MARKETING MODULE

BATCH 2008 – 2010

PRINCIPLES OF MANAGEMENT

Evolution of Management

The real development of management thought began with scientific management

approach put forward by Frederick Winslow Taylor though some concepts have been

developed by early thinkers. However it was only by the end of the nineteenth

century that the stage was set for systematic study of management and the beginning

was made by Taylor.

Scientific management

In 1911, Frederick Winslow Taylor published his work, The Principles of Scientific

Management, in which he described how the application of the scientific method to

the management of workers greatly could improve productivity. Scientific

management methods called for optimizing the way that tasks were performed and

simplifying the jobs enough so that workers could be trained to perform their

specialized sequence of motions in the one "best" way.

Prior to scientific management, work was performed by skilled craftsmen who had

learned their jobs in lengthy apprenticeships. They made their own decisions about

how their job was to be performed. Scientific management took away much of this

autonomy and converted skilled crafts into a series of simplified jobs that could be

performed by unskilled workers who easily could be trained for the tasks.

Taylor became interested in improving worker productivity early in his career when

he observed gross inefficiencies during his contact with steel workers.

He is often called the father of scientific management.

His contribution consists of the features and principles of Scientific Management

Taylor conducted experiments at his work places to find out how human beings could

be made more efficient by standardising the work and through better method of

working. Taylor argued that even the most basic, mindless tasks could be planned in

a way that dramatically would increase productivity, and that scientific management

of the work was more effective than the "initiative and incentive" method of

motivating workers. The initiative and incentive method offered an incentive to

increase productivity but placed the responsibility on the worker to figure out how to

do it.

To scientifically determine the optimal way to perform a job, Taylor performed

experiments that he called time studies, (also known as time and motion studies).

These studies were characterized by the use of a stopwatch to time a worker's

sequence of motions, with the goal of determining the one best way to perform a job.

The following are examples of some of the time-and-motion studies that were

performed by Taylor and others in the era of scientific management.

Pig Iron

If workers were moving 12 1/2 tons of pig iron per day and they could be incentivized

to try to move 47 1/2 tons per day, left to their own wits they probably would become

exhausted after a few hours and fail to reach their goal. However, by first conducting

experiments to determine the amount of resting that was necessary, the worker's

manager could determine the optimal timing of lifting and resting so that the worker

could move the 47 1/2 tons per day without tiring.

Not all workers were physically capable of moving 47 1/2 tons per day; perhaps only

1/8 of the pig iron handlers were capable of doing so. While these 1/8 were not

extraordinary people who were highly prized by society, their physical capabilities

were well-suited to moving pig iron. This example suggests that workers should be

selected according to how well they are suited for a particular job.

The Science of Shoveling

In another study of the "science of shoveling", Taylor ran time studies to determine

that the optimal weight that a worker should lift in a shovel was 21 pounds. Since

there is a wide range of densities of materials, the shovel should be sized so that it

would hold 21 pounds of the substance being shoveled. The firm provided the

workers with optimal shovels. The result was a three to four fold increase in

productivity and workers were rewarded with pay increases. Prior to scientific

management, workers used their own shovels and rarely had the optimal one for the

job.

These experiments gave rise to the following features of scientific management

1) Separation of planning and doing: Emphasized the importance of this. Planning

should be left to the supervisor and the doing to the worker.

2) Functional foremanship

3) Standardisation: Standardisation should be maintained in instruments and

tools,period and amount of work, working conditions, cost of production etc as this

would enhance efficiency .

4) Scientific Selection and training of workers: Workers should be selected on a

scientific basis considering their education, work experience, physical strength etc.

Proper training is needed to ensure efficiency and effectiveness.

5) Financial incentives: These act as a motivating factor. Provide higher wages for

extra effort.He suggested the differential piece rate system which should be based on

individual performance and not on the position occupied by the worker.

6) Mental revolution: Scientific management depends on mutual cooperation

between the workers and management.This requires a mental change in both parties

from the traditional attitude of conflict to cooperation.

Taylor's 4 Principles of Scientific Management

After years of various experiments to determine optimal work methods, Taylor

proposed the following four principles of scientific management:

1. Replace rule-of-thumb work methods with methods based on a scientific study of

the tasks.

2. Scientifically select, train, and develop each worker rather than passively leaving

them to train themselves.

3. Cooperate with the workers to ensure that the scientifically developed methods are

being followed.

4. Divide work nearly equally between managers and workers, so that the managers

apply scientific management principles to planning the work and the workers

actually perform the tasks.

These principles were implemented in many factories, often increasing productivity

by a factor of three or more. Henry Ford applied Taylor's principles in his automobile

factories, and families even began to perform their household tasks based on the

results of time and motion studies.

Drawbacks of Scientific Management

While scientific management principles improved productivity and had a

substantial impact on industry, they also increased the monotony of work. The core

job dimensions of skill variety, task identity, task significance, autonomy, and

feedback all were missing from the picture of scientific management.this reductionist

approach dehumanizes the worker.

The methods of motivation started and finished at monetary incentives only.

Taylor`s attitude towards workers had a negative bias.According to him, in the

majority of cases workers plan to do as little as they safely can.

Despite its controversy, scientific management changed the way that work was done,

and forms of it continue to be used today.

Administrative Theory

Perhaps the real father of modern management theory is the French industrialist

Henri Fayol.His contribution is termed as administrative management. His

contributions were first published in the book titled “Administration Industrielle at

Generale” in French

Fayol found that the activities of an organisation can be divided into

1) Technical(production related)

2) Commercial(buying, selling and exchange)

3) Financial(search for capital and its optimum use)

4) Security(protection of person and property)

5) Accounting

6) Managerial( planning, organising, coordinating, leading and controlling)

Fayol recognized the need for management teaching and developed fourteen

principles of management.

These principles according to Fayol are not exhaustive, nor rigid. They are

1) Division of work: this leads to the advantage of specialisation. According to him

specialisation belongs to natural order. The workers always work on the same part

and a particular manager is concerned with the same matters. This help to acquire an

ability, sureness, accuracy and increase in output.

2) Authority and responsibility: Official authority is derived from the mangers

position in the organisation. Responsibility arises from the assignment of activities.

There should be parity between the two.

3) Discipline: Discipline may be self imposed or command discipline. Self imposed

comes from within while command stems from recognised authority and uses rules,

regulations and deterrents etc to ensure compliance

4) Unity of Command: A person should get orders from only one boss. This will help

to avoid conflict in instructions and will lead to greater personal responsibility of

managers and workers.

5) Unity of Direction: Each group of activities with the same objective must have one

head and on plan. The different departments must work in tandem towards the

common goal.

6) Subordination of individual to general interest: Workers individual interest must

bow down before general organisational interest and must be aligned with the

interest of the organisation.

7) Remuneration: fair and adequate remuneration is needed to provide satisfaction.

Fayol also favoured non financial benefits.

8) Centralisation: The extent of centralisation or decentralisation should be

appropropriately determined. In small firms centralisation is natural but in large

ones decentralisation of authority and a taller organisation structure is needed.

9) Scalar chain: There should be a scalar chain of authority and of communication

ranging from highest to lowest. It suggests that each communication going up or

down must flow through each position in the line of authority. It can be short-

circuited only in circumstances where following it would be detrimental.

10) Order: This is the principle relating to the arrangement of things and people. In

material order there should be a place for everything and everything should be in its

right place. In social order the right man should be in the right place.

11) Equity: Equitable, just treatment and behaviour towards employees brings loyalty

to the organisation.

12) Stability of tenure: Reasonable job security should be provided. Efforts should be

made to ensure that unnecessary turnover does not take place.

13) Initiative: Within the limits of authority and discipline, employees should be

encouraged to take initiative.

14) Espirit de Corps: This is the principle that ‘union is strength’, and of establishing

team work.

Bureaucratic Management (1864-1920)

A bureaucracy is a highly structured, formalized, and impersonal organisation. It is a

formal organisation structure with set of rules and regulations. Max Weber

embellished the scientific management theory with his bureaucratic theory. Weber

focused on dividing organizations into hierarchies, establishing strong lines of

authority and control. He suggested organizations develop comprehensive and

detailed standard operating procedures for all routinized tasks.

Bureaucratic organisation emphasizes the need for organisations to function on

rational basis.

Features

• A continuous organisation of official functions bound by rules.

• Systematic division of labour rights and power

• Principle of hierarchy

• The rules governing the conduct of an organisation may be technical rules or

norms. Specialized training is needed.

• It is a matter of principle that members of the administrative staff should be

separated from the ownership of the means of production and administration.

• There should be complete absence of appropriation of official position by the

incumbent.

Advantages

• Removes ambiguity and inefficiency owing to clarity of work and processes

• Highly structured

• Very formalized

• Impersonal organisation

Drawbacks

• Overemphasis on rules and procedures, record keeping and paperwork as an end

rather than a means to an end

• Dependence on bureaucratic status, symbols and rules

• Lack of initiative due to lack of accountability in many cases

• Position in the organisation often gives rise to officious bureaucratic behaviour

• Impersonal organisation leads to stereotype behaviour and lack of responsiveness

to individual incidents and problems

• Red tapism

• The compartmentalisation of work restricts psychological growth of the individual

and may cause frustration, feelings of failure and conflict

• Over emphasis on process rather than purpose, fragmented responsibility and

hierarchical control means that it is all too easy to neglect the larger purpose for

which the smaller effort is being put.

Human Relations School

Behavioural or human relations management emerged in the 1920s and dealt with

the human aspects of organizations. It has been referred to as the neoclassical school

because it was initially a reaction to the shortcomings of the classical approaches to

management. The human relations movement began with the Hawthorne Studies

which were conducted from 1924 to 1933 at the Hawthorne Plant of the Western

Electric Company in Cicero, Illinois.

The Hawthorne Studies

Harvard Business School researchers, T.N. Whitehead, Elton Mayo, and George

Homans, were led by Fritz Roethlisberger. Elton Mayo, known as the Father of the

Hawthorne Studies, identified the Hawthorne Effect or the bias that occurs when

people know that they are being studied. The Hawthorne Studies are significant

because they demonstrated the important influence of human factors on worker

productivity.

There were four major phases to the Hawthorne Studies: the illumination

experiments, the relay assembly group experiments, the interviewing program, and

the bank wiring group studies. The intent of these studies was to determine the effect

of working conditions on productivity.

The illumination experiments tried to determine whether better lighting would lead

to increased productivity. Both the control group and the experimental group of

female employees produced more whether the lights were turned up or down. It was

discovered that this increased productivity was a result of the attention received by

the group.

In the relay assembly group experiments, six female employees worked in a special,

separate area; were given breaks and had the freedom to talk; and were continuously

observed by a researcher who served as the supervisor. The supervisor consulted the

employees prior to any change.

The bank wiring group studies were analyzed thoroughly by Homans and were

included in his now classic book, The Human Group. The bank wiring groups

involved fourteen male employees and were similar to the relay assembly group

experiments, except that there was no change of supervision. Again, in the relay and

bank wiring phases, productivity increased and was attributed to group dynamics.

The conclusion was that there was no cause-and-effect relationship between working

conditions and productivity. Worker attitude was found to be important. An

extensive employee interviewing program of 21,000 interviews was conducted to

determine employee attitudes toward the company and their jobs. As a major

outcome of these interviews, supervisors learned that an employee's complaint

frequently is a symptom of some underlying problem on the job, at home, or in the

person's past.

MANEGERIAL SKILLS

A skill is an individual’s ability to translate knowledge into action. Hence, it is

manifested in an individual’s performance. Skill is not necessarily inborn. It can be

developed through practice and through relating learning’s to one’s own personal

experience and background.

