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CMA Part 3: Section C Corporate Finance Prepared by:Section C – Corporate FinanceThis section represents approximately 25% of the Part 3 Exam. You should expect somewhere between 26 and 27 questions from Section C.The three Parts to Corporate Finance are:Working Capital Management,Corporate Finance, andRisk and Return.Working CapitalWorking capital is the term for short-term assets that a company uses in its day-to-day operations. Working capital finance concerns the optimal level, mix and use of current assets and current liabilities. Working capital is one of the measures of a company’s short-term solvency, which is its ability to pay liabilities as they become due.
Net working capital is calculated as follows:Net Working Capital = Current Assets – Current Liabilities
Working Capital GoalsWorking capital management is a process of balancing different goals by management. On one hand, every company must be certain that they have enough cash to be able to pay their liabilities as they come due. However, the short-term assets (cash, inventory, receivables) that the company holds provide very little, if any, return.
Therefore, the more short-term assets held by the company, the lower the chance of insolvency, but the lower the return that is earned on company assets. Levels of Working CapitalA conservative working capital policy seeks to minimize liquidity risk by increasing the amount of working capital that it holds. The company gives up the potentially higher returns available from using the additional working capital to acquire long-term assets, but is in a safer position with respect to liquidity and possible insolvency because of the greater amount of working capital. An aggressive working capital policy reduces the current ratio (calculated as current assets ÷ current liabilities) and accepts a higher risk of short-term cash flow problems in exchange for a greater return on investment. The company will have a very low (maybe even negative) level of working capital, but will also have a higher return on its assets. In the short term it is possible to have a negative working capital. In this case, the company is planning to collect additional cash or receive a new source of financing before its current liabilities become due.
Types of Working CapitalBecause a company may have different cash needs throughout the year, it is possible that it will maintain different levels of working capital at different times of the year. Permanent working capital is the minimum amount of working capital that is maintained at all times.The increases that occur from time to time are called temporary working capital.
Changing Levels of Working CapitalA company may increase its net working capital by either: 1) Increasing current assets, or 2) Decreasing current liabilities. Conversely, a company may decrease its net working capital by either: 1) Decreasing current assets, or 2) Increasing current liabilities.
Effect of Other TransactionsTransactions in which one current asset is exchanged for another current asset have no effect on net working capital. An example of this type of transaction is the collection of accounts receivable. When cash received, there will be an equal decrease in account receivable. Another type of transaction that does not affect net working capital is one in which both current assets and liabilities are increased (or decreased). If a company purchases inventory on short-term credit, the current assets of the company will increase, but so will current liabilities. Similarly, the payment of the payable will not have an effect on working capital because both a current asset and a current liability are reduced by an equal amount. Short-Term Liquidity RatiosShort-term liquidity ratios (also called solvency ratios) measure the short-term viability of a business. This is a firm’s ability to continue operating in the short term by paying its obligations as they come due. A company must have enough working capital to finance its daily operations. This working capital, which the company holds, bridges the gap between production (spending money) and sales (collecting money). As discussed earlier, maintaining a comfortable level of working capital is important, and doing so enhances the company’s ability to meet its current liabilities, expand production, and take advantage of business opportunities that may arise. However, maintaining too much working capital can make it difficult for a company to maximize the return from its assets. Current RatioThe current ratio measures working capital as a ratio instead of a dollar amount. It is calculated as:Current AssetsCurrent Liabilities
Again, this number should be more than 1. The specific ‘target’ amount depends on the business and the industry.
Quick RatioThe quick ratio is based on the current ratio, but it does not include inventory in the numerator. This is because the company should not use inventory to pay its liabilities as the company would then have nothing left to sell.
Cash + Cash Equivalents + Receivables + Short-term SecuritiesCurrent Liabilities
This is also called the ‘Acid-test Ratio’Cash RatioThe cash ratio further adjusts the current ratio by not including receivables in the numerator
Cash + Cash Equivalents + Short-term SecuritiesCurrent LiabilitiesCash Flow RatioThe cash flow ratio compares the cash flows from operating activities with the average current liabilities during the period.
Annual Cash Flows from Operating ActivitiesAverage Current Liabilities
Cash ManagementCash management is one of the most critical processes for a company. If there is not enough cash at any one point in time a company will face, at worst, bankruptcy or at least high interest charges to obtain the necessary cash from a bank on short notice. A company must manage cash from both a short-term and a long-term perspective. In the short-term it is essential that the company have enough cash to pay its obligations as they come due.In the long-term, it is critical that the company has enough cash to grow and expand as needed. How Much Cash is Needed?Among these factors that influence how much cash is held are:How much cash will be needed in the near future,The amount of risk a company is willing to take in respect to solvency,The level of other short-term assets that a company holds,The available return on other short-term investments, At what point in its business cycle it is in (if a business is a seasonal business it will have more cash at the peak periods than at the slow periods).
Reasons for Holding CashThe reasons that a company holds cash are many and varied. However, we can break the reasons for holding cash into the following categories:As a medium of exchange. Cash is still needed for some business transactions.As a precautionary measure. Cash may be held for use in unforeseen situations where cash is needed quickly. There is no longer a need to keep cash outside of the bank as a protection against the failure of the bank because bank accounts in the U.S. are guaranteed. For speculation. Cash may be held in order to be able to act quickly on good investment opportunities that arise. Cash may be held as a compensating balance. This occurs when a bank requires that a company maintain a minimum balance in its bank account during the period that a loan is outstanding.
Operating Cycle and Cash CycleThe operating cycle measures the amount of time it takes to convert an investment in inventory back into cash after the collection of the sale. It is calculated as:Days in Inventory + Days of Sales in Receivables
The cash cycle represents the number of days that cash is tied up in the operating cycle of the business. It is:Days in Inventory + Days of Sales in Receivables – Days of Purchases in Payables
Both of these are better if they are shorter.
Timing of Cash FlowsThe main two elements of managing cash are:Collecting cash as quickly as possible (speeding cash inflows), andDisbursing cash as slowing as possible (slowing cash outflows).
Speeding Cash Inflows A company should always endeavor to receive its cash payments as soon as possible in order to maximize its cash management position. The following measures can help to expedite cash inflows and minimize collection float (the collection of receivables):All invoices should be mailed as soon as possible under the terms of the sales agreement so that they can be paid as soon as they are due.The payment terms for credit should be such that they encourage prompt payment. Giving a discount if the invoice is paid before the due date may achieve this. We will look at the calculations related to this in the slowing payments section.Use of electronic data interchange (EDI), electronic funds transfer (EFT) and automated clearinghouses (ACHs).
Speeding Cash Inflows, continuedAccept credit cards (Visa, MasterCard and American Express, for example) can be used as an alternative method of speeding up collection rates. The bank that issued the card charges the seller a fee equal to 1% - 3% of a charge sale, but the funds are instantly available to the seller when a buyer uses a credit card. The responsibility for collection has been transferred to the credit card in exchange for the fee that they charge. Use wire transfers as a means of collection from customer. Utilize a lockbox system. This method will be discussed in greater detail.Lockbox SystemIn a lockbox system, a company maintains special mailboxes in different locations around the country. Customer send their payment to the closest lockbox. This reduces the amount of time the money is in the mail.The company then authorizes a bank to check these mailboxes as often as is reasonable, given the number of payments that will be received. Because the bank is making the collection, the funds that have been received are immediately deposited into the company’s account without first being processed by the company’s accounting system, thereby speeding up cash collection. Benefits of a Lockbox SystemFor a company to benefit from a lockbox system, the interest earned from the additional day(s) on the cash received (because the bank collected it directly and deposited it immediately) must be greater than the cost of the bank fees for providing this service. Having several lockbox locations reduces the time a payment is in the postal system. It also allows concentration banking to be used. This is a system in which a regional bank is responsible for the transfer of lockbox receipts in that region. By also having a disbursement account at each of the regional centers, a company will have faster access to its money because there is no need to wait for the money to be transferred to the central bank account. Calculating the Lockbox BenefitThe calculation of the benefit from a lockbox system is calculated using the following steps:Calculate the amount of cash that is collected each day.Multiply this by the number of days that the collection float will be reduced (this calculates the increase in the cash balance that the company will have for the year).Multiply the increase in the cash balance by the interest rate at which the company can invest their funds. This is the benefit that the company will receive.The final step is to compare the amount of the benefit to the company to the cost that they will need to pay for the new system. If the savings are more than the cost, the company should invest in the new cash management system.
Slowing Cash OutflowsAs opposed to cash inflows, a company should slow its cash disbursements in order to increase the amount of time that it has the cash.Payments should be made as close to deadline requirements as possible. However, it is important to remember that if a company misses the payment date they may incur interest charges or lose the chance to purchase from that supplier again.Payments should be made within the cash discount period, if taking the discount provides a better return than not taking the discount. This will be looked at in more detail later.Slowing Cash Outflows, continuedMaking payments via drafts (check). The advantage to the payer is that there is a delay of time between when the check is presented for payment (this is when the recipient receives the money) and when the money is taken out of the account of the company that wrote the check. This delay (cash taken out of the account) is called the check float. The effect of this delay is an interest free loan for the time that the check has been paid, but not yet deducted from his cash account. There are two types of floats, depending on if the person is making payment or receiving payment by the check. The person paying has what is called the disbursement float and the person receiving the money has what is called the collections float. Slowing Cash Outflows, continuedUsing Payable Through Drafts (PTD) are a specific type of draft that a company can use. It functions largely like a check, except the recipient needs to present the PTD to the company who issued it. Some banks offer zero balancing checking accounts, although a fee may be charged for this service. In a zero-balance account, the account balance is maintained at zero until the bank receives a check for payment. This resulting overdraft (having a negative balance in an account) is then automatically ‘covered’ by the bank by transferring money from another account that the company holds. This other account is one that bears interest and a zero-balance arrangement allows the company to earn interest on its funds for as long as possible. Slowing Cash Outflows, continuedUsing Overdrafts as a method of slowing payment is similar to zero-balance checking accounts except the fact that in an overdraft there is no second account from which to transfer the money. Therefore, the company has a negative balance at the bank and as a result will need to pay various penalties and/or high interest on this amount. Because of the penalties and interest, this should not be a common method used by a company to slow its payments. Calculating compensating balances on an average basis rather than an absolute basis. By using an average daily cash balance for the compensating balance, the company can manage its cash more effectively as it doesn’t always need to keep a minimum balance in the bank as long as the average is the required amount. Taking the Cash DiscountA cash discount is when the company receives a discount if they pay their payable within a certain number of days after it is created. A typical cash discount would be 2/10, n/30. This means that if the company pays within 10 days, they get a 2% discount. If they do not pay within 10 days, the full amount is due in 30 days.Payments should be made within the cash discount period, if taking the discount provides a better return than not taking the discount. Taking the Cash Discount CalculationThe calculation of the cost of not taking the cash discount that is offered for early payment, is calculated as follows:

