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CHAPTER 13 Crafting a Deployment Strategy SYNOPSIS OF CHAPTER A deployment strategy should accelerate adoption of new products through the use of effective timing, licensing and compatibility, pricing, distribution, and marketing strategies. A new product introduction may be timed to take advantage of business cycle or seasonal effects. The introduction needs to be well coordinated to ensure production capacity is sufficient to meet initial demand and that complementary goods will be available. The timing decision should also include an analysis of the possibility of continuing to generate cash from existing products versus the likelihood of cannibalizing those cash flows by introducing a new product. Cannibalization may be an appropriate trade-off to prevent competitors from attaining a competitive advantage. Licensing and compatibility questions address the need to make a system open enough to encourage the production of complementary goods while at the same time preventing the firm’s installed base from serving as a source of leverage for competitors. Pricing strategies can signal a products’ position in the market and may range between pricing at or below cost to gain market share to charging the highest price feasible to maximize short-term profits. The opportunity for significant earnings from complementary goods or services may justify penetration pricing to gain access to the market. The form and timing of payment for a product can also influence the customer’s perception of price. Whether or not to use intermediaries and the role they will play can be an important part of deployment strategy. Alliances with distributors, bundling goods with more established products, exposing the market to the new technology via contracts and sponsorships, and using guarantees and consignment programs with distributors or developers of complementary goods are all means of promoting a rapid deployment. Marketing plays an important role in a deployment strategy by creating demand for the new product. Marketing methods will vary with the market segment targeted and the nature of the innovation. TEACHING OBJECTIVES 1. Familiarize students with the key elements of deployment including timing, licensing and compatibility, pricing, distribution, and marketing. 2. Provide students with an understanding of the analyses that should be conducted when deciding on a deployment strategy. 114 LECTURE OUTLINE I. Overview A. Deployment is a key component of the innovation process because a new product has little value in and of itself. It is only when people understand the innovation, can access it and utilize it regularly that the product is of value. The best deployment strategies accelerate adoption by reducing uncertainty about the product and lowering resistance to switching from competing goods. Five key elements of deployment are covered in this chapter: timing, licensing and compatibility, pricing, distribution, and marketing. II. Timing A. Beyond the issues of timing discussed in Chapter 5, timing a product introduction to take advantage of seasonal effects, or to prevent or allow cannibalization of existing products, can be an important part of a deployment strategy. B. Strategic Timing of Entry is a function of many factors including seasonal or business cycles and the availability of complementary goods. Video game producers typically introduce new game consoles to coincide with the Christmas shopping season, but it is essential that complementary goods (to help create demand) and sufficient production (to meet demand) are readily available when the product is introduced. For products characterized by rapid technological change, new product introductions should not follow so closely after the previous generation that consumers are reluctant to replace it, nor should the next generation be so long in coming that a competitor gets to the market first and establishes itself as the market leader. C. Optimizing Cash Flow versus Embracing Cannibalization is a very difficult choice for firms to make. There are instances when it is in the firm’s best interest to introduce new generations of technology while the current generation is still viable. Though this strategy will result in the new generation cannibalizing sales of the previous generation, it is more likely to keep consumers loyal to the product and prevent them from switching to another manufacturer. III. Licensing Strategies and Compatibility A. Firms should consider the new product’s compatibility with competitors’ or its own products when developing a deployment strategy. By making the new product compatible with existing products, the firm can take advantage of a large installed base. A firm with a large installed base for its own goods may choose to make its products incompatible with other technologies in order to prevent competitors from leveraging the installed base to create demand for competing products. The decision to make new products backward compatible with previous generations can be especially effective when combined with continuous innovation. It takes advantage of the existing installed base and prevents competitors from creating a technological gap. 115 IV. Pricing Strategies A. V. Pricing strategies influence a product’s position in the market, the rate of adoption and the firm’s cash flow. A range of goals and corresponding pricing strategies are listed below: 1. Survival pricing covers variable costs and some fixed costs and may be used in short run when there is overcapacity or intense price competition. 