In order to be able to successfully discharge his roles, a manager should possess

three major skills. These are:

• Conceptual Skill

• Human Relations Skill

• Technical Skill

Robert L. Katz, a teacher and business executive, popularized the concept of

managerial skills, which was developed by Henri Fayol, a famous management

theorist.

The skills that managers possess are the most valued resources of the organisation.

Conceptual skill deals with formulation of ideas, technical skill with things and

human skill with people. While both conceptual and technical skills are needed for

good decision-making, human skill is necessary for a good leader.

Conceptual Skill

The conceptual skill refers to the ability of a manager to take a broad and farsighted

view of the organisation and its future, his ability to think in abstract, his ability to

analyse the forces working in a situation, his creative and innovative ability and his

ability to assess the environment and the changes taking place in it. It involves the

ability to see the organisation as a whole, understanding how its parts depend on one

another, and anticipating how its parts depend on one another, and anticipating how

a change in any of its parts will affect the whole. Also to solve problems in a way that

benefits the entire organisation. Analytical, creative and intuitive talents make up the

manager’s conceptual skills. These abilities are essential to effective decision making.

It is this conceptual requirement that enables an executive to recognize the

interrelationships and relative values of the various factors intertwined in a

managerial problem. In short, it is his ability to conceptualise the environment, the

organisation, and his own job, so that he can set appropriate goals for his

organisation, for himself, and for his team. This skill seems to increase in importance

as manager moves up to higher positions of responsibility in the organisation.

Managers may acquire these skills initially through formal education and then

further develop them by training and job experience.

Examples of situations that require conceptual skills include the passage of laws that

affect hiring patterns in an organisation, a competitor’s change in marketing

strategy, suggesting a new product line for the company, entering the international

market, or the reorganisation of one department which ultimately affects the

activities of other departments in the organisation.

Technical Skills

The technical skill is the manager’s understanding of the nature of job that people

under him have to perform. It refers to a person’s knowledge and proficiency in any

type of process or technique. In a production department, this would mean an

understanding of the technicalities of the process of production. Technical skills

usually consist of specialised knowledge and the ability to perform within that

speciality. It enables person to accomplish the mechanics demanded in performing a

particular job. Whereas this type of skill and competence seems to be more

important at the lower levels of management, its relative importance as a part of the

managerial role diminishes as the manager moves to higher positions. Technical

skills are usually obtained through training programs that an organisation may offer

its managers or employees or maybe obtained by way of college degree.

Examples of technical skills are writing computer programs, completing accounting

statements, analysing marketing statistics, writing legal documents, or drafting a

design for a new airfoil on an airplane. Accountants, engineers, market researchers,

and computer scientists, as examples, possess technical skills.

Human Relations Skill

Human relations skill is the ability to interact effectively with people at all levels.

This skill develops in the manager sufficient ability (a) to recognise the feelings and

sentiments of others; (b) to judge the possible reactions to, and outcomes of various

courses of action he may undertake; and (c) to examine his own concepts and values

which may enable him to develop more useful attitudes about himself. Human

relations skills are used to build positive interpersonal relationships, solve human

relations problems, build acceptance of one’s co-workers, and relate to them in a way

that their behaviour is consistent with the needs of the organisation. It involves the

ability to work with, motivate, and direct individuals or groups in the organisation

whether they are subordinates, peers, or superiors. It is cooperative effort; it is

teamwork; it is the creation of an environment in which people feel secure and free to

express their opinions. Human relations skills can be developed through an

understanding of human and group behaviour. This type of skill remains consistently

important for managers at all levels in order to interact and communicate with other

people successfully. A manager with good human skills has a high degree of self-

awareness and a capacity to understand or empathize with the feelings of others.

Some managers are naturally born with great human skills, while others improve

their skills through classes or experience.

The application of human skill may involve persuading a sales force to accept a

revised sales presentation, or obtaining support from an office and clerical staff to

save money on supplies and energy costs (e.g., reusing old files, turning off lights,

setting thermostats lower in the winter).

A manager's level in the organization determines the relative importance of

possessing technical, human, and conceptual skills. The figure below gives an idea

about the required change in the skill-mix of a manager with the change in his level.

The relative importance of conceptual, human and technical skills changes as a

person progresses from lower, to middle, to top management. Although all three

management skills are important at all three levels of management, technical skills

become least important at the top level of the management hierarchy. That is why,

people at the top shift with great ease from one industry to another without an

apparent fall in their efficiency. This skill is replaced with a greater emphasis on

conceptual skills. Technical skills are most pronounced at lower levels or supervisory

levels of management because first-line managers are closer to the production

process, where technical expertise is in greatest demand. Human skills are equally

necessary at each level of the management hierarchy. Conceptual skills are critical for

top managers because the plans, policies, and decisions developed at this level

require the ability to understand how a change in one activity will affect changes in

other activities.

References

Principles of Management, Second Edition, P C Tripathi and P N Reddy, Tata

McGraw-Hill publishing Company, New Delhi. (Pg No. 7 and 8)

Management, Sixth Edition, James A.F. Stoner, R. Edward Freeman, Daniel R.

Gilbert, Jr., Patience Hall of India Private Limited, New Delhi. Part One, Chapter 1,

Pg No. 17

Principles of Management, Eighth Edition, George R. Terry and Stephen G. Franklin,

A.I.T.B.S Publishers & Distributors, Delhi.Part 1, Chapter 1, Pg No. 7 & 8

Principles of Management, Theories, Practices, Techniques. Prof. Nirmal Singh.

Deep & Deep Publications Pvt. Ltd., New Delhi. Part 1, Chapter 1, Pg No. 51

Ollie.dcccd. edu/MGMT1374/ book_contents/1

overview/management_skills/mgmt_skills.htm

Ohioonline.osu.edu/~mgtexcel/Function.html

En.articlesgratuits.com/management-skills-id1586.php

Cliffnotes.com/WileyCDA/CliffsReviewTopic/Functions-of-Managers.topicArticleId-

8944,article-8848.html

INDIAN BUSINESS ENVIRONMENT

Accelerator effect

The accelerator effect in economics refers to a positive effect on private fixed

investment of the growth of the market economy (measured e.g. by Gross Domestic

Product). Rising GDP (an economic boom or prosperity) implies that businesses in

general see rising profits, increased sales and cash flow, and greater use of existing

capacity. This usually implies that profit expectations and business confidence rise,

encouraging businesses to build more factories and other buildings and to install

more machinery. (This expenditure is called fixed investment.) This may lead to

further growth of the economy through the stimulation of consumer incomes and

purchases, i.e., via the multiplier effect.

The accelerator effect also goes the other way: falling GDP (a recession) hurts

business profits, sales, cash flow, use of capacity and expectations. This in turn

discourages fixed investment, worsening a recession by the multiplier effect.

The accelerator effect fits the behavior of an economy best when either the economy

is moving away from full employment or when it is already below that level of

production. This is because high levels of aggregate demand hit against the limits set

by the existing labor force, the existing stock of capital goods, the availability of

natural resources, and the technical ability of an economy to convert inputs into

products.

Accelerator models

The accelerator effect is shown in the simple accelerator model. This model assumes

that the stock of capital goods (K) is proportional to the level of production (Y):

K = k×Y

This implies that if k (the capital-output ratio) is constant, an increase in Y requires

an increase in K. That is, net investment, In equals:

In = k×ΔY

Suppose that k = 2. This equation implies that if Y rises by 10, then net investment

will equal 10×2 = 20, as suggested by the accelerator effect. If Y then rises by only 5,

the equation implies that the level of investment will be 5×2 = 10. This means that

the simple accelerator model implies that fixed investment will fall if the growth of

production slows. An actual fall in production is not needed to cause investment to

fall. However, such a fall in output will result if slowing growth of production causes

investment to fall, since that reduces aggregate demand. Thus, the simple accelerator

model implies an endogenous explanation of the business-cycle downturn, the

transition to a recession.

Modern economists have described the accelerator effect in terms of the more

sophisticated flexible accelerator model of investment. Businesses are described as

engaging in net investment in fixed capital goods in order to close the gap between

the desired stock of capital goods (Kd) and the existing stock of capital goods left

over from the past (K-1):

In = x(Kd - K-1)

where x is a coefficient representing the speed of adjustment (1 ≥ x ≥ 0).

The desired stock of capital goods is determined by such variables as the expected

profit rate, the expected level of output, the interest rate (the cost of finance), and

technology. Because the expected level of output plays a role, this model exhibits

behaviour described by the accelerator effect but less extreme than that of the simple

accelerator. Because the existing capital stock grows over time due to past net

investment, a slowing of the growth of output (GDP) can cause the gap between the

desired K and the existing K to narrow, close, or even become negative, causing

current net investment to fall.

Obviously, ceteris paribus, an actual fall in output depresses the desired stock of

capital goods and thus net investment. Similarly, a rise in output causes a rise in

investment. Finally, if the desired capital stock is less than the actual stock, then net

investment may be depressed for a long time.

In the Neoclassical accelerator model of Dale Jorgenson, the desired capital stock is

derived from the aggregate production function assuming profit maximization and

perfect competition.

Business Cycle

The business cycle or economic cycle refers to the fluctuations of economic activity

about its long term growth trend. The cycle involves shifts over time between periods

of relatively rapid growth of output (recovery and prosperity), and periods of relative

stagnation or decline (contraction or recession). These fluctuations are often

measured using the real gross domestic product. Despite being named cycles, these

fluctuations in economic growth and decline do not follow a purely mechanical or

predictable periodic pattern.

Types of business cycle

Traditional business cycle models

The main types of business cycles enumerated by Joseph Schumpeter, and others in

this field, have been named after their discoverers or proposers:

the Kitchin inventory cycle (3–5 years) — after Joseph Kitchin,

the Juglar fixed investment cycle (7–11 years) — after Clement Juglar,

the Kuznets infrastructural investment cycle (15–25 years) — after Simon Kuznets,

Nobel Laureate,

the Kondratieff wave or cycle (45–60 years) — after Nikolai Kondratieff.

the Forrester cycles (200 years) - after Jay Wright Forrester.

the Toffler civilisation cycles (1000-2000 years) - after Alvin Toffler.

Even longer cycles are occasionally proposed, often as multiples of the Kondratieff

cycle.

Juglar cycle

In the Juglar cycle, which is sometimes called "the" business cycle, recovery and

prosperity are associated with increases in productivity, consumer confidence,

aggregate demand, and prices. In the cycles before World War II or that of the late

1990s in the United States, the growth periods usually ended with the failure of

speculative investments built on a bubble of confidence that bursts or deflates. In

these cycles, the periods of contraction and stagnation reflect a purging of

unsuccessful enterprises as resources are transferred by market forces from less

productive uses to more productive uses. Cycles between 1945 and the 1990s in the

United States were generally more restrained and followed political factors, such as

fiscal policy and monetary policy. Automatic stabilisation due to the government's

budget helped defeat the cycle even without conscious action done by policy-makers;

A colloquial term for a crisis of this time scale is a "decennial crisis" (meaning one

that occurs after about ten years). The phrase was noted during the Great Depression

due to the similarity of the coming of the Panic of 1825 in London ten years after the

end of the Napoleonic Wars, which had been bankrolled by Britain, with that of Black

Monday in New York eleven years after the First World War, which had been

similarly paid for by the United States. After the Second World War, however, the

nearest equivalent in time and intensity was the recession of 1958.

Politically-based business cycle models

Another set of models tries to derive the business cycle from political decisions.

The partisan business cycle suggests that cycles result from the successive elections

of administrations with different policy regimes. Regime A adopts expansionary

policies, resulting in growth and inflation, but is voted out of office when inflation

becomes unacceptably high. The replacement, Regime B, adopts contractionary

policies reducing inflation and growth, and the downwards swing of the cycle. It is

voted out of office when unemployment is too high, being replaced by Party A.