If this cost of not taking the discount is higher than the cost of capital to the company, they should take the cash discount and pay within the discount period. Marketable Securities ManagementMost companies try to avoid holding large cash balances and prefer to borrow to meet any extraordinary short-term cash needs because holding cash does not provide any return on the cash that is heldMarketable securities provide some return on what is invested. Marketable securities may be purchased so that the maturity periods of the securities will match a time period of low cash balances or higher than usual cash needs. These securities may be used to synchronize the cash inflows and the cash outflows of the business. Marketable Securities Management, continuedThe purpose of a marketable securities portfolio is to provide a store of liquidity. The return on the portfolio is only a secondary objective. Liquidity has two components: time and amount. Marketable securities should be converted into cash quickly (usually in less than 24 hours).The risk of change in value should be very low, meaning that they can be sold without a large discount.
Marketable Securities Management, continuedA firm should choose its investments with a view of the financial (repayment) risks involved with each security. As a result, a higher return may be given up in exchange for greater safety (less chance of default) by placing cash in investments with lower rates of return in exchange for a lower risk profile. Interest rate risk is the change in value of a fixed income security that results from a change in market interest rates. In order to minimize interest rate risk, marketable securities should be investments with short-term maturities. Liquidity is a function of how quickly an asset can be converted into cash, and how safe the investment is from loss of value. Only high quality, short-term debt instruments typically qualify as marketable securities. Tax Issues with Marketable SecuritiesSome marketable securities that are issued by cities, states or the federal government are tax-exempt. This means that the interest earned from this security is exempt from taxation by federal, state and/or other local authorities. These are frequently called “municipal bonds” even though they may not have been issued by a municipality (city).
Because of this tax-exempt status of the interest, the interest rate on a tax-exempt security is less than that from a corporate bond. This is because the tax exemption provides extra compensation to the holder of the security. The higher the tax bracket of the investor, the more attractive the tax-free alternative becomes. Investment PoliciesBecause of the variety of factors that go into the decisions related to marketable securities, it is very helpful if a company has an investment policy statement. This statement provides guidance to the individuals who need to make these decisions and as a result, ensures that the investments that are made throughout the company are in line with its policies. Types of Marketable SecuritiedThere are a number of different types of instruments that may be classified as marketable securities.The main ones that you need to know are:Treasury bills,Certificates of deposits (CDs),Money market accounts, andHigh-grade commercial paper.
Other marketable securities are listed after a discussion of these.Treasury BillsTreasury bills (also called T-Bills) are short-term government debt securities (mature in 30, 90, or 120 days) guaranteed by the full faith and confidence of the U.S. government. The income from T-Bills is exempt from state and local taxes, but not federal taxation. T-Bills differ from obligations of federal agencies, which are guaranteed only by the agency that is issuing the bill and not the U.S. government. T-Bills are sold at a discount, which means you pay less than the face value, and redeem them at par on maturity. The difference is the discount. Treasury Bills – Calculating the DiscountThe calculation of the amount of the discount is: Face value of the Bill - Interest earned while the T-Bill is outstanding = Discounted Basis
The T-Bill interest rate is calculated as follows:Certificates of Deposit (CDs)CDs are a form of savings deposit with a bank that may not be withdrawn before their maturity without a high penalty. CDs usually have a higher rate of interest when compared with other savings instruments because they are for fixed, usually long-term periods. The longer the period of the CD, the higher the interest rate that is paid. A negotiable CD is usually sold with higher denominations ($100,000 and more) and can be freely traded on secondary markets, but fall under the regulation of the Federal Reserve System. The return on a negotiable CD is high, but not as high as the return on commercial paper since the risk is lower than for commercial paper. Money Market AccountsMoney market accounts operate in a manner similar to checking accounts but they pay higher interest rates, generally in line with money market mutual funds. The number of checks that can be written against the account is usually limited although unlimited transfers can be made via ATMs. Balances in the account may be withdrawn at any time without penalty, but in return for this flexibility, the interest rate that is earned is less than on CDs. High-Grade Commercial PaperHigh-grade commercial paper is marketable short-term, unsecured debt that is issued by large companies that have solid credit histories and high credit ratings. These instruments are sold to other large companies and institutional investors. Commercial paper is usually issued in very large denominations ($100,000 or more) and is unsecured. Like T-Bills, commercial paper is sold at a discount, and the face value is paid at maturity. High-grade commercial paper may yield a higher return than CDs because of the higher risks involved with the unsecured debt. Maturities for commercial paper are at most 270 days. Other Marketable SecuritiesOther types of marketable securities that you need to recognize as marketable securities are:Bankers’ acceptances,Federal agency securities,Eurodollars,Money market mutual funds,State and local government securities,Treasury notes and bonds, andRepurchase agreements.
Cash and Marketable Security Models There are 2 models of marketable securities management that both address the need of the company to balance the amounts of cash and marketable securities that they hold.Too much cash (and not enough marketable securities) reduces the return that the company received on their assets.Not enough cash (and too many marketable securities) increases the risk of insolvency.The two models are:Baumol Cash Management Model, andThe Miller-Orr Management Model.The Baumol Cash Management ModelThis model is based off of the same equation that we will see in the calculation of the economic order quantity (EOQ) for inventory. (This is covered in more detail in the inventory section.) In the application of EOQ to cash management, a company is calculating the optimal cash (OC) level to receive every time it converts marketable securities to cash. Another way of looking at this formula is that it determines the amount of cash that should be converted from securities each time a conversion is made in order to minimize the costs of conversion and the opportunity cost that is given up by holding cash instead of marketable securities. The Baumol FormulaIn this formula the assumption is that cash that is not needed in the immediate future by the company are held as marketable securities. To get more cash the company simply needs to convert these marketable securities into cash. However, in order to convert these securities to cash, there is a fixed fee (such as a brokerage fee) that is paid for each conversion. Also, any time that cash is held, the company gives up the interest that was being earned by the marketable securities. This formula balances the cost of converting marketable securities into cash with the interest benefit of holding marketable securities. The Miller-Orr ModelThe Miller-Orr addresses the issue that the demand for cash is not known and is not constant over time. Similarly, the source of cash is not known and not constant. The Miller-Orr Model creates an upper limit and a lower limit for the cash balance that a company holds. As long as the cash balance is between these two levels, there is no need for the company to make any cash transactions to either increase or decrease the balance. As soon as the cash balance moves outside of this corridor, the company needs to do something to bring it back into the corridor.The model also establishes a cash balance that the company will move towards whenever it makes a cash transaction. Accounts Receivable ManagementIn managing accounts receivable a company must balance the amount of receivables outstanding and the amount of bad debts resulting from receivables not collected. The company must balance the trade-off betweenThe rewards of credit sales (additional sales that would not be made if only cash sales were accepted), and The costs of having and collecting the corresponding accounts receivable (these costs include collection costs, foregone interest, bad debt costs, etc). Obviously, it would be best for a company to never have bad debts, but the only way to do this is to never make a credit sale. Credit Policy VariablesThere are three credit policy variables Credit standards – these determine who the company grants credit to. Relaxed terms mean that the company gives credit to more people, and strict terms means that the company gives credit to only those with very low risk of default.Credit terms – the terms of sale, including the payment period, discount for early payment or penalty for late payment, and the size of the discount or penalty.Collection efforts – the amount of time and money spent on collection of past due accounts. Changing Credit Policy ItemsAny action that changes any of these variables will have both costs and benefits. The benefits may be in the form of increased sales revenues, the reduction of opportunity costs due to lower accounts receivable balances, fewer bad debts or lower collection expenses. The costs may include lost sales revenue, increased discounts taken, the opportunity cost of higher accounts receivable balances, higher bad debts or higher collection expensesSome companies use a system called credit scoring in an attempt to manage their credit policies and extend credit policies only to worthy customers. In a credit scoring system, a potential customer is graded against specific criteria and they get points for meeting certain criteria. The ‘score’ that a potential customer receives then determines whether or not it will receive credit. Impact of Credit Policy ChangesIf the credit standards are made softer (changed so that more people are able to obtain credit), there will be:An increase in sales. A corresponding increase in bad debts and collection costs resulting from people with worse credit histories who can borrow money from the company. In other words, as the credit terms are relaxed and more people obtain credit, there is an increase in the default risk. Conversely, a change to more strict credit policies will have the opposite effect. This will cause lower levels of accounts receivables and bad debts, but also lower levels of credit sales. Other Types of ReceivablesIn addition to accounts receivable (called an invoice), a company has other options about how it may make a sale and then collect the money at a later date. Among these other options are:Promissory Note – this is an unconditional promise by one party to pay another party a certain amount of money at a time in the future. Conditional Sales Contract – this is often used for larger cost items and the seller sells the item to the buyer, but retains the actual title to the item until all of the payments have been made. After all payments have been made, title is transferred to the buyer.Commercial Draft – this is a business-to-business order for payment. Credit Cards – credit cards are in a sense another form of a credit sale, but this is much closer to a cash sale because the seller almost immediately collects the money from the credit card company. The credit card company that needs to collect from the buyer. One drawback to this type of sale is that the seller does not receive 100% of the sales price as the credit card company takes a commission on the sale. Accounts Receivable TurnoverLike the Inventory Turnover number, this measures how many times during the period the company collects its receivables.
Annual Credit SalesAverage Annual Accounts Receivable
Days of Sales in ReceivablesThis is the number of sales that are outstanding and not yet collected (held as receivables)
365, 360 or 300 (told in the question)Receivables Turnover
Inventory ManagementInventory management is a critical part of the accounting function of any company that produces or sells a product. If a company is a seller of finished goods or a producer of goods, it is very possible that inventory will be the largest, or one of the largest, items on the balance sheet. Therefore, a small incremental percentage increase or decrease in the cost of inventory will translate into a very large dollar amount of cost when it runs through all of the inventory that is produced or sold. Cost of InventoryAs a result of this potential impact, a firm should minimize its total inventory costs. These are divided into the following three main categories. Ordering Costs,Carrying Costs, andStockout Costs.
Ordering CostsThese are the costs that are incurred every time inventory is ordered. These costs include:The costs of placing an order, The cost of receiving an order,Discounts lost by not ordering enough units, andAny setup costs.
Carrying CostsThese are the costs of keeping one unit of inventory in stock. These costs include the costs of:Storing the inventory, Insuring and securing the inventory, Inventory taxes, Depreciation or rent of facilities, Obsolescence and spoilage, andThe Opportunity cost of inventory investment. This is the cost of capital and it represents the amount of interest that is lost by investing our cash in inventory instead of in some other longer-term investment that returns dividends or interest.
Stockout CostsThese are the costs that are incurred through lost sales when we don’t have inventory available for the customer. It includes both the cash and profit that is lost from not being able to make that individual sale and also the cost of customer ill will. The cash cost of the lost sale is probably a very small amount and not very crucial in the larger picture, but the cost of the customer ill will is potentially very large. Ill will is almost impossible to measure as it can cause the customer to not return for future purchases, and can instigate the spread of negative information about the company in the marketplace. Safety StockThe level of safety stock a company carries is its main protection against stockouts. The safety stock is the amount of inventory the company plans to have on hand when the next shipment of inventory is due to arrive. A high level of safety stock means that even if the inventory is delayed in its receipt, the company will have sufficient levels of inventory to continue to operate while the shipment arrives.The amount of safety stock that a company is required to hold will be affected by: The variability of the lead time, The variability of the demand for the product, andThe cost of stockout.