2. Maximize current profit pricing establishes the price to maximize cash flow or rate of return on investment in the short run and is based on cost and demand estimates. 3. Maximum market skimming pricing usually begins with a high introductory price to signal high value and recover initial development costs. This approach assumes that demand is unrelated to price and may attract competitors to market. 4. Maximum market share or penetration pricing sets the price as low as possible to attract customers in order to increase volume and decrease production costs. When an industry is characterized by increasing returns this can be a successful strategy because it can provide the firm with a powerful foothold as low cost provider. 5. Pricing below cost can be an effective strategy when a firm expects to generate profits from the sale of complementary goods. 6. Timing strategies enable a firm to manipulate customer perceptions of price by changing how or when the purchase price is paid. Options include payment after a free trial period, leasing programs, or a giveaway of the initial product with profits earned from follow-on services. In addition, introductory pricing allows company to test price points in the market. Distribution A. Selling Direct versus Using Intermediaries is a function of the degree of control the company wants to maintain over pricing, service and selling processes and opportunities to capture customer information and customize products. Firms should consider the following questions when choosing a distribution channel for a product: 1. How does the new product fit with distribution of existing product lines? Does the firm have an existing sales channel that could be used for the new product or will the new product warrant the cost and time required to build a direct sales force? 2. How numerous and dispersed are customers, and how much product education or service will they require? Is pre-purchase trial necessary or desirable? Is installation or customization required? If the answer to any of these is yes, intermediaries are likely to be the best option. 116 3. VI. How are competing products or substitutes sold? Apart from the need to change customer behavior if trying to change the traditional sales channel, the means by which a product is sold may affect how it is perceived in the market (unique, high end, mass market, etc.). B. Intermediaries including OEMs (assemble parts into a new product sold under the OEM’s name) may add value and increase demand by drawing customers with goods from a variety of manufacturers, providing transportation, carrying inventory, providing selling services, handling transactions with customers and providing exposure to customers in geographically dispersed locations. C. Disintermediation has changed the structure of some markets (due mainly to changes in information technology) by eliminating or changing intermediaries. For example, the use of online brokers has reduced reliance on stock brokers and the growth in online sales has increased the role of package delivery businesses. D. Strategies for Accelerating Distribution should be considered when an industry is likely to select single technology as the dominant design. Rapid distribution is central to establishing a large installed base and to encouraging developers of complementary goods to produce products that are compatible with a firm’s new product. These strategies include: 1. Alliances with Distributors or the use of exclusive contracts can provide incentives to carry and promote certain goods. 2. Bundling Relationships increase the likelihood that customers will become familiar with the new product because the product is distributed with another product already enjoying a large installed base. 3. Contracts and Sponsorship encourage distributors, complementary goods providers or large end-users (e.g., universities, government agencies) to use the product increasing the likelihood they will buy it when faced with their own purchase decision. 4. Guarantees and Consignment arrangements can reduce the impact of market uncertainty about a product. For example, a manufacturer can encourage distributors to carry its product by selling it on consignment or agreeing to buy back unsold stock. Similarly, complementary goods manufacturers can be motivated to support a new product with guarantees that a particular quantity of goods will be purchased. Marketing A. Marketing strategy must take into account the nature of target market and the innovation in order to shape perceptions and expectations about the product’s installed base and availability of complementary goods. Consideration should be given tailoring marketing to particular adopter categories. B. Major Marketing Methods include advertising, promotions and publicity/public relations. 117 1. Advertising is used to build customer awareness of a technological innovation through an effective advertising message placed in the advertising media most likely to reach the target market. Show Transparency 1 2. 