The political business cycle is an alternative theory stating that when an

administration of any hue is elected, it initially adopts a contractionary policy to

reduce inflation and gain a reputation for economic competence. It then adopts an

expansionary policy in the lead up to the next election, hoping to achieve

simultaneously low inflation and unemployment on election day.

Preventing business cycles

Because the periods of stagnation are painful for many who lose their jobs, pressure

arises for politicians to try to smooth out the oscillations. An important goal of all

Western nations since the Great Depression has been to limit the dips. Government

intervention in the economy can be risky, however. For instance, some of Herbert

Hoover's efforts (including tax increases) are widely, though not universally, believed

to have deepened the depression.

Managing economic policy to even out the cycle is a difficult task in a society with a

complex economy, even when Keynesian theory is applied. According to some

theorists, notably nineteenth-century advocates of communism, this difficulty is

insurmountable. Karl Marx in particular claimed that the recurrent business cycle

crises of capitalism were inevitable results of the system's operations. In this view, all

that the government can do is to change the timing of economic crises. The crisis

could also show up in a different form, for example as severe inflation or a steadily

increasing government deficit. Worse, by delaying a crisis, government policy is seen

as making it more dramatic and thus more painful.

Additionally, Neoclassical economics plays down the ability of Keynesian policies to

manage an economy. Challenging the Phillips Curve since the 1960s, economists like

Nobel Laureate Milton Friedman or 2006 Nobel Laureate Edmund Phelps have

made ground in their arguments that inflationary expectations negate the Phillips

Curve in the long run. The stagflation of the 70's supported their theory by flying in

the face of Keynesian predictions. Friedman has gone so far as to argue, that all the

Federal Reserve System can do is to avoid making large mistakes, as he believes they

did by contracting the money supply very rapidly in the face of the Stock Market

Crash of 1929, in which they made what would have been a recession into a great

depression. (Friedman calls the Great Depression the "Great Contraction" because of

this).

Alternative interpretations of business cycles

Marxist

Michal Kalecki's Marxian-influenced "political business cycle" theory blames the

government.[1] He argued that no democratic government under capitalism would

allow the persistence of full employment, so that recessions would be caused by

political decisions: persistent full employment would mean increasing workers'

bargaining power to raise wages and to avoid doing unpaid labour, potentially

hurting profitability. (He did not see this theory as applying under fascism, which

would use direct force to destroy labour’s power.) In recent years, proponents of the

"electoral business cycle" theory have argued that incumbent politicians encourage

prosperity before elections in order to ensure re-election -- and make the citizens pay

for it with recessions afterwards.

Problems of measurement

Some argue that modern business cycle theory often measures growth by using the

flawed measure of the economy's aggregate production, i.e., real gross domestic

product, which is not useful for measuring well-being and also generates distortions

in the perception of economic growth because the price changes of the various

products are disproportional. Accordingly, there is a mismatch between the state of

economic health as perceived by many individuals and that perceived by the bankers

and economists, which most likely drives them further apart politically. However,

unlike with issues of long-term economic growth, the economists and bankers may

be right to use real GDP when studying business cycles. After all, it is fluctuations in

real GDP, not those of measures of well-being, that cause changes in employment,

unemployment, interest rates, and inflation, i.e. economic issues which are their

main concern of business cycle experts.

Business cycle theory has been most effective in microeconomics where it aids in the

preparation of risk management scenarios and timing investment, especially in

infrastructural capital that must pay for itself over a long period, and which must

fund itself by cashflow in late years. When planning such large investments, it is

often useful to use the anticipated business cycle as a baseline, so that unreasonable

assumptions, e.g. constant exponential growth, are more easily eliminated.

Circular flow of income

In economics, the term circular flow of income or circular flow refers to a simple

economic model which describes the reciprocal circulation of income between

producers and consumers. In the circular flow model, the inter-dependent entities of

producer and consumer are referred to as "firms" and "households" respectively (In

some models, these are referred to as the residential and business sectors) and

provide each other with factors in order to facilitate the flow of income. Firms

provide consumers with goods and services in exchange for consumer expenditure

and "factors of production" from households.

The circle of money flowing through the economy is as follows: total income is spent

(with the exception of "leakages" such as consumer saving), while that expenditure

allows the sale of goods and services, which in turn allows the payment of income

(such as wages and salaries). Expenditure based on borrowings and existing wealth –

i.e., "injections" such as fixed investment – can add to total spending.

Or

Simplified Diagram

More complete and realistic circular flow models are more complex. They would

explicitly include the roles of government and financial markets, along with imports

and exports.

Labor and other "factors of production" are sold on resource markets. These

resources, purchased by firms, are then used to produce goods and services. The

latter are sold on product markets, ending up in the hands of the households, helping

them to supply resources.

Assumptions

The basic circular flow of income model consists of six assumptions:

The economy consists of two sectors: households and firms.

Households spend all of their income (Y) on goods and services or consumption (C).

There is no saving (S).

All output (O) produced by firms is purchased by households through their

expenditure (E).

There is no financial sector.

There is no government sector.

There is no overseas sector.

Two Sector Model

In the simple two sector circular flow of income model the state of equilibrium is

defined as a situation in which there is no tendency for the levels of income (Y),

expenditure (E) and output (O) to change, that is:

Y = E = O

This means that the expenditure of buyers (households) becomes income for sellers

(firms). The firms then spend this income on factors of production such as labour,

capital and raw materials, "transferring" their income to the factor owners. The

factor owners spend this income on goods which leads to a circular flow of income.

Drawbacks: While the exercise of calculating a circular flow of income can be helpful

in demonstrating the strength or weakness of domestic goods to meet the needs of

domestic customers, the model is very limited. This is due to the factors that are not

considered as part of the model. For example, the flow of income from the household

is assumed to be complete. There are no provisions for households choosing to save

part of the income in some form. The model also assumes that all products produced

by the firms are actually consumed by domestic households. A typical model for a

circular flow of income also does not account for taxes and similar expenses that do

absorb a portion of the income flow of any household.

Five sector model

All leakages and injections in five sector model

Leakages Injections

Saving (S) Investment (I)

Taxes (T) Government Spending (G)

Imports (M) Exports (X)

The five sector model of the circular flow of income is a more realistic representation

of the economy. Unlike the two sector model where there are six assumptions the five

sector circular flow relaxes all six assumptions. Since the first assumption is relaxed

there are three more sectors introduced. The first is the Financial Sector that consists

of banks and non-bank intermediaries who engage in the borrowing (savings from

households) and lending of money. In terms of the circular flow of income model the

leakage that financial institutions provide in the economy is the option for

households to save their money. This is a leakage because the saved money can not

be spent in the economy and thus is an idle asset that means not all output will be

purchased. The injection that the financial sector provides into the economy is

investment (I) into the business/firms sector.

The next sector introduced into the circular flow of income is the Government Sector

that consists of the economic activities of local, state and federal governments. The

leakage that the Government sector provides is through the collection of revenue

through Taxes (T) that is provided by households and firms to the government. For

this reason they are a leakage because it is a leakage out of the current income thus

reducing the expenditure on current goods and services. The injection provided by

the government sector is Government spending (G) that provides collective services

and welfare payments to the community. An example of a tax collected by the

government as a leakage is income tax and an injection into the economy can be

when the government redistributes this income in the form of welfare payments,

which is a form of government spending back into the economy.

The final sector in the circular flow of income model is the overseas sector which

transforms the model from a closed economy to an open economy. The main leakage

from this sector are imports (M), which represent spending by residents into the rest

of the world. The main injection provided by this sector is the exports of goods and

services which generate income for the exporters from overseas residents.

An example of the use of the overseas sector is Australia exporting wool to China,

China pays the exporter of the wool (the farmer) therefore more money enters the

economy thus making it an injection. Another example is China processing the wool

into items such as coats and Australia importing the product by paying the Chinese

exporter; since the money paying for the coat leaves the economy it is a leakage.

In terms of the five-sector circular flow of income model the state of equilibrium

occurs when the total leakages are equal to the total injections that occur in the

economy. This can be shown as:

Savings + Taxes + Imports = Investment + Government Spending + Exports

OR

S + T + M = I + G + X.

Therefore since the leakages are equal to the injections the economy is in a stable

state of equilibrium. This state can be contrasted to the state of disequilibrium where

unlike that of equilibrium the sum of total leakages does not equal the sum of total

injections. By giving values to the leakages and injections the circular flow of income

can be used to show the state of disequilibrium. Disequilibrium can be shown as:

S + T + M ≠ I + G + X

Therefore it can be shown as one of the below equations where:

Total leakages > Total injections

Or

Total Leakages < Total injections

The effects of disequilibrium vary according to which of the above equations they

belong to.

If S + T + M > I + G + X the levels of income, output, expenditure and employment

will fall causing a recession or contraction in the overall economic activity. But if S +

T + M < I + G + X the levels of income, output, expenditure and employment will rise

causing a boom or expansion in economic activity.

To manage this problem, if disequilibrium were to occur in the five sector circular

flow of income model, changes in expenditure and output will lead to equilibrium

being regained. An example of this is if:

S + T + M > I + G + X the levels of income, expenditure and output will fall causing a

contraction or recession in the overall economic activity. As the income falls

households will cut down on all leakages such as saving, they will also pay less in

taxation and with a lower income they will spend less on imports. This will lead to a

fall in the leakages until they equal the injections and a lower level of equilibrium will

be the result.

The other equation of disequilibrium, if S + T + M < I + G + X in the five sector

model the levels of income, expenditure and output will greatly rise causing a boom

in economic activity. As the households income increases there will be a higher

opportunity to save therefore saving in the financial sector will increase, taxation for

the higher threshold will increase and they will be able to spend more on imports. In

this case when the leakages increase they will continue to rise until they are equal to

the level injections. The end result of this disequilibrium situation will be a higher

level of equilibrium.

Consumption

In economics consumption is primary motivating force in the wealth or utility

maximizing paradigm. Consumers choose the group of goods and services that make

them happiest. All activities are directed towards consumption, either of traditional

goods and services, or of personal and perhaps unique activities.

In a one-person world, production is directed towards those goods and services that

the individual prefers. With the advent of exchange, consumption is altered by the

ability of individuals to take advantage of the gains from trade to adjust their

consumption activities with others in the economy.

In Keynesian economics, consumption is the total personal consumption

expenditure, or the purchase of currently produced goods and services out of income,

out of savings (net worth), or from borrowed funds. It refers to that part of

disposable income (income after taxes paid and payments received) that does not go

to saving. Analyzing human consumption of available resources play an important

role in economics, environmentalism, and geographical analysis. Consumption is

generally measured by household consumption expenditures (known as personal

consumption expenditures in the United States) and is determined by the

consumption function, especially by the marginal propensity to consume. It is part of

aggregate demand or effective demand. It can also be defined as "the selection,

adoption, use, disposal and recycling of goods and services", as opposed to their

design, production and marketing.

History

John Maynard Keynes developed the idea of the consumption function, which sees a

consumption as consisting of two main parts:

Induced consumption refers to increases in consumer spending occurring as

disposable income rises. Increases in consumption follow the famous marginal

propensity to consume. An increase in disposable income leads to an increase in

consumption, moving along the consumption function in a graph.

Autonomous consumption refers to consumption spending done as part of long-term

plans for the future (smoothing out income fluctuations, providing for retirement

and other expected future events, etc.) and as a result of habits and contractual

commitments. Changes in plans, expectations, habits, etc. leads to shifts of the

consumption function in a graph.

Often, as in the permanent income hypothesis, the word "consumption" refers

instead to the benefit received from consumer goods and services (as opposed to the

amount spent on such products).