The Reorder PointThe reorder point is the level of remaining inventory that indicates when the company needs to place the order for inventory. It is calculated as follows:
Expected demand during the lead time + Amount of safety stock = Reorder point
The average inventory that the company holds is calculated by adding together the safety stock and the number of units that is ordered each time an order is placed, and dividing this by two. Economic Order QuantityIn using EOQ, a company calculates the number of units that it should order each time it orders inventory for the purpose of achieving the minimum cost for ordering and holding inventory. This is a traditional inventory management approach and if it is used correctly it can help reduce the inventory costs of a company. The factors that are incorporated into the model are:The annual demand for inventory, The cost to carry one unit of inventory for one year (this includes the interest on funds invested in inventory), andThe cost of placing an order. EOQ AssumptionsFor the EOQ calculation to work, the following assumptions are made:The annual demand for the item is known and constant, The cost per order is known and constant, The unit carrying costs are assumed to be known and constant throughout the period, andThere are no stockout costs included in the EOQ model because it is assumed that demand can be determined and planned for. EOQ CalculationThe EOQ is calculated as follows:
2aD EOQ = k
Where a = Variable cost of placing an order D = Periodic demand k = Carrying cost per unit per period
Just-in-Time Inventory ManagementModern inventory management has departed from the EOQ approach in favor of the JIT approach. JIT inventory systems are based on a manufacturing philosophy that combines purchasing, production and inventory control into one function. This reduces the level of inventory that is held within the company at all stages of production, and thereby also reduces the cost of carrying the inventory. However, this reduced level of inventory carries with it an increased risk of stockout costs. JIT, continuedOne of the main differences between JIT and traditional inventory systems is that JIT is a “pull system” rather than a “push system.” The main idea of JIT is that nothing will be produced until the next process in the assembly line needs it. This means essentially that nothing will be produced until a customer orders it. However, we know that this is not actually possible so production is driven by the expected demand for the product. By contrast, in a push system, a department produces all that it can and sends those units to the next step in the process for further processing. This means that a company is producing something without knowing if it is actually needed or not, resulting in a possibly large, useless stock of inventory. Implementing JITTo implement the JIT approach and to minimize inventory storage, the factory must be reorganized to permit what is known as lean production. Under lean production, the plant layout is arranged by manufacturing cells that each produces a product, or product type. Each worker is able to operate all machines, and also perform support tasks within that cell. This reduces the downtime resulting from breakdowns or employee absences.Because inventory levels are kept low in a JIT system, the company must have a very close relationship with its suppliers to make certain that the supplier makes frequent deliveries of smaller amounts of inventory. It is also critical that the inventory is of the required quality because there is no extra to use in place of any defective units that are delivered. Other Inventory SystemsOther systems that you need to be aware of are:Kanban - Kanban is a Japanese inventory system in which ‘cards’ or ‘tickets’ are used to keep track of inventory and the movement of the inventory. Kanban is an integral part of a JIT system. Computer Integrated Manufacturing (CIM),Materials Requirement Planning (MRP), Manufacturing Resource Planning (MRP-II), andEnterprise Resource Planning (ERP).
Inventory Turnover RatioThis measures the number of times the company sells its inventory. If this number is too low, it may indicate that they have too much inventory and have too much cash invested in inventory.If the number is too high it may indicate that they do not have enough inventory and lose sales from stockouts.
Annual Cost of SalesAverage Annual Inventory
Days of Sale in InventoryThis measures the number of days of sales that are held in inventory, on average. The higher the number, the less risk that there is for a stockout; but the more cash is invested in inventory.
365, 360 or 300 (told in the question)Inventory Turnover
Short-Term FinancingWhen discussing short-term financing, we are focusing on the current liabilities portion of the company’s balance sheet and how these items affect a company’s net working capital.
We will discuss these short-term liabilities now because of the overlap between working capital management and capital structure finance. Sources of Short-Term Financing The two most common forms of short-term financing are:Bank loans, andFactoring receivables.
We will look at these in detail and then at other sources of short-term financing.Bank LoansBanks offer many different types of loans to borrowers and you need to be familiar with what the different terms are and also how the interest is calculated under the different arrangements.The effective interest rate is the percentage that is really paid on the loan based upon the amount of interest paid and the actual amount of funds received. This is what is most important to the company in the decision regarding what financing source to use because it eliminates any distortions caused by compensating balances, withheld interest or other items discussed below. Simple and Compound InterestIn simple interest, the interest is calculated only on the original principal amount.
Simple interest contrasts with compounded interest, in which interest is charged on the principal plus any accumulated, unpaid interest.The effective interest rate of compounded interest is higher than the effective interest rate of simple interest.
Loans with Compensating BalancesIn order to provide some sort of collateral to the loan, a bank may require the borrower to keep some amount of cash in an interest bearing checking account at the bank. This amount of cash may be a percentage of the amount of the loan or a fixed amount. This required amount is called a compensating balance. This raises the effective rate of interest paid by the borrower, since not all of the borrowed funds are available. Loans with Compensating Balances, continuedThe amount held as a compensating balance reduces the amount of the loan received.But, it does not reduce the amount of interest paidInterest is calculated from the full amount of the loan.
This greater interest rate compensates a bank for services provided and results in greater profitability for the financial institution. Often, funds kept as a compensating balance can be withdrawn for short periods of time if a certain average balance is maintained.
Compensating Balances – Effective RateThe effective interest rate on loans requiring compensating balances equals total interest cost divided by the effective amount of total cash received. It is calculated as follows:
Interest Paid – Interest received on Additional Cash Required Amount of the Loan – Amount Required to be added for the Compensating Balance Meeting the Compensating RequirementsAs in the formula above, when there is a compensating balance, the total cash received is calculated as principal amount of the loan minus the amount of cash that is necessary to be added to the normal cash balance in order to maintain the compensating balance. It is very possible that the company already has some cash in the bank and therefore already has some of the compensating balance. Therefore, in the calculation of total cash received, we will subtract only the balance that the company needs to add to its account at the bank in order to meet the compensating balance requirement. Loans with Discounted InterestDiscounted interest is a method whereby the bank deducts interest on the loan in advance. The amount of interest on the loan is not even transferred to the borrower. Having the interest discounted and withheld results in a higher effective rate than simple interest because the borrower receives less than the face value of the loan, but still needs to pay interest on the entire amount. In effect, discounted interest acts similar to a compensating balance in that it reduces the amount of funds that are received by and available to the borrower.Again, this raises the effective rate of interest applied on the loan because the interest is paid on the full amount. Discounted Interest – Effective RateThe effective interest rate is calculated as follows:Interest Paid Borrowed Amount – Interest ‘Withheld’
Because the interest portion of the repayment is guaranteed to the bank, there is a reduction of the overall risk to the lender. Therefore, the lender should offer the funds at a lower stated rate of interest. This arrangement may also benefit the borrower because no payments will need to be made to the lender until the maturity date of the loan. Installment Loans An installment loan requires periodic payments, and each payment includes both the repayment of some of the principal and the interest owed on the outstanding balance. This is essentially an annuity in which the amount borrowed is equal to the present value of all of the payments on the loan.The calculation for installment loans is more complex than others, and it is not presented here because it is not expected that installment loans will be tested with a numerical question. Factoring ReceivablesWhen companies factor their receivables, they are selling the receivables for some amount of money to a bank or other company. They also transfer the risk of not collecting the receivables to the company that bought the receivables. However, because what they are essentially doing is obtaining a loan that is guaranteed by the receivables, they are going to have to pay ‘interest’ on this loan, and they will therefore not receive the face amount of the receivables when they factor them.This is a very common practice in many countries as it enables a company to immediately receive the cash from its receivables and use this money for other purposes. Cash Received from FactoringThe company selling the receivables does not receive the face amount of the receivables when it sells them. There are possibly three things that will reduce the amount of money that is actually received from the factoring of the receivables. Factoring fee,Interest charge, andReserve allowance.The Factoring FeeThe company purchasing the receivables (called the factor) will usually charge a fee for this service. The fee is usually a set percentage of the amount of the receivables. This fee will be higher if the factor determines that there is more risk related to the receivables that are purchased. Interest ChargeThe factor is providing a loan to the seller of the receivables and will collect this loan when the receivables are actually paid. The factor will charge an interest rate on the amount of the loan that is provided to the seller. This interest rate will almost always be higher than the market rate of interest. The interest rate is higher than market because it reflects two ‘costs’ that the factor assumes in this transaction.The costs of collection and the risk of noncollection, andThe time value of the money that is given as a loan to the selling company. This occurs because the factor is giving the money to the seller now, but will not be receiving the cash from the receivables until some point in the future. In essence the factoring of the receivables is similar to getting a loan from the bank with the loan being guaranteed by the receivables. Reserve AllowanceIn addition to the factor fee and the interest charge, sometimes the factor withholds some amount of the money that he owes to the seller as a reserve. This reserve acts as a guarantee against noncollection. If all of the receivables are collected, the reserve will then be paid to the seller. If there are some bad debts that are not received by the factor, then they will be deducted from the reserve before it is paid to the seller. Advantages of FactoringOne of the reasons that a company is willing to enter into the factoring agreement is because the factor is probably able to more effectively and efficiently collect the receivables than the company. Other advantages of factoring for a company are:A reduction of the costs of collection by outsourcing this function. This will enable the company to reduce the time and cost of collections,The factor can often operate more efficiently than its clients because of the specialized nature of its service, andBad debts are eliminated because the risk of noncollection is passed to the factor. However, the company needs to pay a fee to the factor instead. (Also, in the case that the factor withholds a reserve, the risk of bad debts is not eliminated.) Disadvantages of FactoringThe only big disadvantage of using factoring as a source of financing is that the reduction in costs that are received from not having to collect the receivables may not completely offset the fee and interest that is charged by the factor. This is a classic example of cost-benefit decision-making. Cash Received from FactoringThe formula to calculate the cash received from factoring is as follows: Face amount of the receivables - The amount of the reserve (based on face amount of receivables) - The factor’s fee (this is also calculated from the face amount) = Amount that the seller needs to pay interest on - Interest for the time period before the collection of the receivables = Cash to be received by the seller
Other Sources of Short-Term FinancingSeveral other secured and unsecured sources of short-term funds are available to companies. Before looking at these other sources of financing, it is important to draw the distinction between secured and unsecured debts.A secured debt is one that involves an asset that is used as collateral for repayment of the loan should the borrower default. An unsecured debts has no such collateral backing them, and thus, will be more expensive (higher interest rate paid by the borrower) to compensate for the higher default risk.
Secured Sources of FinancingOther sources of secured financing that you need to be aware of are:First and second mortgagesChattel mortgagesFloating liensPledged receivablesWarehouse financingInventory financingUnsecured Sources of FinancingOther sources of secured financing that you need to be aware of are:Trade credit (payables)Repurchase agreementsAccrued expenses (wages payable, for example)Line of creditRevolving line of creditCommercial paperBankers’ acceptances