3. C. Promotions are temporary selling tactics used at the customer or distributor level to stimulate purchase or trial. Examples include: a. Offering samples or free trial. b. Offering cash rebates after purchase. c. Including an additional product with purchase. d. Offering sales bonuses to distributor or retailer sales representatives. Publicity and Public Relations can be used to generate word-of-mouth recommendations, public awareness and goodwill. Tailoring the Marketing Plan to Intended Adopters is crucial because each adopter group responds to different marketing content. For example, early adopters usually respond to marketing materials emphasizing technical content and the leading edge nature of innovation. Later adopters respond to marketing materials that communicate a product’s completeness, ease of use, lifestyle match, and legitimacy. Transitioning from marketing to early adopters to late adopters may have to overcome some difficulties when the early majority is not yet convinced of technology’s utility. Show Transparency 2 VII. Creating an Information Epidemic A. Certain individuals can have a disproportionate effect on the marketplace. Gladwell categorized these individuals into three categories: 1. Connectors have an exceptionally high number of diverse acquaintances, a high social drive, and are likely to bring together people that are otherwise unlikely to meet. 2. Mavens are driven to obtain and share knowledge about items of interest to them (product prices, attributes, etc.). 3. Salespersons are able to transmit verbal and nonverbal cues that enable them to influence other’s emotional responses and for our purposes purchasing decisions. 118 B. Using Marketing to Shape Perceptions and Expectations – Advertising, promotions and publicity will all play an important part in shaping the market’s expectations about the product, the installed base and the availability of complementary goods. 1. Preannouncements and Press Releases aggressively promoting existing and planned products can increase the actual and perceived installed base, both of which may drive future adoptions. “Vaporware” is the preadvertising of products not yet on the market and are often used to encourage customers to wait for a firms product when a competitors product is already available. 2. Reputation (for introducing successful, well-supported innovations) will influence customers’, distributors’ and complementary goods producers’ expectations of the new product. 3. Credible Commitments including financial commitments to a new technology, either in R&D costs or in new manufacturing capability, will signal the market about the firm’s confidence in and commitment to the new product. ANSWERS TO OPENING CASE DISCUSSION QUESTIONS 1. What factors do you think enabled Sega to break Nintendo’s near monopoly of the U.S. video game console market in the late 1980s? Nintendo was earning high profits on its 8-bit systems and was unwilling to cannibalize sales of 8-bit games by introducing a new 16-bit console. This gave Sega a window of opportunity to enter with a more technologically advanced product. Sega already had experience and character recognition from its popular arcade games. When Nintendo finally did introduce its 16-bit system, it did not make it backward compatible with the huge library of 8-bit Nintendo games already on the market, forfeiting a large potential source of advantage and forcing it to start from scratch in its competition against Sega. Thus, it appears that Nintendo made poor timing and compatibility decisions, enabling Sega to enter and gain market share. 2. Why did Nintendo choose to not make its video game consoles backward compatible? What were the advantages and disadvantages of this strategy? Nintendo chose not to make its video game consoles backward compatible because they felt they had enough of an edge in the market that they could force consumers into buying entirely new libraries for the next level game. Video game console producers sell the consoles for a price that is at or below cost; they make all their money on games. Nintendo thus did not want to sell 16-bit systems at cost and have customers use their 8bit games on them -- it wanted customers to buy new 16-bit games. Had they been successful in keeping their lead in the market, this strategy would have been a means of generating more sales of new games. 119 By not making their new product backward compatible Nintendo leveled the playing field for Sega by causing customers to incur switching costs to upgrade that were comparable to the costs to switch to Sega’s products. 3. What strengths and weaknesses did Sony have when it entered the video game market in 1995? When Sony entered the video game market their primary weakness was a lack of experience and reputation as a game manufacturer. This weakness was far outweighed by their ability to leverage their reputation and distribution network for consumer electronics to give them a competitive advantage when they entered the game market. They also used technologies developed for other electronics (specifically the compact disc) to develop the game. Finally, Sony had the resources to hire a toy industry veteran and to convince game developers to produce only Playstation titles for the first six months after its introduction. All of these factors combined to give Sony a very significant advantage when they entered the market. 