Additional Reading Material on Consumption

Sociological Studies of Consumption

Studies of consumption investigate how and why society and individuals consume

goods and services, and how this affects society and human relationships.

Contemporary studies focus on meanings of goods, role of consumption in identity

making, and the 'consumer' society (e.g. Douglas et al). Traditionally, consumption

was seen as rather unimportant compared to production, and the political and

economic issues surrounding it. With the development of a consumer society,

increasing consumer power in the market place, the growth in marketing,

advertising, sophisticated consumers, ethical consumption etc, it is recognised as

central to modern life. Sociology of consumption has moved well beyond Veblen's

early work on 'conspicuous' consumption. Current theories investigate the role of

economic and cultural factors in constraining consumption (Bourdieu), as

development of an approach that sees consumers as 'victims' of producers and their

social situation. A counter theory highlights the subversive aspects of consumption,

with consumers buying and using goods, places etc in ways unintended by the

producers. Examples include city squares turned to skateboard parks, and music

sharing on the internet.

Studies of consumption come from a variety of backgrounds. Consumer studies

attempt to help marketing. User research aims to improve product design. Feminist

studies highlight the importance of women as consumers, and particularly the role of

the domestic arena in consumption. Media studies try to understand the

consumption of media products such as television and video games. Cultural Studies

is interested in the role of material goods in culture (e.g. Mackay) Critical Theory is

an important influence on contemporary studies, as consumption is central to

contemporary culture. Domestication theory focuses on mass market technologies.

Studying consumption can be done through traditional survey methods, or various

ethnographic techniques. Consumption studies are difficult because they involve

investigating everyday life situations, bringing research into the private domain,

rather than formalised settings such as the workplace.

Marginal propensity to consume

The marginal propensity to consume (MPC) refers to the increase in personal

consumer spending (consumption) that occurs with an increase in disposable income

(income after taxes and transfers). For example, if a household earns one extra dollar

of disposable income, and the marginal propensity to consume is 0.65, then of that

dollar, the family will spend 65 cents and save 35 cents.

Mathematically, the marginal propensity to consume (MPC) function is expressed as

the derivative of the consumption (C) function with respect to disposable income (Y).

, where a is the change in consumption, and b is the change in disposable income

that produced the consumption.

Let's give an example. Suppose you receive a bonus with your paycheck, and it's $500

on top of your normal annual earnings. You suddenly have $500 more in income

than you did before. If you decide to spend $400 of this marginal increase in income

on a new business suit, your marginal propensity to consume will be 0.8 ($400 /

$500).

The marginal propensity to consume is measured as the ratio of the change in

consumption to the change in income, thus giving us a figure between 0 and 1. The

MPC can be more than one if the subject borrowed money to finance expenditures

higher than their income. One minus the MPC equals the marginal propensity to save

(in a two sector closed economy), both of which are crucial to Keynesian economics

and are key variables in determining the value of the multiplier.

The MPC relies heavily upon the real (inflation-adjusted) rate of interest. A high rate

of interest causes spending in the future to become increasingly attractive due to the

intertemporal substitution effect on consumption. Because a rate increase primarily

decreases the present value of lifetime wealth, the consumer relies on becoming a

lender to offset this effect. In a two period model, as S(1+r) increases with the

interest rate, so does future income[C= -(1+r)c +we(1+r)]. Therefore, every dollar of

current income spent by the consumer is 1(1+r) dollars the consumer will not be able

to spend in the second period.

Economists often distinguish between the marginal propensity to consume out of

permanent income, and the marginal propensity to consume out of temporary

income, because if a consumer expects a change in income to be permanent, then

they have a greater incentive to increase their consumption (Barro and Grilli, p. 417-

8). This implies that the Keynesian multiplier should be smaller in response to

permanent changes in income than it is in response to temporary changes in income

(though the earliest Keynesian analyses ignored these subtleties). However, the

distinction between permanent and temporary changes in income is often subtle in

practice, and there is in some cases hardly any way to assign to income data a so-

called permanent or temporary character. What is more, the marginal propensity to

consume should also be affected by factors such as the prevailing interest rate and

the general level of consumer surplus that can be derived from purchasing.

Multiplier

In economics, the multiplier effect refers to the idea that an initial spending rise can

lead to an even greater increase in national income. In other words, an initial change

in aggregate demand can cause a further change in aggregate output for the

economy.

The multiplier effect is a tool used by governments to restimulate aggregate demand.

This can be done in a period of recession or economic uncertainty. The money

invested by a government creates more jobs, which in turn will mean more spending

and so on.

For example: a company spends $1 million to build a factory. The money does not

disappear, but rather becomes wages to builders, revenue to suppliers etc. The

builders will have higher disposable income as a result, so consumption, hence

aggregate demand will rise as well. Say that all of these workers combined spend $2

million dollars in total, since there was an initial $1 million input which created a $2

million output, the multiplier is 2.

Another example is when a tourist visits somewhere they need to buy the plane

ticket, catch a taxi from the airport to the hotel, book in at the hotel, eat at the

restaurant and go to the movies or tourist destination. The taxi driver needs petrol

(gasoline) for his cab, the hotel needs to hire the staff, the restaurant needs

attendants and chefs, and the movies and tourist destinations need staff and

cleaners.

It must be noted that the extent of the multiplier effect is dependent upon the

marginal propensity to consume and marginal propensity to import. Also that the

multiplier can work in reverse as well, so an initial fall in spending can trigger further

falls in aggregate output.

The basic formula for the economic multiplier, in macroeconomics, is the change in

equilibrium GDP divided by the change in investment (i.e. the initial increase in

spending).

It is particularly associated with Keynesian economics; some other schools of

economic thought reject, or downplay the importance of multiplier effects,

particularly in the long run. The multiplier has been used as an argument for

government spending or taxation relief to stimulate aggregate demand.

The concept of the economic multiplier on a macroeconomic scale can be extended to

any economic region. For example, building a new factory may lead to new

employment for locals, which may have knock-on economic effects for the city or

region.

MEC, Motives to hold money, Liquidity Trap and Unemployment

MEC – Marginal Efficiency of Capital

Investment levels depend on two factors: rate of interest and marginal efficiency of

capital.

The word “marginal” in economics means “on the borderline”. For example, marginal

utility is the utility added to the total utility of a stock of goods by the addition of one

unit of the good. Therefore, MEC is defined as the percentage yield earned on an

additional unit of capital.

In other words, it is profit, expressed as a rate of return on investment, expected

from the last increment of capital.

Motives to hold money

The demand for money is a demand for real balances. In other words, people hold

money for its purchasing power, for the amount of goods they can buy with it. They

are not concerned with the nominal money holdings, that is, the number of currency

bills they hold.

There are three major motives underlying the demand for money:

• The transactions motive, which is the demand for money arising from the use of

money in making regular payments.

• The precautionary motive, which is the demand for money to meet unforeseen

contingencies.

• The speculative motive, which arises from uncertainties about the money value of

other assets that an individual can holds.

These theories of money demand are built around a tradeoff between the benefits of

holding more money versus the interest costs of doing so. Money generally earns no

interest or less interest than other assets. The higher the interest loss from holding a

rupee of money, the less money we expect the individual to hold.

Transactions Demand

The transactions demand for money arises from the use of money in making regular

payments for goods and services. In the course of each month, an individual makes a

variety of payments for rent or a mortgage, groceries, the newspaper, and other

purchases.

The tradeoff here is between the amount of interest an individual forgoes by holding

money and the costs and inconveniences of holding a small amount of money.

Precautionary Motive

Here we concentrate on the demand for money that arises because people are

uncertain about the payments they might want, or have, to make. Realistically, an

individual does not know precisely what payments (s)he will be receiving in the next

few weeks and what payments will have to be made. The person might decide to have

a pizza, or need to take a cab in the rain, or have to pay for a prescription. If the

person does not have money with which to pay, he will incur a loss.

The more money an individual holds, the less likely he or she is to incur the costs of

illiquidity (that is, not having money immediately available). But the more money the

person holds, the more interest (from banks or other such sources) he or she is giving

up. We are back to a tradeoff similar to that examined in relation to the transactions

demand. The added consideration is that greater uncertainty about receipts and

expenditures increases the demand for money.

The Speculative Demand for Money

The transactions and precautionary demand for money emphasize the medium of

exchange function of money, for each refers to the need to have money on hand to

make payments. Now we move over to the store of value function of money and

concentrate on the role of money in the investment portfolio of an individual.

An individual who has wealth has to hold that wealth in specific assets. Those assets

make up a portfolio. One would think an investor would want to hold the asset that

provides the highest returns. However, given that the return on most assets is

uncertain, it is unwise to hold the entire portfolio in a single risky asset.

Money is a safe asset in that its nominal value is known with certainty. It would be

held as the safe asset in the portfolios of investors. The demand for money – the

safest asset – depends on the expected yields as well as on the riskiness of the yields

on other assets. An increase in the expected return on other assets – an increase in

the opportunity cost of holding money (that is, the return lost by holding money) –

lowers money demand. By contrast, an increase in the riskiness of the returns on

other assets increases money demand.

An investor’s aversion to risk certainly generates a demand for a safe asset.

The Liquidity Trap

This is a phenomenon that occurs in the money market of an economy. The supply of

money is decided upon by the central bank of the country and is assumed to not be

affected by any other factors. This is why the money supply curve in the diagram is a

straight vertical line.

The demand for money is a function of rate of interest, among other things. This

implies that when the rate of interest is high, people want to hold less of liquid cash

because they can earn more by keeping their money in the bank. Similarly, if the rate

of interest is low, people prefer to hold ready cash with them because they cannot

earn much in terms of interest on their savings.

The theory states that the equilibrium rate of interest is arrived at when the demand

for money is equal to its supply. But sometimes due to certain reasons, the rate of

interest goes so low that it is not expected to go any lower. Consequently, the demand

for money becomes independent of the ROI. That is to say, people do not care what

the ROI then is, and just prefer to hold liquid cash with them. This is when the

money demand curve becomes flat.

In such a case, the government tries to use its monetary policy in order to stimulate

demand and correct the problems in the economy. So it pumps in more cash into the

market which results in a rightward shift of the money supply curve. It hopes that

this will result in greater spending and consumption by people and also greater

investment thereby giving stimulus to the economy. But the rate of interest does not

move, and the all the extra money supplied is held by the people because the

opportunity cost of holding money is minimum. Banks also behave in the same way

because they do not get much benefit from lending out money, so they hoard money.

When the economy is in a liquidity trap, real interest rates are expected to rise

because according to the speculative theory the ROI cannot fall any further. High

interest rates discourage private investment in the economy and widen the output

gap.

This is usually a spiral, and one of the most effective ways of overcoming this

situation is known to be fiscal expansion.

Unemployment

Cost of unemployment –

• For the economy:

There is loss of aggregate output in the economy.

• For people at individual level:

Loss of income, self respect, and stress.

Unemployment Rate –

Unemployment rate measures the number of jobless persons actively seeking work

compared to the total number of working-age persons participating in the labor

force.

Basic Types of Unemployment

Frictional Unemployment

Occurs because people will always be fired, quitting jobs, taking time to look for the

right job, and relocating from one community to another.

•Better information about alternative sources of jobs and available workers could

help to reduce length of such unemployment.

•It is highest when economy is growing as there are more job opportunities in the

market.

• People are more optimistic about finding better job opportunities.

Voluntary Frictional Unemployment

•Time is needed to find the “right” job.

•Workers do not have perfect information about all available jobs and possible rates

of pay.

• They can get improved information by searching the market.

• With little job market information, it may be wise for an unemployed person to

refuse his/her first job offer.

• By searching, an unemployed person gains valuable information about the labor

market.