STRATEGIC MARKETING

CMA Part 3: Section B

Strategic Marketing

Prepared by:
Section B – Strategic Marketing
 This section represents approximately 15% of the Part 3 Exam. You should expect somewhere between 16 and 17 questions from Section B.
 The six Parts to Strategic Marketing are:
 Strategic role within the firm,
 Managing marketing information,
 Market segmentation, targeting and positioning,
 Managing products and services,
 Pricing strategy, and
 Promotional mix and distribution strategy.
Strategic Marketing in the Company
 Marketing plays a significant role in the strategic planning process of a company, and the senior marketing executive is a key contributor to this process.
 Marketing provides a guiding philosophy, directing company strategy in ways to serve the needs of customers.
 Furthermore, marketing provides input to the strategic planners, helping them to identify attractive marketing opportunities and determining the firm’s ability to take advantage of them.
 Also, marketing develops strategies for achieving the company’s objectives profitably.
Four Organizational Levels in the Company
 To understand the interrelationships between strategy and marketing, it is necessary to look at the four organizational levels that comprise the organization:
 Corporate level  Corporate is responsible for creating the overall corporate strategic plan, making decisions on resource allocation for each division as well as which businesses to start or terminate.
 Division level  Each division creates its division plan to cover the allocation of funds for each business unit with the division.
 Business unit level  Each business unit develops its own strategic plan.
 Product level  Each product level, or product line or brand, within its business unit creates a marketing plan to accomplish its objectives in its specific product market.

Porter’s Three Generic Strategies
 Porter’s three generic strategies are:
 Cost leadership or being the low-cost producer within a particular industry for a given level of quality.
 Differentiation, or development of a product or service with unique attributes that customers perceive to be better or different from competitive offerings, and for which they are willing to pay enough to cover the extra cost of offering the unique product or service.
 Focus, or concentration on a narrow segment for the purpose of achieving either cost advantage or differentiation.

Setting Marketing Objectives
 Corporate goals result from the strategic planning process.
 A goal is a specific, measurable desired future state that the company wants to attain.
 Maximizing shareholder value is the primary goal of for-profit companies, so most companies have goals for profitability and profit growth. Profits can be improved by increasing sales or reducing costs, or both. Sales can be increased by increasing the company’s share of its existing markets or by entering new markets, or both.
 These goals for increasing profits by increasing sales become the company’s marketing objectives.
Marketing Strategies
 Marketing strategies are developed to achieve the marketing objectives. The marketing plan includes the marketing strategies (long-term), as well as marketing tactics (shorter-term).
 The strategic marketing plan outlines the value proposition that the organization will offer based on best market opportunities. The value proposition is a statement that summarizes the customer segment and target market, the competitors, and the core differences of one’s product from the offerings of the competitors.
 The tactical marketing plan dictates the marketing tactics that the organization should use, addressing product features, promotion, merchandising, pricing, sales channels and customer service. The marketing plan, which directs and coordinates the marketing efforts, is developed by teams from all key functions and implemented at relevant levels of the company.

Marketing Strategies, continued
 Marketing strategies and tactics, which are both strategic (long term) and tactical (short-term) include:
 Market segmentation, targeting and positioning,
 Strategies for managing products and services,
 New product development and life-cycle strategies,
 Pricing considerations and strategies,
 Integrated marketing communications strategies (advertising, sales promotion, public relations, personal selling and direct marketing), and
 Marketing and distribution channels and supply chain management strategies.

The Marketing Management Process
 The company’s target customers are central to the marketing process. These target customers are usually divided into smaller segments.
 The company designs its best marketing mix ― based on the four Ps:
 product,
 price,
 place and
 promotion ―
Through engaging in marketing analysis, planning implementation and control.

The Four P’s
 The 4 P’s are:
 Product, which is the combination of the goods and services that the company offers, such as the features, options, style, sizes, packaging, etc.
 Price stands for the amount of money customers will pay to obtain the product or service.
 Place involves the company’s activities that make the product available to customers, such as retail department stores focuses on in terms of advertising, display, stocking arrangements, etc.
 Promotion is how the company communicates the products’ advantages and persuades its target customers to make purchases.
Marketing Segments
 Because a company can’t completely satisfy the wants and needs of all consumers in its market, it must choose the segments that it can profitably serve better than its competitors, which involves four steps:
 demand measurement and forecasting,
 marketing segmentation,
 market targeting, and
 market positioning.

Assessing Marketing Information Needs
 The marketing system serves the company’s marketing and other managers.
 To assess needs, the MIS group interviews managers to find out what information they would like to have.
 Some information they would like to have may not be available, such as information about competitor’s future advertising expenditures.
 Furthermore, some managers may not mention things they could really use, because they do not think to ask for it. The MIS group needs to monitor the competitive environment so they can provide users with information they need, even if they do not ask for it.
 The company must also decide whether the benefits of obtaining information are worth the costs.
Developing Marketing Information
 Marketing information comes from
 Internal data includes internal databases and computerized market decision support systems. Marketing managers can use it to identify marketing opportunities, plan marketing programs, and evaluate results.
 Marketing intelligence is the collection and analysis of information about competitors and developments in the marketing environment that is publicly available.
 Marketing research consists of formal studies to get specific information. It is the systematic design, collection, analysis and reporting of information regarding a specific marketing situation.
The Marketing Research Process
 There are four steps to the marketing research process:
 Defining the problem and researching objectives. This must be done carefully because if the problem is inadequately defined, the research may develop information that does not solve the problem.
 Developing the research plan. Researchers need to decide what information is needed and develop a plan for gathering the information.
 Implementing the research plan.
 Interpreting and reporting the findings. The findings are interpreted, conclusions are drawn, and the results reported to management. The marketing manager may be the best one to do the interpretation, but it should also be done with input from the researchers.
Customer Relationship Management
 To be competitive and build strong relationships with customers, companies must learn more about the behavior and needs of their customers.
 Special software and data analysis techniques, called customer relationship management (CRM) -- bring together all types of information about customers, sales, marketing effectiveness, responsiveness and market trends.
 Companies usually have databases for all sorts of customer information: purchases, sales and service contacts, support calls, website visits, credit information, account payment information, and many other pieces of data.
 CRM software can integrate every piece of data about each individual customer into a single data warehouse, where sophisticated data mining techniques can then be used to find opportunities.
CRM, continued
 CRM analytical tools enable customer information to be analyzed in depth. Analysts can use data from the data warehouse to reveal patterns, trends, customer needs and correlations, and segments.
 CRM is not inexpensive, and the costs are not limited to the software. Using the technology properly requires maintaining the data and then mining it appropriately, which entail additional costs.
 If a company does not clearly define its goals for CRM, or if it relies too much on the technology without being truly customer-oriented, the effort will not be successful. However, when CRM is used properly, it can significantly increase revenues as well as customer loyalty and staff efficiency.
CRM Software
 Some of the CRM software products that are available today include:
 Contact management software, which stores, tracks and manages sales, customer contacts and partner relationships.
 Lead management software, which tracks, manages and forecasts sales leads.
 Self service CRM facilitates web-based customer interaction, e-mail automation, sales and marketing campaign management, web site analysis, and call logging.
 Survey management software automates surveys and enables understanding and managing customer preferences.
 Call center software and help desk software facilitate the management and tracking of sales and marketing calls as well as inquiries from customers.