4. What strengths and weaknesses did Microsoft have when it entered the video game market in 2001? When Microsoft entered the video game market, they had to overcome a lack of experience with arcade games and consumer electronics. They were also a new entrant in a market with a very strong leader that had the bulk of the market share. Microsoft also had to build on their distribution network to include toy distributors, to develop a different brand image than what it had in the software market and use different marketing channels than it had for software sales. Their strengths were significant however. They had some experience in the game market with PC computer games and online game services. The Xbox offered a significant technological advantage over existing game systems and Microsoft had the resources to price it below cost. Finally, Microsoft’s resources enabled them to budget $500 million for a marketing campaign that was spent in part on offering incentives to third party developers including giving them game development kits valued at $10,000. 5. Comparing the deployment strategies used by the firms in each of the generations, can you identify any timing, licensing, pricing, marketing, or distribution strategies that appear to have influenced firms’ success and failure in the video game industry? Looking at the different generations of competition in the video game industry, it appears that important strategies include: Timing: being willing to cannibalize existing generations before competitors do, and timing introduction to coincide with the Christmas selling season. Licensing and compatibility: making new generations of video game consoles backward compatible with previous generations; licensing third-party developers to produce games (though still producing games in house). Profits are made off of game royalties so it is not 120 effective to license console production to others because they will not be able to subsidize console price with game royalties. Pricing: consoles must be priced at or below cost, somewhere under $300 in order to facilitate Christmas sales. Marketing: aggressive advertising and promotion, with preannouncements about upcoming product introductions. Distribution: leveraging distributor relationships (as Sony did), providing guarantees if necessary (as Nintendo did with its early consignment policies), and making sure that a wide range of distributors receive sufficient shipments (to avoid Sega’s mistake with the Saturn). ANSWERS TO DISCUSSION QUESTIONS 1. Can you identify one or more circumstances when a company might wish to delay introducing its product? A company might choose to delay introducing a new product when they have an existing product still generating positive cash flows and there are no potential competitors likely to establish a competitive advantage by entering earlier. Delay might also be part of a strategy to bring the product to market at a particular point in the business cycle or buying season, or to wait until production capacity can satisfy demand or complementary products are ready for the market. 2. What factors will (or should) influence a firm’s pricing strategy? Pricing strategy is a function of the need to recoup initial investments, competitor presence or likelihood of entry, and the likelihood that volume will decrease production costs. Firms should also consider the opportunity to earn profits on complementary goods or services when establishing a price for the product. 3. Pick a product you feel you know well. What intermediaries do you think are used in bringing this product to market? What valuable services do you think these intermediaries provide? Students should provide examples from their own experience. A previously provided example follows: “On-line DVD rentals are a relatively new product that enables a subscriber to create a list of films they wish to rent that are sent to them three at a time for a monthly subscription fee. The DVDs are shipped to consumers through the U.S. postal service and the borrower returns them via a prepaid envelope provided by the rental agency. The postal service is an intermediary that provides distribution. The argument could be made that the internet is also an intermediary as it is the means by which potential customers shop for the service and communicate with the rental agency.” 121 4. What marketing strategies are used by the producers of the product you identified for question 3? What are the advantages and disadvantages of these marketing strategies? From the previously provided example: “Netflix, the DVD rental agency, uses a number of different marketing strategies. While they advertise in print media, they rely most heavily on word-of-mouth referrals and offer existing customers a bonus for referring new customers. They also provide an opportunity to try the service for free to familiarize customers with it. A disadvantage of advertising in print media is that Netflix is likely to reach readers that do not have access to the internet and/or a DVD thereby reducing the efficiency of their advertising expenditures. Word-of-mouth is one of the most effective means of promoting a product and costs nothing. Rewarding the existing customer base with a bonus is also a very low cost means of promoting word-of-mouth, but does not cost anything until the company knows they have won another customer as the bonus is based when the customer signs up. While word-of-mouth may not traditionally be an especially fast way of transmitting information about a product, the advent of email has changed this situation dramatically and allows a user to very quickly tell dozens of people about the service.” 122