•This type of unemployment is a productive activity that has benefits as well as costs:

(1) Benefit: information about job opportunities and pay

(2) Cost: foregone wage associated with the first job opportunity available.

Cyclical Unemployment

•Happens when we have less than full utilization of all productive resources in the

economy due to recession.

•Unemployment resulting from business recessions that occur when aggregate

demand is insufficient to create full employment.

Seasonal Unemployment

•This kind of unemployment occurs due to seasonal pattern of products or services of

an industry.

•Construction

•Tourism, summer resorts

•Agriculture, Canning

Structural Unemployment

•Occurs due to fundamental change in the structure of the economy.

•Reasons:

1. Demand for a product could fall drastically so that workers specializing in the

production of it become unemployed.

2. May result from technological changes that reduce the demand for labor to do

specific tasks (production welders).

3. An imbalance exists between the skills possessed by workers and the skills

demanded in the labor markets.

4. Some of the unemployed people lack proper skills and training while others lack

the geographic mobility to take advantage of job opportunities.

5. Some are unemployed because they are covered by a mandated wage/benefit

package so high that they become unqualified for work because their value to

employers is less than the mandated minimum.

Structural unemployment can last for a long time.

• Significant retraining time.

•Industries

-Automobiles

-Steel

-Banking

Full Employment/Natural Rate of Unemployment

•An arbitrary level of unemployment that corresponds to “normal” friction in the

labor market.

•Does not mean the unemployment rate is zero. There will always be some frictional

unemployment.

INFLATION

Persistent tendency for the general level of prices to rise is known as Inflation.

Inflation is defined as the rate at which the general price level of goods and services

is rising, causing purchasing power to fall. This is different from a rise and fall in the

price of a particular good or service. Individual prices rise and fall all the time in a

market economy, reflecting consumer choices or preferences and changing costs. So

if the cost of one item, say a particular model car, increases because demand for it is

high, this is not considered inflation. Inflation occurs when most prices are rising by

some degree across the whole economy. This is caused by four possible factors, each

of which is related to basic economic principles of changes in supply and demand:

1. Increase in the money supply.

2. Decrease in the demand for money.

3. Decrease in the aggregate supply of goods and services.

4. Increase in the aggregate demand for goods and services.

Types of Inflation

There are 2 kinds of inflations in which we ignore the effects of money supply and

concentrate specifically on the effects of aggregate supply and demand: cost-push

and demand-pull inflation.

Cost-Push Inflation

Aggregate supply is the total volume of goods and services produced by an economy

at a given price level. When there is a decrease in the aggregate supply of goods and

services stemming from an increase in the cost of production, we have cost-push

inflation.

Cost-push inflation basically means that prices have been “pushed up” by increases

in costs of any of the four factors of production (labour, capital, land or

entrepreneurship) when companies are already running at full production capacity.

With higher production costs and productivity maximized, companies cannot

maintain profit margins by producing the same amounts of goods and services. As a

result, the increased costs are passed on to consumers, causing a rise in the general

price level (inflation).

Production Costs

To understand better their effect on inflation, one must understand how and why

production costs can change. A company may need to increases wages if labourers

demand higher salaries (due to increasing prices and thus cost of living) or if labour

becomes more specialized. If the cost of labour, a factor of production, increases, the

company has to allocate more resources to pay for the creation of its goods or

services. To continue to maintain (or increase) profit margins, the company passes

the increased costs of production on to the consumer, making retail prices higher.

Along with increasing sales, increasing prices is a way for companies to constantly

increase their bottom lines and essentially grow. Another factor that can cause

increases in production costs is a rise in the price of raw materials. This could occur

because of scarcity of raw materials, an increase in the cost of labour and/or an

increase in the cost of importing raw materials and labour (if the they are overseas),

which is caused by a depreciation in their home currency. The government may also

increase taxes to cover higher fuel and energy costs, forcing companies to allocate

more resources to paying taxes.

Putting It Together

To visualize how cost-push inflation works, we can use a simple price-quantity graph

showing what happens to shifts in aggregate supply. The graph below shows the level

of output that can be achieved at each price level. As production costs increase,

aggregate supply decreases from AS1 to AS2 (given production is at full capacity),

causing an increase in the price level from P1 to P2. The rationale behind this

increase is that, for companies to maintain (or increase) profit margins, they will

need to raise the retail price paid by consumers, thereby causing inflation.

Demand-Pull Inflation

Demand-pull inflation occurs when there is an increase in aggregate demand,

categorized by the four sections of the macro economy: households, businesses,

governments and foreign buyers. When these four sectors concurrently want to

purchase more output than the economy can produce, they compete to purchase

limited amounts of goods and services. Buyers in essence “bid prices up”, causing

inflation. This excessive demand, also referred to as “too much money chasing too

few goods”, usually occurs in an expanding economy.

Factors Pulling Prices Up

The increase in aggregate demand that causes demand-pull inflation can be the

result of various economic dynamics. For example, an increase in government

purchases can increase aggregate demand, thus pulling up prices. Another factor can

be the depreciation of local exchange rates, which raises the price of imports and, for

foreigners, reduces the price of exports. As a result, the purchasing of imports

decreases while the buying of exports by foreigners increases, thereby raising the

overall level of aggregate demand (we are assuming aggregate supply cannot keep up

with aggregate demand as a result of full employment in the economy). Rapid

overseas growth can also ignite an increase in demand as more exports are consumed

by foreigners. Finally, if government reduces taxes, households are left with more

disposable income in their pockets. This in turn leads to increased consumer

spending, thus increasing aggregate demand and eventually causing demand-pull

inflation. The results of reduced taxes can lead also to growing consumer confidence

in the local economy, which further increases aggregate demand.

Putting It Together

Demand-pull inflation is a product of an increase in aggregate demand that is faster

than the corresponding increase in aggregate supply. When aggregate demand

increases without a change in aggregate supply, the ‘quantity supplied’ will increase

(given production is not at full capacity). Looking again at the price-quantity graph,

we can see the relationship between aggregate supply and demand. If aggregate

demand increases from AD1 to AD2, in the short run, this will not change (shift)

aggregate supply, but cause a change in the quantity supplied as represented by a

movement along the AS curve. The rationale behind this lack of shift in aggregate

supply is that aggregate demand tends to react faster to changes in economic

conditions than aggregate supply.

As companies increase production due to increased demand, the cost to produce each

additional output increases, as represented by the change from P1 to P2. The

rationale behind this change is that companies would need to pay workers more

money (e.g. overtime) and/or invest in additional equipment to keep up with

demand, thereby increasing the cost of production. Just like cost-push inflation,

demand-pull inflation can occur as companies, to maintain profit levels, pass on the

higher cost of production to consumers’ prices.

Inflation is not simply a matter of rising prices. There are endemic and perhaps

diverse reasons at the root of inflation. Cost-push inflation is a result of decreased

aggregate supply as well as increased costs of production, itself a result of different

factors. The increase in aggregate supply causing demand-pull inflation can be the

result of many factors, including increases in government spending and depreciation

of the local exchange rate. If an economy identifies what type of inflation is occurring

(cost-push or demand-pull), then the economy may be better able to rectify (if

necessary) rising prices and the loss of purchasing power.

CONTROLS OF INFLATION

There are 2 main methods used to control the inflation in an economy. Fiscal policy

and Monetary measures. These two policies are used in various combinations in an

effort to direct a country's economic goals

Fiscal policy

Fiscal policy is the means by which a government adjusts its levels of spending in

order to monitor and influence a nation's economy. Fiscal policy is the deliberate and

thought out change in government spending, government borrowing or taxes to

stimulate or slow down the economy. It contrasts with monetary policy, which

describes policies concerning the supply of money to the economy.

Fiscal policy is described as being either neutral, expansionary, or contractionary. An

expansionary fiscal policy occurs when the government lowers taxes and/or increases

spending; thus expanding output (national income). An increase in government

spending or a cut in taxes shifts the aggregate demand curve to the right. An

expansionary fiscal policy will expand the economy's growth. A contractionary fiscal

policy occurs when the government raises taxes and/or lowers spending; thus

lowering output (national income). A decrease in government purchases or an

increase in taxes shifts the aggregate demand curve to the left. A contractionary fiscal

policy will constrict the economy's overall growth.

Monetary Policy

It is the process by which the government, central bank, or monetary authority

manages the supply of money, or trading in foreign exchange markets. Monetary

theory provides insight into how to craft optimal monetary policy.

Monetary policy is generally referred to as either being an expansionary policy, or a

contractionary policy, where an expansionary policy increases the total supply of

money in the economy, and a contractionary policy decreases the total money supply.

Expansionary policy is traditionally used to combat unemployment in a recession by

lowering interest rates, while contractionary policy has the goal of raising interest

rates to combat inflation (or cool an otherwise overheated economy). Monetary

policy should be contrasted with fiscal policy, which refers to government borrowing,

spending and taxation.

There are different types of monetary policies:

Open market operations - The process of changing the liquidity of base currency

through the open sales and purchases of (government-issued) debt and credit

instruments is called open market operations.

Changing the Cash Reserve Ratio – The RBI has the power to set an amount, or

percentage, of deposits that its member banks must keep in reserve at them. If the

RBI raises its reserve requirements then banks have less money on hand and thus

have less to lend. This lowers the amount of money in circulation and could have the

impact of slowing the economy and inflation. Conversely if the fed lowers the reserve

requirement , banks have more money on hand, more to lend and more money goes

into circulation, thus increasing spending and possibly inflation.

Changing of discount Rates - One of the most important functions of the RBI is the

changing of the discount rate, the discount rate is interest rate that the RBI charges

banks on money the banks borrow from the RBI. Member banks borrow money from

the RBI to pay out loans and other investments but they must pay a fee, the discount

rate. The reason this can be done is because the RBI acts as the central bank and

makes loans to other depository institutions. These institutions may borrow money

from the RBI because they either have an unexpected drop in their member bank

reserves or because they are faced with seasonal demands for loans.

If the RBI lowers the discount rate, banks are charged less for the money they borrow

and thus more people borrow. This increases the amount of money in circulation,

speeds up the economy and increases inflation. Conversely, if the RBI raises the

discount rate this lowers the amount of money in circulation because fewer loans are

expended as the Prime goes up. This slows the economy and lowers inflation.

Printing Money - The simplest and clearest of all the RBI’s operations. The

government does not, as a matter of sound economic policy, print money or destroy

money in order to effect changes in the economy. The power, however to do so, does

exist. If the government prints money it increases the amount in circulation and if it

destroys money it restricts the amount in circulation. This has a corresponding effect

on inflation.

INFLATIONARY GAP

Inflationary Gap may be defined as a situation in which the demand of the economy

exceeds productive potential, leading immediately to inflation and an unfavorable

balance in trade.

Inflationary gaps can arise when the economy has grown for a long time on the back

of a high level of aggregate demand. Total spending may rise faster than the

economy's ability to supply goods and services. As a result, actual GDP may exceed

potential GDP leading to a positive output gap in the economy.

Controlling an inflationary Gap

The government may use monetary and or fiscal policy to help reduce the size of the

inflationary gap. This would involve controlling total spending by either increasing

interest rates or raising taxation.

• An improvement in the supply-side performance of the economy would also achieve

this.

• Monetary Policy: Higher interest rates to curb consumer demand

• Fiscal Policy: A rise in the burden of taxation to reduce real disposable incomes

• Supply-side Policy: Measures to increase productivity and efficiency. This leads to a

rise in aggregate supply and reduces the amount of excess demand in the long run.

MONETARY POLICY

The Monetary and Credit Policy is the policy statement, traditionally announced

twice a year, through which the Reserve Bank of India seeks to ensure price stability

for the economy. These factors include - money supply, interest rates and the

inflation. In banking and economic terms money supply is referred to as M3 - which

indicates the level (stock) of legal currency in the economy.