Distributing and Using Marketing Information
 In order to be useful, marketing information must be available to managers and others who make decisions and deal with customers.
 Companies are increasingly using internal intranets to make the data available to those who have the need to know. The intranet also makes available research information; reports, shared work documents, and contact information.
 In addition, many companies give key customers and network partner's authority to access product information and their own account information through extranets, which let them make purchases as well.
Market Segmentation, Targeting and Positioning
 Mass marketing is the mass production, distribution and promotion of standardized products to all buyers.
 Mass marketing creates the biggest potential market.
 However, increasing splintering (breaking apart) of today’s markets along with an increase in the number of advertising and distribution channels make mass marketing expensive and more and more difficult to accomplish.
 Because of this, many companies are pursuing market segmentation and market targeting in order to concentrate on buyers who have the greatest interest in what they do best.
Steps in Market Segmenting and Targeting
 The three major steps in target marketing are market Segmentation, Targeting and Positioning (STP). The company:
 Determines the different marketplace needs and groups (segmentation),
 Evaluates the various segments it has identified and selects the segments that it can serve in a unique and superior manner (targeting) and
 Develops products and services and a detailed marketing mix that will set it apart from its competitors, so that its target market(s) will recognize the company’s distinctive offering and image (positioning).

Target Marketing
 Target marketing strategies aim at one of the following four levels: segments, niches, local areas or individuals.
 A market segment is a customer group that shares a similar set of needs or wants, such as customers seeking to buy practical, inexpensive homes versus those wanting large, luxurious homes.
 In niche marketing, companies identify niches, which are defined groups looking for a unique mix of benefits, by dividing a segment into subsegments.
 Local marketing is directed specifically to local customers such as in specific cities or neighborhoods.
 Individual marketing involves customizing products to individual customers’ needs and wants.
Segmenting Consumer Markets
Geographic Segmentation
 Geographic segmentation divides the market into geographical units which may be a large as a whole nation or as small as specific neighborhoods.
 Geographic segmentation might be used to offer specific products in line with different geographical needs and wants.
 Or a company may decide to concentrate on one or only a few geographical areas.
 Geographic segmentation may also mean concentrating on large metropolitan areas or small towns.
 Operating costs are lower in the smaller areas, and the smaller-size stores can be supported by the buying public in those areas.
Demographic Segmentation
 Demographic segmentation divides the market according to things such as age, gender, income, family size, occupation, education, and nationality.
 Demographic variables are easier to measure than other types of variables.
 Consumers’ needs change with their age and stage in the life-cycle. Different age groups, from children to teenage to adults and seniors, can be targeted with different messages and different media.
 Gender segmentation is used in selling clothing, cosmetics, magazines, and financial services, to name just a few.
 Income segmentation is used to target affluent consumers with luxury products and convenience services. Income segmentation is also used to target lower-income consumers with inexpensive goods.
Psychographic Segmentation
 Psychographic segmentation divides buyers according to their social class, lifestyle, or personality characteristics.
 For example, casual clothing appeals to people with a casual lifestyle, whereas upscale clothing would appeal to people with a more formal lifestyle. Sports enthusiasts, even if they are simply armchair sports enthusiasts, can be drawn by offers for clothing or other products carrying the logo of their favorite sports team.

Behavioral Segmentation
 Behavioral segmentation divides the market into groups according to their knowledge, attitudes, uses, or responses to a particular product to determine whether different characteristics can be attributed to each consumer-response segment.
 For instance, occasion segmentation can be used when a product is used on a particular occasion, such as a holiday. Or buyers can be grouped according to the benefits that they want from the product, such as those who travel for business, those who travel for fun, those who travel for adventure, or those who travel for educational purposes.
 A market can also be segmented according to customer brand loyalty.
Segmenting Business Markets
 Some of the same variables used for consumer market segmentation are often used for business markets, including geography, benefits sought and usage rates, but other variables are also used.
 Business marketers will use variables such as customer operating characteristics, purchasing approaches, situational factors, and personal characteristics. And a company can segment further according to company size or geographic location.
 Technology companies often have separate divisions for large corporations and small businesses, because they each have unique needs. Or an office furniture company might segment its market into different industries, such as financial services, manufacturing, and so forth.
Segmenting International Markets
 A global firm operates in more than one country and plans, operates and coordinates its activities on a worldwide basis.
 International firms group world markets into segments, as well, with each having different buying needs and behaviors.
 World markets can be segmented according to
 Geographic location (countries and regions),
 Economic factors (i.e., highly industrialized versus developing economies),
 Political and legal factors (such as type and stability of the government, monetary regulations and government regulation), or
 Cultural factors (such as language, religion, customs, and values).
 Intermarket segmentation involves targeting consumers with similar needs although they may be located in different countries.
Effective Market Segmentation
 Market segmentation needs to be done in such a way that it will be effective.
 To be useful, market segments must be:
 Measurable. The segment needs to be one on which data is available, so that the size of the segment can be measured.
 Accessible. The market segment needs to be reached by the communications media available to the firm, so that advertising can be directed to it.
 Substantial. The segment needs to be large enough to be profitably served.
 Differentiable. The segments identified should be ones that can be distinguished and ones that will respond differently to specific marketing programs.
 Actionable. In order for the exercise of segmenting its market to be useful, it must be possible for the firm to design a program to reach and serve the segment.
Market Targeting
 After identifying the opportunities within market segments, the company must assess the segments and make decisions about how many and which prospects to target. Companies want to target the segments that have the size and growth characteristics that will fit with its resources and skills.
 Considerations in selecting segments are:
 The existence of strong competitors
 The existence of substitute products which could limit prices and profits
 The relative power of buyers, such as buyers with strong bargaining power who will force prices down and demand services versus those who will not do those things
 The existence of powerful suppliers who could raise prices or reduce the quality of purchased goods and services.

Market Coverage Strategies
 There are three basic market-coverage strategies used in selecting markets:
 Undifferentiated marketing - ignores market segment differences and focusing on what is common in consumers’ needs rather than on what is different. The product and the marketing program are designed to appeal to the largest possible number of buyers,
 Differentiated marketing - offers variations in the products and the marketing approaches used. and
 Concentrated marketing - pursue one or just a few segments or niches and will seek a large share of each one.

Socially Responsible Target Marketing
 Target marketing can raise ethical issues which must be kept in mind.
 For example, tobacco companies have been accused of targeting underage smokers. And the marketing of alcoholic beverages to groups in neighborhoods already plagued by crime and violence is inappropriate.
 As long as target marketing is used to serve the special needs of special segments, it is fine. But controversy develops when marketers try to profit at the expense of a targeted segment.
The Positioning Strategy
 A product’s position in its market is the way the product is defined by consumers, or the place that the product occupies in their minds as opposed to competing products.
 The process of designing the company’s offering and image to occupy its own unique place or position in the minds of consumers in a target market is called positioning.
 Marketers need to plan their products’ positions in order to give their products the best advantage in their selected target markets.
 A unique selling proposition advocates promoting only one product benefit, based on the premise that people remember “number one.”
 Double-benefit positioning and triple-benefit positioning can also be successful approaches but should be used cautiously.

Products vs. Services
 A product is a commodity that is offered for sale. It is a tangible that can be produced by human or mechanical effort (such as clothing, automobiles, pharmaceuticals or computers) or by a natural process (such as petroleum, gold or water).
 A service is work or an act sold to another (such as medical assistance, financial services or computer network support), and the work does not produce a tangible commodity.

 Both products and services meet market wants and needs.

Classifications of Products and Services
 Products and services are traditionally classified on the basis of durability, tangibility and whether they are for consumer or industrial use.
 Recently, the classification of other marketable entities has been added.

Durability and Tangibility
 Goods and services are classified into the following groups based on durability and tangibility.
 Nondurable goods, such as breakfast cereal and shampoo, are consumed quickly and purchased frequently. They are typically offered to many people in many geographic areas at a low mark-up. Marketing and advertising approaches are aimed at persuading first use and developing preference.
 Durable goods, such as clothing and washing machines, last longer and are purchased less frequently. They require a personal selling (and service) approach accompanied by a higher margin, often along with guarantees from the seller.
 Services, such as medical assistance and computer repair, are intangible and, in a sense, perishable products. They require quality control and adaptability as well as strong credibility from the supplier of the service.

Consumer Goods
 Consumer goods are products that are bought by the final consumer and are used for their personal consumption.
 Convenience goods, such as magazine and cigarettes, are those that people purchase often and immediately, with little effort or planning. Convenience goods are further divided into:
 staples, such as a specific brand of milk;
 impulse goods, such as a candy bar bought without advance planning while passing through the store; and
 emergency goods, such as a snow shovel bought during a winter storm.
Marketers want to place convenience products in as many locations as possible so that they will be easily accessible when consumers need them.
Consumer Goods, continued
 Shopping goods, such as a sofa or refrigerator, are those that people do comparison shopping for before selecting and purchasing the product. Shopping goods are broken down into:
 homogeneous shopping goods, which differ in price but are similar in quality (requiring comparison); and
 heterogeneous shopping goods, which differ in services and features that can be more important to the buyer than the price.
 Specialty goods, such as a motorcycle or wedding dress, have brand identification or distinctive characteristics. The buyer makes a special effort, even travels far, to find and purchase this product. Sellers must market their locations, which are sometimes inconvenient. Buyers do not normally do comparison shopping for specialty products.

Consumer Goods, continued
 Unsought goods are those that the consumer may not normally know about or think of buying. New products are unsought until the public becomes aware that they are available. An example of an unsought good would be life insurance. These goods require greater amounts of advertising, marketing and personal-selling effort than other goods.

Industrial Goods
 Industrial goods are goods that are purchased either for processing into a manufactured product or for use in conducting a business.
 The same product can be classified as either a consumer or an industrial good, if it may be purchased and used either by a consumer or by a business.
 Classified by their costliness and how they enter the production process, industrial goods include the following are three groups.
 Materials and Parts
 Capital Items
 Supplies and Business Services
Materials and Parts
 Materials and parts fall into two classes:
 Raw materials - either farm products, such as eggs or corn, or natural products, such as coal or fish, and
 Manufactured materials and parts - either component materials, such as cotton, which is fabricated further into fabric, or component parts, such a small motor, which is put into a lawn mower.

