisions that satisfy the interests of all participants, such as the ability of the company to serve as a sole-source supplier of a device, customer service capabilities, pricing and discounting. Companies faced with the challenge of selling high-value devices to such purchasing groups typically must work hard to sell them on the value of the products. Similarly, they must continue to innovate and improve to retain the business once a buying decision has ten made. However, it should be noted that, in most cases, these aggregate purchasers play a limited role in high-value devices because the purchasing decision is more directly driven by physicians (and aggregate purchasers exercise little control over physician choices). Payers should also be viewed as customers for more complex, high-value medical devices, as they are responsible for the incremental reimbursement of new and expensive products. The reimbursement process is not unlike the sales process in that it involves identifying who will be the major payers, developing relationships early to understand what product information and value propositions will be required, lobbying for coverage and payment policy in anticipation of or in conjunction with launch, contracting and discounting, and payer account maintenance (i.e., fielding product questions or concerns as they arise). However, while “selling” to payers requires significant effort and focus, it typically only occurs once. After the product is accepted by the payer, less effort is needed to maintain product acceptance, although constant follow-up is necessary to keep the product in a favored position. Stanford Casebook

108 Confidential - for classroom use only Appendix: Pricing for MedTech

109 Confidential - for classroom use only Pricing for Medtech Before an entrepreneur thinks about setting a baseline price, s/he must first understand all of the costs associated with developing, manufacturing, and marketing the offering. S/he should also determine what sort of mark-up (profit) the company would ideally earn to support its overhead and ongoing development efforts. Once these factors are clearly understood, the next step is to perform an evaluation of real and perceived value associated with the offering. Cost/benefit analyses and the value propositions defined for the device can provide important inputs to this assessment. Value-based pricing is typically the easiest type of pricing strategy for a company to support. If the price of a new technology can be directly linked to the value it will deliver (with the value exceeding the cost), buyers and payers are far more likely to support the adoption of the offering if the most persuasive value-based pricing argument is related to direct savings in healthcare costs. If a physician or hospital will save money with each device used (relative to the current standard of care), this gives the company a strong argument for justifying its price. Another common pricing argument is related to improved outcomes. If a device leads to improved results such that a payer saves money on follow-up care and/or treatment related to complications, this is frequently a compelling argument. Companies can sometime encounter resistance, however, when the pricing argument is based on quality of life. Buyers and payers are generally willing to support the adoption of devices that lead to significant, measurable, evidence- based improvements in quality of life. Yet, their standards for demonstrating such a change are growing increasingly stringent, especially for high-end, high-cost devices that represent a sizable potential cost burden to the healthcare system. Another way that companies can establish a baseline price is to perform a comparables analysis. By evaluating the pricing strategies (and associated reimbursement status) of similar offerings in field, companies can gain valuable information to help them choose a price. In general, medical device pricing for established products should give the entrepreneur a strong sense of what the market will bear. Comparables analysis can be accomplished through primary and secondary research. Performing this type of market research can also be helpful in terms of understanding the price sensitivity of key stakeholders (i.e., identifying the price point at which they will resist the technology). Stanford Casebook

110 Confidential - for classroom use only Pricing for Medtech (contd.) The company must also decide under what circumstances it might be convinced to deviate from its baseline price. Pricing strategies that require a company to adopt a more complex approach to pricing include the following: 1. Differential pricing – Differential pricing refers to the basic concept of pricing the same product or service differently for different customer segments. For example, in some cases, medical device companies might negotiate discount pricing with large purchasers (e.g., group purchasing organization, integrated delivery facilities). While this strategy can be effective in driving volume, it has the potential to create conflict in the market among customers, as well as payers. It may also create legal challenges, if it is perceived as creating a financial inducement to physicians. 2. Bundled pricing – Bundled pricing refers to setting a single price for a combination of products and/or services. A medical device manufacturer might bundle service contracts or ancillary products and services with its primary offering to try to drive increased revenue. Bundled pricing can be a way of offering discounts to buyers while incentivizing them to buy a wider range of products and services than they would otherwise. While this works in some cases, it is not successful for all offerings. For example, Guidant offered bundled pricing on its catheter and guidewire products in an effort to drive more widespread adoption. However, because physician preference is so strong in this particular field, practitioners wanted to choose products a la carte, despite the discounts that could be realized by purchasing bundled products. 3. Gainsharing – Gainsharing agreements between a hospital and its physicians represent another subtlety in pricing. Under these agreements, hospitals can negotiate reduced prices with certain manufacturers in exchange for increased volume. Gainsharing differs from differential pricing, however, in that physicians are given direct incentives to adopt certain devices. For instance, these plans often provide them with a percentage of the cost savings derived from reduction of waste and use of specific supplies during procedures. While some observers view gainsharing programs as an effective cost-cutting tool, others perceive them to be laden with inherent conflicts of interest, an obstacle to innovation and proper patient care, and possibly even a violation of anti-kickback statutes. 4. Pay-for-Performance – As the Genomic Health example illustrates, companies may agree to set their prices contingent on the realization of specific results. If the company delivers on its value proposition (as measured by mutually agreed-upon performance metrics), a payer or customer will pay its baseline price. If not, certain discounts will be to justify the lower “payback” on the device. As with gainsharing pay-for- performance arrangements are relatively new and are still somewhat controversial within the industry. The company should seek legal counsel when creating pricing strategies. The healthcare space is highly regulated and arrangements that may be perceived as creating an inducement for a physician to use a particular device or procedure can run afoul of the Stark Law. This law governs what is referred to as physician self-referral, or the practice of a physician referring a patient to a medical facility (or form of treatment) in which s/he has a financial interest, be it ownership, investment, or a structured compensation arrangement. While the law remains controversial, entrepreneurs should exercise appropriate caution to avoid a potential conflict of interest. Stanford Casebook

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1 Confidential - for classroom use only Reminder: The Marketing Imagination Per Theodore Levitt, Marketing is about – gaining differential advantage over.

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