Besides, the RBI also announces norms for the banking and financial sector and the

institutions which are governed by it. These would be banks, financial institutions,

non-banking financial institutions, Nidhis and primary dealers (money markets) and

dealers in the foreign exchange (forex) market.

Monetary policy can be summarized as the central bank’s actions to influence the

availability and cost of money and credit in the economy. The primary objective of

these actions is to ensure price stability.

2. HOW DOES MONITARY POLICY WORK

As an illustration, consider that an economy is growing too fast. This is also referred

to as overheating of the economy: a situation that typically happens in the boom

phase when GDP (gross domestic product) growth exceeds the long-term growth

potential of the economy. The producers of goods are not able to make enough goods

to meet the rising demand. The resultant demand-supply mismatch creates

inflationary pressures in the economy. This situation is regarded as unsustainable, as

the high growth translates into higher inflation. In this situation, the RBI raises

interest rates to depress spending and reduce the pressure on inflation.

3. OBJECTIVES OF THE MONETARY POLICY

The objectives are to maintain price stability and ensure adequate flow of credit to

the productive sectors of the economy.

Stability for the national currency (after looking at prevailing economic conditions),

growth in employment and income are also looked into. The monetary policy affects

the real sector through long and variable periods while the financial markets are also

impacted through short-term implications.

There are four main 'channels' which the RBI looks at:

• Quantum channel: money supply and credit (affects real output and price level

through changes in reserves money, money supply and credit aggregates)

• Interest rate channel

• Exchange rate channel (linked to the currency)

• Asset price

4. DIFFERENCE BETWEEN MONETARY AND FISCAL POLICIES

Two important tools of macroeconomic policy are Monetary Policy and Fiscal Policy.

The Monetary Policy regulates the supply of money and the cost and availability of

credit in the economy. It deals with both the lending and borrowing rates of interest

for commercial banks. The Monetary Policy aims to maintain price stability, full

employment and economic growth. The Reserve Bank of India is responsible for

formulating and implementing Monetary Policy. It can increase or decrease the

supply of currency as well as interest rate, carry out open market operations, control

credit and vary the reserve requirements.

The Monetary Policy is different from Fiscal Policy as the former brings about a

change in the economy by changing money supply and interest rate, whereas fiscal

policy is a broader tool with the government. The Fiscal Policy can be used to

overcome recession and control inflation. It may be defined as a deliberate change in

government revenue and expenditure to influence the level of national output and

prices.

For instance, at the time of recession the government can increase expenditures or

cut taxes in order to generate demand. On the other hand, the government can

reduce its expenditures or raise taxes during inflationary times. Fiscal policy aims at

changing aggregate demand by suitable changes in government spending and taxes.

The annual Union Budget showcases the government's Fiscal Policy.

5. SOME MONETARY POLICY TERMS

5.1 Bank Rate

Bank rate is the minimum rate at which the central bank provides loans to the

commercial banks. It is also called the discount rate. Usually, an increase in bank

rate results in commercial banks increasing their lending rates. Changes in bank rate

affect credit creation by banks through altering the cost of credit.

5.2 Repo & Reverse Repo

A repurchase agreement or ready forward deal is a secured short-term (usually 15

days) loan by one bank to another against government securities.

Legally, the borrower sells the securities to the lending bank for cash, with the

stipulation that at the end of the borrowing term, it will buy back the securities at a

slightly higher price, the difference in price representing the interest.

Repo rate is the rate that RBI charges the banks when they borrow from it. Repo

operations increase liquidity in the system. Reverse repo rate is the rate that RBI

offers the banks for parking their funds with it. Reverse repo operations suck out

liquidity from the system.

5.3 Cash Reserve Ratio

All commercial banks are required to keep a certain amount of its deposits in cash

with RBI. This percentage is called the cash reserve ratio. The current CRR

requirement is 8 per cent.

CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have

to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of

bank deposits is totally risk-free and secondly it enables that RBI control liquidity in

the system, and thereby, inflation.

Unlike repo and reverse repo rates, which act as signaling devices, CRR is a blunt

instrument that directly acts on liquidity. By raising CRR, the RBI sucks out liquidity

from the system and puts upward pressure on interest rates.

5.4 Statutory Liquidity Ratio

Banks in India are required to maintain 25 per cent of their demand and time

liabilities in government securities and certain approved securities.

These are collectively known as SLR securities. The buying and selling of these

securities laid the foundations of the 1992 Harshad Mehta scam.

Besides the CRR, banks are required to invest a portion of their deposits in

government securities as a part of their statutory liquidity ratio (SLR) requirements.

The government securities (also known as gilt-edged securities or gilts) are bonds

issued by the Central government to meet its revenue requirements. Although the

bonds are long-term in nature, they are liquid as they can be traded in the secondary

market.

5.5 Inflation

Inflation refers to a persistent rise in prices. Simply put, it is a situation of too much

money and too few goods. Thus, due to scarcity of goods and the presence of many

buyers, the prices are pushed up.

The converse of inflation, that is, deflation, is the persistent falling of prices. RBI can

reduce the supply of money or increase interest rates to reduce inflation.

5.6 Money Supply (M3)

This refers to the total volume of money circulating in the economy, and

conventionally comprises currency with the public and demand deposits (current

account + savings account) with the public. The RBI has adopted four concepts of

measuring money supply.

The first one is M1, which equals the sum of currency with the public, demand

deposits with the public and other deposits with the public. Simply put M1 includes

all coins and notes in circulation, and personal current accounts.

The second, M2, is a measure of money, supply, including M1, plus personal deposit

accounts - plus government deposits and deposits in currencies other than rupee.

The third concept M3 or the broad money concept, as it is also known, is quite

popular. M3 includes net time deposits (fixed deposits), savings deposits with post

office saving banks and all the components of M1.

5.7 Open Market Operations

An important instrument of credit control, the Reserve Bank of India purchases and

sells securities in open market operations. In times of inflation, RBI sells securities to

mop up the excess money in the market. Similarly, to increase the supply of money,

RBI purchases securities.

6. MEASURES TO REGULATE MONEY SUPPLY

The RBI uses the interest rate, OMO, changes in banks' CRR and primary placements

of government debt to control the money supply. OMO, primary placements and

changes in the CRR are the most popular instruments used.

Under the OMO, the RBI buys or sells government bonds in the secondary market.

By absorbing bonds, it drives up bond yields and injects money into the market.

When it sells bonds, it does so to suck money out of the system. When inflationary

pressures exist, the RBI sells securities to mop up excess cash from the system; and

vice-versa in case of tight liquidity/shortage of funds.

The changes in CRR affect the amount of free cash that banks can use to lend -

reducing the amount of money for lending cuts into overall liquidity, driving interest

rates up, lowering inflation and sucking money out of markets.

Primary deals in government bonds are a method to intervene directly in markets,

followed by the RBI. By directly buying new bonds from the government at lower

than market rates, the RBI tries to limit the rise in interest rates that higher

government borrowings would lead to.

.

7. IMPACT OF MONETARY POLICIES

7.1 Impact on Individuals

In recent years, the policy had gained in importance due to announcements in the

interest rates. Earlier, depending on the rates announced by the RBI, the interest

costs of banks would immediately either increase or decrease. A reduction in interest

rates would force banks to lower their lending rates and borrowing rates. So if you

want to place a deposit with a bank or take a loan, it would offer it at a lower rate of

interest. On the other hand, if there were to be an increase in interest rates, banks

would immediately increase their lending and borrowing rates. Since the rates of

interest affect the borrowing costs of corporate and as a result, their bottom lines

(profits), the monetary policy is very important to them also.

But over the past 2-3 years, RBI Governor Bimal Jalan has preferred not to wait for

the Monetary Policy to announce a revision in interest rates and these revisions have

been when the situation arises. Since the financial sector reforms commenced, the

RBI has moved towards a market-determined interest rate scenario. This means that

banks are free to decide on interest rates on term deposits and loans. Being the

central bank, however, the RBI would have a say and determine direction on interest

rates as it is an important tool to control inflation.

The bank rate is a tool used by RBI for this purpose as it refinances banks at this rate.

In other words, the bank rate is the rate at which banks borrow from the RBI. The

central bank can influence the cost of funds and availability of credit in the economy

by altering the repo/reverse repo rates, changing the reserve requirements, and

engaging in open market operations.

7.2 Impact of cut in CRR on interest rates

From time to time, RBI prescribes a CRR or the minimum amount of cash that banks

have to maintain with it. The CRR is fixed as a percentage of total deposits. As more

money chases the same number of borrowers, interest rates come down.

7.3 Impact of change in SLR and gilts products on interest rates

SLR reduction is not so relevant in the present context for two reasons:

First, as part of the reforms process, the government has begun borrowing at market-

related rates. Therefore, banks get better interest rates compared to earlier for their

statutory investments in government securities.

Second, banks are still the main source of funds for the government. This means that

despite a lower SLR requirement, banks' investment in government securities will go

up as government borrowing rises. As a result, bank investment in gilts continues to

be high despite the RBI bringing down the minimum SLR to 25 per cent a couple of

years ago.

Therefore, for the purpose of determining the interest rates, it is not the SLR

requirement that is important but the size of the government's borrowing program.

As government borrowing increases, interest rates, too, rise.

Besides, gilts also provide another tool for the RBI to manage interest rates. The RBI

conducts open market operations (OMO) by offering to buy or sell gilts. If it feels

interest rates are too high, it may bring them down by offering to buy securities at a

lower yield than what is available in the market.

7.4 Impact on domestic industry and exporters

Exporters look forward to the monetary policy since the central bank always makes

an announcement on export refinance, or the rate at which the RBI will lend to banks

which have advanced pre-shipment credit to exporters.

A lowering of these rates would mean lower borrowing costs for the exporter.

7.5 Impact on jobs, wages and output

At any point of time, the price level in the economy is determined by the amount of

money floating around. An increase in the money supply - currency with the public,

demand deposits and time deposits - increases prices all round because there is more

currency moving towards the same goods and services.

Typically, the RBI follows a least-inflation policy, which means that its money market

operations as well as changes in the bank rate are generally designed to minimize the

inflationary impact of money supply changes. Since most people can generally see

through this strategy, it limits the impact of the RBI's monetary moves to affect jobs

or production. The markets, however, move to the RBI's tune because of the link

between interest rates and capital market yields. The RBI's policies have maximum

impact on volatile foreign exchange and stock markets.

Jobs, wages and output are affected over the long run, if the trends of high inflation

or low liquidity persist for very long period. If wages move slower than other prices,

higher inflation will drive real wages lower and encourage employers to hire more

people. This in turn ramps up production and employment.

This was the theoretical justification of a long-term trend that showed that higher

inflation and employment went together; when inflation fell, unemployment

increased.

8. STOCK MARKET AND MONEY MARKET

The stock markets and money move similarly, in some ways. Most people attribute

the link between the amount of money in the economy and movements in stock

markets to the amount of liquidity in the system. This is not entirely true.

The factor connecting money and stocks is interest rates. People save to get returns

on their savings. In true market conditions, this made bank deposits or bonds (whose

returns are linked to interest rates) and stocks (whose returns are linked to capital

gains), competitors for people's savings.

A hike in interest rates would tend to suck money out of shares into bonds or

deposits; a fall would have the opposite effect. This argument has survived

econometric tests and practical experience.

9. TRANSMISSION MECHANISM

It is the ‘how’ of monetary policy impacting the economy through various channels,

directly as well as indirectly.