 Because these are directly sold to industrial users, service and price are important marketing considerations, while branding and advertising are not.
Capital Items
 Capital items are either installations or equipment which are long lasting and contribute to the development or management of finished products.
 Installations include buildings, such as a factory and equipment, such as the elevators in the factory. Installations are usually major, direct purchases, often custom built. Advertising is less important than personal selling.
 Equipment includes factory equipment and office equipment. Equipment manufacturers often use intermediaries to sell their products because of wide geographical distribution, numerous buyers, and smaller orders. Quality, special features, service and price are key considerations, and the sales force is usually more important than advertising.
Supplies and Business Services
 Supplies facilitate the development and management of finished goods. These goods and services are short-lived and fall into two categories: maintenance and operating supplies. Supplies, like convenience consumer goods, are usually purchased without much effort or comparison.
 They are usually marketed through intermediaries, and price and service are important.
 Business services include maintenance and repair services such as janitorial or copier repair that are often supplied under contract or by the manufacturer, as well as business advisory services such as legal or accounting services, which are usually sold based on the supplier’s reputation.
Other Marketable Entities
 Other marketable entities are organizations, persons, places, and ideas.
 Organization marketing includes activities intended to create, maintain, or change the attitudes and behavior of a target group toward an organization. Organization marketing is practiced by both profit and nonprofit organizations. Image advertising is used to create a memorable image in the mind of the public.
 Person marketing is used to create, maintain, or change attitudes and behavior toward people. Politicians and political parties use this type of marketing to get their parties, their platforms and themselves elected. Entertainers and other public personalities use it to promote their careers. Doctors, lawyers, accountants and other professionals also market themselves and their services. Person marketing also includes the use of well-known personalities to endorse products.
Other Marketable Entities, continued
 Place marketing involves activities that create, maintain, or change attitudes or behavior toward specific places, such as cities, states, or regions that compete to attract visitors, new residents, and new company locations for their communities. Local Chamber of Commerce organizations are quite active in industrial development activities and travel and tourism promotion.
 Idea marketing is the marketing of social ideas, for example, public service advertising directed to parents on how to talk to their children about not smoking or using drugs. Idea marketing, also called social marketing, uses marketing concepts to influence individuals’ behavior in order to improve their well-being and the well-being of society.

Product Decisions
 The development and marketing of a product or service involves decisions on
 Product attributes, or defining the benefits it will offer;
 Branding, or creating, maintaining, and enhancing the name, term, sign, symbol and/or design that identifies the manufacturer or seller of a product or service;
 Packaging, or designing and producing the package for a product;
 Labeling, or designing the label that will identify the product or brand; and
 Product support services, which consists of customer service after the sale.

Product Attributes
 The benefits that a product will offer include product quality, product features, and product style and design.
 Product quality is an important tool available to marketers to use in positioning their products. In product development, a marketer needs to decide upon a quality level that is appropriate to the product’s position in its target market.
 Product features on a product model can vary. The company can produce a basic model without any features and then create higher-level models by adding more options. Features are used to differentiate the company’s products from those of its competitors.
 Product style and design is another way to add customer value. Style describes the appearance of a product, and a great style can be eye-catching and attention-getting. Design is what makes the product perform, however.
Branding
 Branding is a focal point in product strategy, which marketers sometimes refer to as “the art and cornerstone of marketing.”
 Creating, sustaining, protecting and enhancing brands are a distinctive skill of marketing professionals. The seller of a product or service is granted exclusive rights to the use of the brand name in perpetuity (forever) under trademark law.
 A brand can convey up to six levels of meaning, including attributes, benefits, values, culture, personality and type of user.
 Ultimately, branding lies in the perception of customers, so it is critical for a company to research the position that its product(s) or service(s) occupy in the minds of customers.
Brand Identity
 Marketing professionals must make good decisions regarding the brand’s name, logo, tag line, type style and colors, or symbol, which bring about recognition (brand identity) from customers and prospects.
 This process must go far beyond a brand campaign  it should be backed up by delivery of a consistent product or service that brings real value to the customer. This is, in a sense, a brand contract. When customers have a completely positive experience with the company in the delivery of its contract, or promise, including all communications and contacts with company employees, it’s called brand bonding.
Brand Equity
 Brand equity is the positive effect that familiarity with the brand name has on customer response to a product or service. It results in customers’ showing a preference for the product or service, even when it may be identical to or cost more than another offering. A brand with a lot of brand loyalty, brand awareness, perceived quality and other assets such as patents and trademarks has a lot of power and value in the marketplace and is said to have high brand equity.
 A brand must be carefully managed so that its brand equity doesn’t depreciate. To sustain brand leadership, companies may need to not only maintain, but improve the product through R&D investment, positive advertising, and excellence in trade and consumer service.
Packaging and Labeling
 Some products must be packaged and labeled, which serve not only as a physical necessity but create convenience and promotional value.
 Packaging includes all the activities involved in creating and producing the container, or package, for a product. The development of effective packaging is often costly and time-consuming.
 A package is not just a container for the product. Packaging is an important marketing tool, as well. In order to stand out on a retail store shelf, the package needs to attract attention, describe the product, and make the sale. Packaging can create recognition of the company and the brand. And a package that is convenient to use can give a product an advantage over the competition.
Labeling
 Labeling is critical because it identifies the product or brand and also may grade and describe the product.
 This can include the list of contents, where it was made, how to use the product and how to use it safely.
 A label can also be promotional through use of eye-catching graphics, which typically become outdated and require periodic redesign.
 In 1914, the Federal Trade Commission Act prohibited false, misleading or deceptive labels. The Fair Packaging and Labeling Act, created by the U.S. Congress in 1967, outlined additional requirements.
Product Support Services
 The product support services offered by a company supplement the actual product.
 Good product support service can be a tool that provides competitive advantage.
 Poor product support service can also hinder competitiveness.


Product Line Decisions
 A product line is a group of products that are closely related to each other in some way.
 The product line could be products that do the same things, are sold to the same groups of customers, are marketed through the same distribution channel, or are priced within the same price range.
 The most important product line decision is the product line length. Product line length refers to how many items are in the product line. The decision is dependent upon profits: if profits can be increased by adding items, then the product line is too short. If profits can be increased by dropping items, then the product line is too long.

Product Line Decisions, continued
 Systematic, planned management of the product line is preferable to cycles of uncontrolled growth followed by major cutbacks.
 Stretching the line occurs when the product line is enlarged beyond its current range.
 A product line can be stretched downward, upward, or both ways to plug a market hole or respond to an attack by a competitor.
 A stretch downward adds a product at the lower end of the range (a lower-priced product), while a stretch upward adds a product at the upper end of the range (a higher-priced product).
Product Line Decisions, continued
 Product line filling involves adding products within the current range of the line. Product line filling can provide additional profits, utilize excess capacity, or plug holes to keep out competitors, in addition to satisfying resellers and maintaining the company’s reputation for being the leading full-line company.
 However, new items should have clear differences from old ones, or sales of current products could suffer and customers could become confused.

Product Mix Decisions
 Sometimes called product assortment, the product mix is the complete set of all products and services that a given organization offers.
 A company’s product mix has four dimensions:
 Width,
 Length,
 Depth and
 Consistency.

 The decisions the company makes with regard to these four dimensions determine the company’s product strategy.
Product Mix Decisions, continued
 Product mix width describes how many different product lines the company offers. For instance, a consumer products company might offer cleaning supplies, baby supplies, health care products, beauty products, and more.
 Product mix length refers to the total number of items the company carries in all of its product lines. It includes all of the products within each of the company’s product lines.
 Product mix depth is how many variants of each product (such as a peanut candy bar and a caramel candy bar) are offered in the line.
 Consistency of the mix refers to how closely related the company’s various product lines are in terms of production requirements, distribution channels, end use, etc.
Services Marketing
 As defined earlier, a service is work or an act sold to another that is basically intangible, and this service does not result in ownership of anything. It is often not even tied to a physical product.
 Service providers include:
 the government sector (examples: military, police, courts);
 private non-profit (examples: universities, hospitals, churches); and
 the business sector (examples: banking, insurance, airlines, consulting
 With their extraordinary growth in recent years, service organizations now account for 79% of all jobs and 74% of gross domestic product in the U.S. They have finally caught up with manufacturing organizations in implementing marketing concepts and tools.
Characteristics of Services
 Services have four major characteristics, and each one requires its own marketing strategy.
 Intangibility  Services cannot be seen, touched, heard, smelled, or tasted prior to purchase, and customers cannot see the results or outcome of a service before it is performed. Because of this, the organization must adopt a strategy that supplies evidence of the service quality.
 Inseparability  Unlike physical goods, services are usually produced and consumed simultaneously.
 Variability  Services are greatly variable because the quality of the services depends on who provides them as well as where and when they are provided.
 Perishability  Services cannot be stored for sale later, so they are said to be perishable.
Services Marketing Strategy
 In addition to the external marketing used by product and service marketers alike, service marketing strategy requires two additional efforts:
 Internal marketing, for the purpose of motivating the company’s employees to provide superior service, and
 Interactive marketing, which refers to the fact that service quality is heavily dependent on the quality of the interaction between the buyer and the seller during the service encounter. Providers of services must interact effectively with customers if they want to create superior value for the customer. This effective interaction requires not only good customer-service skills on the part of the employees who actually interact with the customers.
Service Organization Marketing
 To be successful, the service organization must take on three tasks:
 It must differentiate itself. through innovative features and its image, by the use of symbols and branding.
 It should manage service quality for the purpose of meeting or exceeding customers’ expectations by delivering consistently higher quality than its competitors. And when problems develop, good service recovery can win more loyal customers than if things had gone smoothly.
 It needs to manage productivity by helping employees to work more skillfully, by enhancing the quantity and quality of service, creating more effective services, “industrializing” the service by adding equipment and standardizing the production process, inventing new client solutions, or using technology to save time and money.