At the cost of simplification, let us take an illustration. Assume that inflation is rising

in the economy and the RBI, to tackle it, decides to signal a rate hike by raising the

reverse repo rate. This reduces money supply in the economy as banks are induced to

park their cash with the RBI. That puts pressure on the longer term interest rates in

the economy — for example, the lending rates for housing, consumer loans, etc.

These rates tend to go up.

The impact of RBI actions on longer-term commercial rates also depends on the

expectations of financial market participants, which are shaped by both actions and

statements of the central bank.

9.1 Flip side to controlling inflation

Continuing the example, higher interest rates discourage consumption and

investment, leading to a reduced aggregate demand (GDP growth) in the system. As a

consequence of reduced demand, the pressure on inflation eases. The policy objective

of reducing inflation is achieved but at the cost of growth. This is often referred to as

the growth-inflation trade-off.

9.2 Time taken by monetary policies to attain its objective

Monetary policy impulses do not impact the real sector and inflation immediately but

with a lag, which varies across countries and sectors. In economies such as the US,

the lag of monetary policy transmission to the real sector is estimated to be around

one-and-a-half years. In India, the transmission mechanism of monetary policy and

the lags involved are not very well understood.

9.3 Other challenges for the conduct of monetary policy face in India

Apart from the issues related to monetary policy transmission, the huge inflow of

foreign capital has complicated the conduct of monetary policy. The capital inflows

have increased the supply of dollars, which makes the rupee stronger.

10. STERILIZATION

It refers to the selling of securities to suck liquidity. The extent of sterilization

depends on the stock of securities with the government available for intervention.

The entire process is quite cumbersome. To understand the dilemma faced by the

RBI, one needs to bring in the macroeconomic dilemma of ‘impossible trinity’.

Impossible Trinity states that a country cannot simultaneously have an inflexible

exchange rate, independent monetary policy, and free capital mobility. With massive

capital inflows, the RBI is finding it difficult to simultaneously protect the currency

and pursue its monetary policy objectives.

11. CONSTITUENTS OF INDIAN MONEY MARKET

Mumbai, Kolkata, Delhi, Chennai, Ahmedabad and Bangalore are the principal

centers of the organized sector of the Indian money market, of which Mumbai is the

most prominent. The Mumbai money market has now become synonymous with the

Indian money market. Today the Mumbai money market occupies the same position

in India as the London money market in England and New York money market in the

U.S.A. The presence of the head offices at the Reserve Bank and other commercial

banks, the leading stock exchange, well organized market of the government

securities, the bullion exchange and cotton exchange have made Mumbai the most

prominent financial centre of the country.

• The Call Money Market

• The Treasury Bill Market,

• The Repo Market,

• The Commercial Bill Market,

• The Certificate of Deposits Market,

• The Commercial Paper Market,

• Money Market Mutual Funds.

• Government Securities Market

11.1 The Call Money Market

The call mane market exists in almost all developed money markets. It is generally

the most sensitive part of the financial system. Any change in flow of funds and the

demand for them clearly reflected in it and the response is generally quick. In India,

the call money market is centered at mainly Mumbai, Kolkata and Chennai. Among

these the market at Mumbai is the most important. In the call money market

borrowing and lending transactions are carried out for one day. These loans, often

called as call loans may or may not be renewed the next day. The call money market

is also known as inter-bank call money market. Scheduled commercial banks, co-

operative banks and the Discount and Finance House of India (DFHI) operate in it.

As a special case, institutions like the UTI, the LIC, the mc, the IDBI and the

NABARD were allowed to operate in the call money market as lenders. Among the

banks the State Bank of India on account of its strong liquidity position is on the

lender's side of the market.

Brokers lay an important role in the call money market as they keep in touch with

banks in the city and continuously try to bring borrowing and lending banks

together. In the banking system there are no permanently surplus or deficit banks. In

fact, their cash position keeps on changing from hour to hour. Therefore, there has to

be a system whereby temporary cash surpluses of some banks should be available to

others who have temporary deficit. The call money market provides an institutional

arrangement which serves this purpose. On account of its highly sensitive nature is

considered to be the most appropriate indicator of the liquidity position of the money

market. The Reserve Bank of India, therefore, takes note of it in adjusting its day to

day monetary policy.

11.2 The Treasury Bill Market

The Market which deals in Treasury bills is known as the treasury bill market. In

India, Treasury bills are short term (l4-day, 2lday, 82-day and 364-day) liability of

the Central government. Theoretically Treasury bills should be issued for meeting

temporary benefits which a government faces due to its excess of revenue over

expenditure at some point of time.

The Treasury Bill Market in India is very much undeveloped. Except the Reserve

Bank of India there are no major holders of Treasury bills. In fact, even the Reserve

Bank as been a passive or captive holder of these bills which implies that it is under

an obligation to purchase all the Treasury bills which are being offered to it by the

government. It is also required to rediscount whatever Treasury bills are presented to

it by banks and others for this purpose. This has resulted in the monetization of

public debt and has become a major source of inflationary expansion of money

supply.

At present Treasury bills are largely held by the Reserve Bank. Other holders, such as

commercial banks, State governments and semi-government bodies do not hold

them in large quantities. Non-bank financial intermediaries, such as the LlC and the

UTI and corporate and non-corporate firms do not hold Treasury bills. In contrast, in

the U.S.A. and the U.K., Treasury bills are the most important money market

instrument, and as a result the open market operations of the central bank in these

countries are quite effective.

11.3 The Repo Market

Repo is a money market instrument which helps in collateralized short-term

borrowing and lending through sale/purchase operations in debt instruments. Under

a repo transaction, securities are sold by their holder to an investor with an

agreement to repurchase them at a predetermined rate and date. Under reverse repo

transaction, securities are purchased with a simultaneous commitment to resell at a

predetermined rate and date.

Initially repos were allowed in the Central government treasury bills and dated

securities created by converting some of the treasury bills. In order to make the repo

market an equilibrating force between the money market and the government

securities market, the RBI gradually allowed repo transactions in all government

securities and treasury bills of all maturities. Lately State government securities,

public undertaking bonds and private corporate securities have been made eligible

for repos to broaden the repo market. ¬

Repos help to manage liquidity conditions at the short-end of the market spectrum.

Repos have been used to provide banks an avenue to park funds generated by capital

inflows to provide a floor to the call money market. During times of foreign exchange

volatility, repos have been used to prevent speculative activities as the funds tend to

flow from the money market to the foreign exchange market.

11.4 The Commercial Bill Market

The commercial big market is the sub-market in which the trade bills or the

commercial bills are handled. The commercial bill is a bill drawn by one merchant

firm on the other. Generally commercialize out of domestic transactions. The

legitimate purpose of a commercial bill is to reimburse the seller while the buyer

delays payment. In India, the commercial bill market is undeveloped. The two major

factors which have arrested the growth of a bill market are:

(i) popularity of cash credit system in bank lending and

(ii) Unwillingness of the larger buyer to associate himself to bind himself to payment

discipline associated with the commercial bills.

The commercial bills as instruments are useful to both business firms and banks.

Secondly, since the drawees of the bill usually manage to recover the cost of the

goods form their resale or processing and sale during the time it matures, the bill

acquires a self- liquidating character.

The old bill market scheme introduced in January 1952 was not correctly designed to

develop a bill market. It merely provided for further accommodation to banks in

addition to facilities they had already enjoyed. Not satisfied, the RBI came up with a

new scheme in 1970, in this the bills covered under the scheme are genuine trade

bills and the scheme provided for their rediscounting.

In order to increase the use of the same, the RBI advised banks that at least 25% of

their inland credit purchases should be through these bills.

11.5 The Certificate of Deposit (CD) Market

A Certificate of Deposit (CD) is a certificate issued by a bank to depositors of funds

that remain on deposit at the bank for a specified period. Thus CDs are similar to

traditional term deposits but are negotiable and tradable in the short-term money

markets. In the mid-1980s, the short-term bank deposit rates were much lower than

other comparable interest rates. The Vaghul Committee stressed that it was

necessary for the introduction of the CD that the short-term bank deposit rates were

aligned with other inter rates.

In 1988-89, the Reserve Bank, as a corrective measure revised upwards the rate of

interest on term deposits of 46 to 90 days. Once this was done in March 1989, the

Reserve Bank of India took a decision to introduce Certificates of Deposit (CD) with

the objective of widening the range of money market instruments and to provide

investors eater flexibility in the deployment of their short-term surplus funds.

CD’s are issued at a discount to face value and the discount rate is freely determined.

They are further freely transferable by endorsement and delivery. Banks pay a high

interest rate on CD’s.

11.6 The Commercial Paper Market

The Commercial Paper (CP) is a hart-term instrument of raising funds by corporate.

It is essentially a sort of unsecured promissory note sold by the issuer to a banker or

a security house. The issuance of CP is not related to any underlying self-liquidating

trade. Therefore, maturity of this instrument is flexible. Usually borrowers and

lenders adapt the maturity of a CP to their needs. Highly rated corporate which can

obtain funds at a cost lower than the cost of borrowing from banks are particularly

interested in it. Institutional investors also find CP’s as an attractive outlet for their

short-term funds.

The Vaghul Committee had strongly recommended the introduction of CP’s in the

Indian money market. In its observations on this instrument, the Committee had

stated, "the issue of commercial paper imparts a degree of financial stability to the

system as the issuing company has an incentive to remain financially strong. The

possibility of raising short-term, finance or relatively cheaper cost would provide an

adequate incentive to the corporate clients to improve the financial position and in

the process the financial health of the corporate sector should show visible

improvement.

A CP can be issued by a listed company with a working capital of more than 5 Crore.

With maturity ranging from three to six months they can be issued in multiples of 25

laks subject to a minimum size of Rs.1 Crore.

11.7 Money Market Mutual Funds

A scheme of Money Market Mutual Funds (MMMFs) was introduced by the Reserve

Bank in 1992. The objective of the Scheme was to provide an additional short-term

avenue to the individual investors. As the initial guidelines were not attractive, the

scheme did not receive a favorable response. Hence, with a view to making the

scheme more flexible, the Reserve Bank permitted certain relaxations in November

1995. The existing guideline allows banks, public financial institutions and also the

institutions in the private sector to set up MMMFs. The ceiling of Rs. 50 crore on the

size of MMMFs, stipulated earlier has been withdrawn. The prescription of limits on

any investments in individual instruments by MMMF’s has been generally

deregulated.

Since April 1996, MMMFs are allowed to issue units to corporate enterprises and

others on par with other mutual funds. Resources mobilized by the MMMFs are now

required to be invested in call/notice money, CDs, CPs, Commercial bills arising out

of genuine trade transactions, treasury bills and government dated securities having

an unexpired maturity up to a year. The MMMFs have been brought/under the

purview of the SEBI regulations since March 7, 2000. Banks are not allowed to set up

MMMFs as a separate entity. Currently there are three MMMFs functioning in the

country.

11.8 Government Securities Market

It is also known as the gilt-edged market. Since the securities guaranteed by the

government are risk-free they are known as gilt-edged. Thus there is no scope for

speculation or manipulation in the market. It consists of two parts – the new issues

market and the secondary market. Since the RBI manages the entire public debt

operations of the Central as well as the State governments, it is responsible for all the

new issues of the government loans. In the government securities market RBI plays a

dominant role and its position is that of a monopolist.

The investors in the government securities market are predominantly institutions

which are required statutorily to invest a certain portion of their funds in

government securities. These are commercial banks, LIC, GIC, and provident funds.

Also, these are the most liquid debt instruments. Many private sector mutual funds

have entered this market because of the risk- free returns. Many individual investors

too have welcomed this opportunity due to better liquidity and exemption from tax

on dividends.