Three P’s of Service Marketing
 Booms and Bitner recommend three Ps for service marketing (in addition to the four Ps for products: product, place, price and promotion), which are:
 People  Most services are provided by people, so selection, training and motivation of employees can make a big impact on customer satisfaction.
 Physical evidence  Service quality is demonstrated through physical evidence and/or presentation, such as a hotel that delivers a look and style to its customers that fulfill its intended customer value proposition, including elements such as elegance, cleanliness and efficiency.
 Process  Service organizations can select from different processes to deliver their services. For example, restaurants can choose different formats such as fast-food, home-cooked food, cafeterias, buffets or highly personalized candlelight service.


International Product and Service Marketing
 International product and services marketing presents unique challenges:
 The company needs to decide what products and services to introduce in what countries.
 It must decide how much the products and services should be standardized or adapted for the different countries.
 Packaging can create problems, because names, labels, and colors may not translate easily. A particular color might have a meaning in one country that it does not have in another country. And words carry connotations in some languages that they do not carry in others.

International Service Marketing
 International service marketers face additional international challenges:
 Service companies operating in other countries face barriers, even though they may not be subject to tariffs and quotas like product marketers are. Rules and regulations may exist to protect the host country’s service industries.
 Laws may exist that require a service provider to have local partners and market under those partners’ names instead of their own.
 Certain services may not be allowed to be offered by companies from outside the country.
 Despite the barriers, growth of global services companies is continuing, particularly in financial services, airlines, telecommunications, and professional services.

New Product Development
 New technologies, changing customer needs, shortened product life cycles and competition at home and abroad put companies at risk if they lack strategies for developing new products. Companies add new products through acquisition or development.
 The best strategy is usually identifying a product that is both unique and superior in the marketplace, with higher quality, new features, and higher value in use by customers; and in having a clearly defined product concept.
 The company needs to define and assess the target market, the product requirements, and the benefits prior to beginning development. To successfully develop new products that will deliver superior value to its customers, the company must understand its consumers, its markets, and its competitors.
The New Product Development Process
 The new product development process has eight steps:
 Idea generation,
 Idea screening,
 Concept development and testing,
 Marketing strategy development,
 Business analysis,
 Product development,
 Test marketing,
 Commercialization.

Product Life Cycles
 Brands, products and technologies all have life cycles. The stages in the life cycle of a product are:
 Product development stage – During product development, there are no sales and so no revenues. The company’s investment costs increase.
 Introduction stage  This stage is typically one of slow growth and minimal profits, because of the heavy upfront expenses to introduce a new product.
 Growth stage  If the introduction stage is successful, the product will experience rapid sales growth and increasing profits in the growth stage.
 Maturity stage  Sales growth usually slows down and profits level off or decrease. The company has to spend more for marketing to defend the product against the competition.
 Decline stage  Sales drop and profits fall.

Pricing Strategy
 Price retains its importance in the marketing mix even though other nonprice factors are taking on substantial roles in contemporary marketing. Of the four components of the marketing mix (the four Ps = product, price, promotion and place), only price produces revenue, while the others create costs.
 Both internal company factors and external factors in the company’s environment affect a company’s pricing decisions.
Internal Factors Affecting Price
 Internal factors that the company takes into consideration in setting prices are:
 Its marketing objectives – Its target market and the positioning the company has chosen for the product will affect the price. This is known as product quality leadership. Other examples of objectives include:
 survival, by a firm that has too much capacity and not enough sales;
 profit maximization, when the company estimates what its demand and its costs will be at different price levels and chooses the price that produces the maximum current profit;
 market share leadership, which will require that prices be set as low as possible;
 setting prices low to discourage competition; and
 setting prices to maintain resellers’ loyalty, to avoid government intervention, to stabilize the market, to draw customers into a retail store, or setting the price of one product in order to improve sales of other products of the company.

Internal Factors Affecting Price, continued
 Its marketing mix strategy – Pricing decisions need to be coordinated with the other decisions in the marketing mix -- product design, distribution (place), and promotion plans – to create a consistent marketing program. Decisions made about quality, promotion and distribution will affect pricing decisions. Marketers must consider the total marketing mix, because customers want products that give them the best value for the price they pay.
 Target costing may be used. Target costing begins with the selling price and then figures out how to produce the product at a cost that permits an adequate profit.
 Price and quality may be determined by customer needs.
Internal Factors Affecting Price, continued
 Its costs – The company will want to charge a price that covers all of its costs, both fixed and variable, and gives it a fair profit. Costs include not only production costs but also distribution costs and selling costs. Costs determine the lower limit for prices. If a company’s costs are higher than those of its competitors for the same product, the company will have to either price the product above its competitors’ prices, or it will be less profitable than its competitors. This will put it at a competitive disadvantage.
 • Organizational considerations – The company’s management needs to decide who has the authority to set prices. In large companies, prices are usually set by division or product managers. In some cases, salespeople negotiate with customers within set price ranges. Others with input into the pricing decision are sales managers, production managers, finance managers, and accountants. However, senior management still determines pricing policies and may even approve prices proposed by lower-level managers.

Internal Factors Affecting Price, continued
 Its costs – The company will want to charge a price that covers all of its costs, both fixed and variable, and gives it a fair profit. Costs include not only production costs but also distribution costs and selling costs. Costs determine the lower limit for prices.
 Organizational considerations – The company’s management needs to decide who has the authority to set prices. In large companies, prices are usually set by division or product managers. In some cases, salespeople negotiate with customers within set price ranges. Others with input into the pricing decision are sales managers, production managers, finance managers, and accountants. Senior management still determines pricing policies and may even approve prices proposed by lower-level managers.

External Factors Affecting Price
 External factors also affect pricing decisions, such as:
 The market and demand – The market and demand for the product set the upper limit for prices. Factors include what type of market the company operates in (monopoly, oligopoly, oligopolistic competition, or pure competition); what consumers perceive the value of the product to be; and what the product’s demand curve and its price elasticity of demand is. Since these topics are covered extensively in the Part 1 CMA exam, they will not be elaborated on here.
 Competitors’ activities – Competitors’ prices, offers, and possible competitor reactions to the company’s pricing is another external factor to consider. Companies need to know the prices and the quality of their competitors’ products, and they need to compare their costs with those of their competitors. Consumers considering a purchase compare products in terms of value and price.

Other External Factors Affecting Price
 Other external factors – Factors such as inflation, recession, and interest rates affect pricing strategies, because they affect the product costs as well as consumers’ perceptions of the product’s value to them.
 Resellers’ reactions are also important, because the company’s price needs to be set so that its resellers make a fair profit. The government also affects pricing decisions, with taxes and regulations being a concern. Social concerns may also be a factor that needs to be considered.

General Pricing Approaches
 The basic factors that go into pricing decisions are: (1) product cost; (2) customer perception of the product’s value; and (3) competitors’ prices. Prices are usually set by a general pricing approach that includes one or more of these considerations.
 Three general pricing approaches are used:
 The cost-based approach,
 The value-based approach, and
 The competition-based approach.

Cost-Based Approaches
 Cost-based pricing includes cost-plus pricing, break-even pricing, and target profit pricing.
 When cost-plus pricing is used, the company simply determines what its costs are and then adds a standard markup to the cost to arrive at the price for the product.
 The drawback to cost-plus pricing is it ignores both customer demand and competitors’ prices. But it is used because:
 Sellers can be more confident about their costs than about demand for their product. If the price is tied to the cost, then they do not have to make pricing adjustments to reflect changes in demand.
 If all of the companies in an industry use the same pricing method, prices are similar and price competition is minimized.
Cost-Based Approaches, continued
 In break-even pricing and target profit pricing, the firm determines a price at which it will break even or make a target profit.
 Break-even pricing and target profit pricing do not take the price-demand relationship into account. So when this method is used, the company must also realize that sales volume will be affected by price and must build that into the model.
 In cost-based pricing, the company designs a product, figures out the total costs to make the product, and sets a price that covers its cost plus a factor for profit. If the market decides that the price is too high, the company has to reduce its price and settle for lower profits, or leave the price high and settle for lower sales, also resulting in lower profits.
Value-Based Approaches
 Value-based pricing (also called buyer-based pricing) bases prices on buyers’ perceptions of the value of the product instead of on the seller’s cost.
 Value-based pricing is the reverse of cost-based pricing. The target price is based on customer perceptions of the value of the product. The targeted value and price are then used in making all the decisions about the product’s design and what its costs must be.
 The pricing process begins with consumer needs and value perceptions, and the price is set to match that.
 Thus, price is a part of the marketing mix variables that are considered before the marketing program is set.

Value-Based Approaches, continued
 The company must, of course, be able to find out what value future buyers will assign to various products, and measuring perceived value can be difficult. If the company overestimates perceived value, it will price the product too high and sales will suffer. If the company underestimates the product’s perceived value, it will underprice the product. Sales will be good, but the low price will produce less revenue than would be possible.
 More companies are adopting value pricing strategies, and this has led to introduction of less expensive versions of brand-name products.

Value-Based Approaches, continued
 An important type of value pricing is called everyday low pricing. Everyday low pricing is used at the retail level to charge an everyday low price with few temporary price reductions.
 Another type of pricing is called high-low pricing, and it involves charging high everyday prices but offering frequent discounts and sales. But constant sales and promotions increase costs and erode consumer confidence in the everyday prices. Consumers also lack the patience to wait for specials in order to make their purchases.
 But to offer everyday low prices, a company’s costs must be low. If a retailer lowers its prices but its costs remain high, it will not be in business for long.
Competition-Based Approaches
 Customers’ use competitors’ prices to form their perceived value of a product, and going-rate pricing is based almost entirely on competitors’ prices. This does not mean that the company charges the same price as its competitors charge. It may charge the same price as its competitors, or it may charge more or less.
 The firm’s strategy may be determined by whether its products are homogeneous with (identical to) or nonhomogeneous with (different from) its competitors’ products.
 If the industry is one selling a commodity, i.e., a homogeneous good with little differentiation among producers, competing firms normally all charge the same price. Smaller firms follow the lead of large firms.

New Product Pricing Strategies
 Some pricing strategies that may be followed when a new product is introduced are the following:
 Market penetration pricing  When a company wants to penetrate a market quickly and maximize its market share with a new product, it may set a low initial price with the expectation that high sales volume will result. The resulting high sales volume is expected to lead to lower unit costs and higher long-term profit. The goal is to win market share, stimulate market growth and discourage competition.
 Market skimming  A company unveiling a new technology may set an initial high price to “skim” the market, then quickly reduce the price to attract new customers after those who could afford to pay the highest price. This is often followed by subsequent lowering of prices, thereby skimming maximum revenues from the different market segments.
Price Adjustment Strategies
 Companies frequently confront special situations in which they need to adjust their prices in response to certain situations, such as declining market share, oversupply, excess plant capacity, economic recession, lower prices from competitors, geographic issues, etc. These require implementing price adjustment strategies.

Discount and Allowance Pricing
 Discount and allowance pricing  When a company adjusts its list prices in order to provide discounts and allowances to customers for volume purchases, early payment, cash payment or off-season buying, it is using discount and allowance pricing.
 Cash or quantity discounts may be given,
 A functional discount or trade discount is a discount given to trade channel partners who perform specific functions such as storing goods. Manufacturers must offer the same functional discount to all of their trading partners within one trade channel.
 Seasonal discounts may be offered to those who buy products or services that are out of season. Seasonal discounts enable companies to maintain some production and cash flow during slow times.
Segmented Pricing
 In this approach, the company charges different prices under different circumstances, such as differences in customers, products, and locations, but the differences are not based on differences in the company’s costs. Segmented pricing is used to reflect differences in the value that customers attribute to the product or service, rather than differences in cost.
Segmented Pricing, continued
 Segmented pricing can occur in several forms.
 One is customer-segment pricing, in which different customers are charged different prices for the same product or service, such as senior citizens who may receive special low prices at entertainment functions or restaurants.
 In product-form pricing, there are different versions of the same product and they are priced differently. But the pricing differences are not really related to differences in cost to manufacture.
 If a company uses location pricing, it charges different prices for different locations.
 With time pricing, the company varies its price according to the day, the season, or even the time.
Psychological Pricing
 Consumers typically believe that price indicates quality. For instance, high priced cars are perceived to be high quality, and high quality cars are perceived to be high priced, often more than they actually are. A seller might position a particular vehicle in the more expensive class, using the price to signal quality.
 Reference prices are prices that buyers expect to see when they are considering buying a certain product, and small differences in price can suggest differences in quality. Companies that state “manufacturers suggested retail price” alongside their price for the item are using reference pricing.
Promotional Pricing
 Promotional pricing strategies are temporary price reductions, sometimes even below cost, that are used to stimulate purchases.
 Loss leaders are used to attract customers into a store so that they will purchase not only the loss leader item but also other items at regular prices.
 Special-event pricing, such as holiday sales, are also used to draw customers.
 Cash rebates, where the customer files paperwork with the manufacturer and then receives cash back directly from the manufacturer, are used as a method of stimulating sales (and many people buy the product for the rebate but then don’t bother to send in the paperwork to receive the rebate).
 Promotional pricing should be used sparingly, because it can damage the image of the brand and impact profits negatively if used too much.
International Pricing
 A critical element of a company’s international marketing plan is an effective pricing strategy, and this is affected by the company’s objectives, price controls, market size and prices of competitors, to name a few.
 The producer has three choices:
 Set a market-based price for each country,
 Set a uniform or one price for every country where the product is sold, or
 Set a cost-based price for each country.

Price Decisions and Pricing Laws
 When pricing products and services, companies must avoid the following:
 Price fixing,
 Predatory pricing,
 Price discrimination,
 Resale price maintenance,
 Price increases, and
 Deceptive pricing.

The Buyer’s Role in Pricing
 At the end of the day, the buyer decides whether a product is priced properly. Buyers exchange something of value (money) for something else of value (the benefits they gain from the product or service). Pricing must therefore be buyer oriented. The seller must understand how much value the buyers place on the benefits they receive from the product or service and set a price that fits that value.
 It can be difficult to measure the value that customers attach to a product or service, and furthermore, its value will vary from consumer to consumer and even from situation to situation. But if prospective customers perceive that a product or service’s price is greater than its value to them, they will not buy it. On the other hand, if they perceive that the price is below the product’s value to them, they will buy the product, but the seller has lost an opportunity for more profit.
Marketing Communications Mix
 The following five modes of communication make up the marketing communications mix, or promotion mix, and each has its unique characteristics and price tag:
 Advertising, including print, broadcast, outdoor and other media such as the Internet;
 Sales promotion, such as point-of-purchase displays, premiums, and demonstrations;
 Public relations, including publicity and special events such as grand openings;
 Personal selling, including sales presentations, booths at trade shows, and incentive programs; and
 Direct and interactive marketing, such as direct mail catalogs, telemarketing, Internet marketing, etc.

Advertising
 Advertising can communicate a message to a mass audience that is geographically dispersed at a low cost per person reached, and it makes it possible for the seller to repeat the message over and over. Institutional advertising (advertising of a company’s name instead of a particular product) can be used to create a long-term image for a company. Product advertising can be used to create a long-term image for a product, or it can be used to promote quick sales.
 Advertising has the disadvantage of being impersonal, though. The receiver of the message has no obligation to respond, or even to read or listen to the message.
 Advertising can be very expensive, too, especially network television advertising.

Sales Promotion
 Sales promotion includes a variety of short-term incentives aimed at promoting trial or purchase of a product or service. These include coupons, contests, premiums, etc., that offer three benefits:
 Communication,
 Incentive, and
 Invitation.
 Sales promotions such as these attract a strong, quick buyer response and are good for boosting sagging sales.
 Sales promotion also includes point-of-purchase displays such as a stand-up counter card promoting some product or service at the place where the product or service is offered. It also includes demonstrations, such as a person in a grocery store handing out to passing customers samples of some food sold there.

Public Relations
 Public relations covers a variety of programs or campaigns that promote or protect a company’s image or its individual products. PR and publicity can bring about high credibility through news stories, lobbying, and providing information to customers or prospects who tend to avoid salespeople and advertisements.
 Some companies hire PR firms to work with management to accomplish their objectives.
 Publicity is a subset of public relations. In the past, publicity was charged with securing editorial rather than paid space in print and broadcast to promote a product or service, or perhaps to announce the opening of a new branch in a community.
Personal Selling
 Personal selling involves personal interaction with prospects for the purpose of answering questions, providing information, making presentations and procuring orders.
 A most effective tool at later stages of the buying process, personal selling involves an immediate and interactive relationship that results from personal confrontation, cultivates numerous types of relationships including long-term, and can make the consumer feel an obligation to provide a response, even a negative one.

Direct and Interactive Marketing
 Direct marketing plays an important part in the current movement toward targeting customers more narrowly and toward individual, or one-to-one, marketing.
 Direct marketing makes it possible for companies to reach carefully targeted customers in a more efficient manner and to create personal, one-to-one relationships with them.
 Direct marketing involves direct connection with carefully targeted consumers with the objective of obtaining an immediate response and also of cultivating long-term customer relationships with them. It includes mail, phone, fax, interactive TV, kiosks, e-mail or the Internet with the purpose of communicating with or soliciting responses or dialogues directly with consumers, without use of marketing middlemen.

Direct and Interactive Marketing, continued
 Direct marketing has four distinct characteristics:
 It is nonpublic, because the message is directed to a specific person.
 It is immediate, in that messages can be prepared very quickly.
 It can be customized to appeal to a specific customer segment.
 It is interactive, because it provides for interaction between the company and the consumer, and messages can be adjusted depending on the response of the potential customer.
Promotional Mix Strategies
 Two basic promotion mix strategies are used by businesses:
 Push promotion, or pushing the product through the distribution channel to the final consumers. The manufacturer’s marketing efforts are primarily personal selling and trade promotion. They are directed toward other businesses in their distribution channels to convince them to carry the product.
 Pull promotion, or directing marketing efforts to the final consumers in order to create demand for the product. Pull promotion uses primarily advertising and consumer promotion. The philosophy of pull promotion is that when consumers demand the product from distribution channel members, the distribution channel members will demand it from the producer. So consumer demand pulls the product through the distribution channel.

The Advertising Process
 Companies approach advertising in different ways. In most small companies, someone in sales or marketing works with an advertising agency, which is a communication company that assists clients in enhancing their communication effectiveness.
 Larger companies often have their own advertising departments that prepare budgets and develop overall advertising strategies, but frequently use an outside agency to help create ad campaigns, including the selection of appropriate media. It is critical for global companies with multiple divisions in different countries to coordinate their advertising efforts  some use a global ad agency that can integrate successful marketing communications, often at lower costs.
Advertising Programs
 Advertising programs require a five-step course of action:
 Setting the advertising objectives or mission,
 Creating the budget, or money,
 Selecting the message, including generation and execution methods,
 Determining the appropriate advertising media, and
 Appraising the results, or measurement, of the communication and sales efforts.

Setting the Advertisement Budget
 It is not easy for the company to determine if it is spending the appropriate amount of money on the advertising budget. You should note that part of advertising is investment that creates an intangible asset, or brand equity. When establishing the advertising budget, the company should consider the following:
 the stage in the life cycle of the product,
 market share and the consumer base,
 competition and clutter,
 frequency of advertising, and
 substitutability of product.

Setting the Budget
 There are four methods that companies use to decide on an advertising budget:
 The affordable method, or what can we afford? This method is often used by small businesses. The size of advertising budget depends on what is left after operating expenses and capital expenditures are deducted from total revenues. The affordable method usually results in underspending.
 The percentage-of-sales method, in which the advertising budget is set at a percentage of current or forecasted sales. However, this method views sales as the cause of promotion rather than promotion as the cause of sales.
Setting the Budget, continued
 The competitive-parity method involves the company setting its advertising budget to match the amount being spent by other companies in its market. Industry spending estimates are available from publications and trade associates.
 The objective-and-task method is the most logical method of setting a budget. The company sets its advertising budget according to what it wants to accomplish. The process involves (1) setting the promotion objectives; (2) determining what is needed to achieve the objectives; and (3) determining the cost of performing the tasks needed to achieve the objectives. The objective-and-task method requires management to make assumptions about what results they expect from the dollars spent.