12. DEFICIENCIES OF THE INDIAN MONEY MARKET

• Lack of integration

• Lack of rational interest rates structure

• Absence of an organized bill market

• Shortage of funds in the money market

• Seasonal stringency of funds and fluctuating interest rates.

• Inadequate banking facilities

12.1 Lack of Integration

As already stated, the Indian money market is divided into two sectors, viz,, the

organized sector and the unorganized sector. As the two sectors are completely

separate from each other, their financial operations are quite independent, and

whatever goes on in one sector has little effect on the other. There is more of

competition than cooperation and coordination between various components of the

Indian money market. For example, cooperative banks compete with the commercial

banks, particularly in the countryside. Commercial banks not only compete among

themselves but also with the foreign banks.

To make matters worse, the indigenous bankers have absolutely no connections with

the Reserve Bank of India. This sorry state of affairs in the banking system is most

regrettable in the context of development needs of the country. Moreover,' if even

after around six and a half decades of the establishment of the Reserve Bank its

monetary policy, particularly the bank rate policy has not been found sufficiently

effective, then it is the lack of adequate integration in' the money market that we

shall have to blame.

12.2 Lack of rational interest rates structure

For a long time a major defect of the Indian money market has been lack of rational

interest rates structure in it. This was particularly due to lack of adequate

coordination between different banking institutions. Lately situation has somewhat

improved due to the authority of the Reserve Bank. Further, standardization of

interest rates has also introduced some rationality in the structure of interest rates.

However, the prevailing system of interest rates suffers from various defects. These

are: (1) relatively low yield on government securities, (2) certain concessional rates of

interest, and (3) inappropriate deposit and lending rates of commercial banks. These

defects in interest rates have led to a situation in which there is often excess demand

for credit. The policy of subsidizing bank lending has also led to displacement of

labor by capital and is thus responsible for sub-optimal utilization of productive

resources.

12.3 Absence of an organized Bill market

Though both inland and foreign bills are purchased and discounted by the

commercial banks, it cannot be said that an organized bill market exists in the

country. Only a limited bill market that has been created by the Reserve Bank of

India under its schemes of 1952 and 1971 now exists but it has failed to popularize

bill finance in this country. Before the first Bill Market Scheme was introduced in

1952 by the Reserve Bank very few banks other than Foreign Banks discounted bills

of approved parties fulfilling certain conditions. Since no bill market existed in the

country, further dealings in bills were not possible. Therefore, banks had either to

keep them until they matured or they got them rediscounted in the London money

market. The latter was possible only in respect of export bills.

Some say popularity of cash credit system and lack of uniformity in commercial bills

proved to be serious obstacles to the development of the bill market.

12.4 Shortage of funds in the Money Market

The Indian money market is characterized by shortage of funds. Invariably demand

for loanable funds in the money market far exceeds its supply. This is attributed to a

variety of factors. In the first place, savings are small due to low per capita income.

Because of widespread poverty a vast multitude of population has virtually no ability

to save. Those of the people who have the ability to save often indulge in wasteful

consumption. Secondly, inadequate banking facilities, lack of banking habit among

the people and absence of ample diversified investment opportunities have

contributed to the shortage of funds. Finally, emergences of a large parallel economy

and vast amount of black money in the country have also caused shortage of financial

resources in the money market.

12.5 Seasonal stringency of funds

Being an agricultural country, farm operations have a large bearing on the demand

as well as the supply of funds in the money market. From October to June when farm

operations and trading in agricultural produce require additional finance there is a

stringency created in the market. If the money market had been sufficiently elastic,

and if the supply of funds could be augmented more o less automatically in response

to seasonal rise in the demand, interest rates would have been much more stable.

12.6 Inadequate Banking facilities

Though commercial banks have opened branches on a huge scale, yet banking

facilities are somewhat inadequate. Mobilization of small savings is both difficult and

uneconomic, but in an underdeveloped country like ours where very bit of saving is

to be used for productive purposes. Banking facilities have to be expanded.

13. SCENARIO PRIOR TO RECENT LIBERALISATION

Prior to recent liberalization, the RBI resorted to direct instruments like interest

rates regulation, selective credit control and CRR (cash reserve ratio) as monetary

instruments. One of the risks emerging in the past 5-7 years (through the capital

flows and liberalization of the financial sector) is that potential risk has increased for

institutions. Thus, financial stability has become crucial and there are concerns

relating to credit flows to the agricultural sector and small-scale industries.

14. IS THE MONETARY POLICY LOSING ITS IMPORTANCE

Considering that interest rates are now tweaked looking at market conditions is the

Monetary Policy losing its importance? Bimal Jalan has said he would make the

Credit Policy a 'non-event' and would use the policy only to review developments in

the banking industry and money markets. Interest rate announcements since 1998-

99 were based on economic and market developments. The policy now concentrates

mostly on structural issues in the banking industry.

History of Banking in India

Without a sound and effective banking system in India it cannot have a healthy

economy. The banking system of India should not only be hassle free but it should be

able to meet new challenges posed by the technology and any other external and

internal factors.

For the past three decades India's banking system has several outstanding

achievements to its credit. The most striking is its extensive reach. It is no longer

confined to only metropolitans or cosmopolitans in India. In fact, Indian banking

system has reached even to the remote corners of the country. This is one of the main

reason of India's growth process.

The government's regular policy for Indian bank since 1969 has paid rich dividends

with the nationalisation of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for getting

a draft or for withdrawing his own money. Today, he has a choice. Gone are days

when the most efficient bank transferred money from one branch to other in two

days. Now it is simple as instant messaging or dial a pizza. Money have become the

order of the day.

The first bank in India, though conservative, was established in 1786. From 1786 till

today, the journey of Indian Banking System can be segregated into three distinct

phases. They are as mentioned below:

• Early phase from 1786 to 1969 of Indian Banks

• Nationalization of Indian Banks and up to 1991 prior to Indian banking sector

Reforms.

• New phase of Indian Banking System with the advent of Indian Financial &

Banking Sector Reforms after 1991.

To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II

and Phase III.

PhaseI

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan

and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank

of Bombay (1840) and Bank of Madras (1843) as independent units and called it

Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank

of India was established which started as private shareholders banks, mostly

Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab

National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906

and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian

Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic

failures between 1913 and 1948. There were approximately 1100 banks, mostly small.

To streamline the functioning and activities of commercial banks, the Government of

India came up with The Banking Companies Act, 1949 which was later changed to

Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965).

Reserve Bank of India was vested with extensive powers for the supervision of

banking in india as the Central Banking Authority.

During those days public has lesser confidence in the banks. As an aftermath deposit

mobilisation was slow. Abreast of it the savings bank facility provided by the Postal

department was comparatively safer. Moreover funds are largely given to traders.

PhaseII

Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on

19th July, 1969, major process of nationalisation was carried out. It was the effort of

the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in

the country was nationalised.

Second phase of nationalisation Indian Banking Sector Reform was carried out in

1980 with seven more banks. This step brought 80% of the banking segment in India

under Government ownership.

The following are the steps taken by the Government of India to Regulate Banking

Institutions in the Country:

• 1949 : Enactment of Banking Regulation Act.

• 1955 : Nationalisation of State Bank of India.

• 1959 : Nationalisation of SBI subsidiaries.

• 1961 : Insurance cover extended to deposits.

• 1969 : Nationalisation of 14 major banks.

• 1971 : Creation of credit guarantee corporation.

• 1975 : Creation of regional rural banks.

• 1980 : Nationalisation of seven banks with deposits over 200 crore.

After the nationalisation of banks, the branches of the public sector bank India rose

to approximately 800% in deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith and

immense confidence about the sustainability of these institutions.

PhaseIII

This phase has introduced many more products and facilities in the banking sector in

its reforms measure. In 1991, under the chairmanship of M Narasimham, a

committee was set up by his name which worked for the liberalisation of banking

practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being

put to give a satisfactory service to customers. Phone banking and net banking is

introduced. The entire system became more convenient and swift. Time is given

more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered from

any crisis triggered by any external macroeconomics shock as other East Asian

Countries suffered. This is all due to a flexible exchange rate regime, the foreign

reserves are high, the capital account is not yet fully convertible, and banks and their

customers have limited foreign exchange exposure.

BANKING TODAY:

Banks in India can be categorized into non-scheduled banks and scheduled banks.

Scheduled banks constitute of commercial banks and co-operative banks. There are

about 67,000 branches of Scheduled banks spread across India. During the first

phase of financial reforms, there was a nationalization of 14 major banks in 1969.

This crucial step led to a shift from Class banking to Mass banking. Since then the

growth of the banking industry in India has been a continuous process.

As far as the present scenario is concerned the banking industry is in a transition

phase. The Public Sector Banks (PSBs), which are the foundation of the Indian

Banking system account for more than 78 per cent of total banking industry assets.

Unfortunately they are burdened with excessive Non Performing assets (NPAs),

massive manpower and lack of modern technology.

On the other hand the Private Sector Banks in India are witnessing immense

progress. They are leaders in Internet banking, mobile banking, phone banking,

ATMs. On the other hand the Public Sector Banks are still facing the problem of

unhappy employees. There has been a decrease of 20 percent in the employee

strength of the private sector in the wake of the Voluntary Retirement Schemes

(VRS). As far as foreign banks are concerned they are likely to succeed in India.

Indusland Bank was the first private bank to be set up in India. IDBI, ING Vyasa

Bank, SBI Commercial and International Bank Ltd, Dhanalakshmi Bank Ltd, Karur

Vysya Bank Ltd, Bank of Rajasthan Ltd etc are some Private Sector Banks. Banks

from the Public Sector include Punjab National bank, Vijaya Bank, UCO Bank,

Oriental Bank, Allahabad Bank, Andhra Bank etc.

Financial and Banking Sector Reforms

The last decade witnessed the maturity of India's financial markets. Since 1991, every

governments of India took major steps in reforming the financial sector of the

country. The important achievements in the following fields is discussed under

serparate heads:

• Financial markets

• Regulators

• The banking system

• Non-banking finance companies

• The capital market

• Mutual funds

• Overall approach to reforms

• Deregulation of banking system

• Capital market developments

• Consolidation imperative

Financial Markets

In the last decade, Private Sector Institutions played an important role. They grew

rapidly in commercial banking and asset management business. With the openings

in the insurance sector for these institutions, they started making debt in the market.

Competition among financial intermediaries gradually helped the interest rates to

decline. Deregulation added to it. The real interest rate was maintained. The

borrowers did not pay high price while depositors had incentives to save. It was

something between the nominal rate of interest and the expected rate of inflation.

Regulators

The Finance Ministry continuously formulated major policies in the field of financial

sector of the country. The Government accepted the important role of regulators. The

Reserve Bank of India (RBI) has become more independant. Securities and Exchange

Board of India (SEBI) and the Insurance Regulatory and Development Authority

(IRDA) became important institutions. Opinions are also there that there should be a

super-regulator for the financial services sector instead of multiplicity of regulators.

The banking system

Almost 80% of the business are still controlled by Public Sector Banks (PSBs). PSBs

are still dominating the commercial banking system. Shares of the leading PSBs are

already listed on the stock exchanges.

The RBI has given licences to new private sector banks as part of the liberalisation

process. The RBI has also been granting licences to industrial houses. Many banks

are successfully running in the retail and consumer segments but are yet to deliver

services to industrial finance, retail trade, small business and agricultural finance.

The PSBs will play an important role in the industry due to its number of branches

and foreign banks facing the constrait of limited number of branches. Hence, in

order to achieve an efficient banking system, the onus is on the Government to

encourage the PSBs to be run on professional lines.

Development finance institutions

FIs's access to SLR funds reduced. Now they have to approach the capital market for

debt and equity funds.

Convertibility clause no longer obligatory for assistance to corporates sanctioned by

term-lending institutions.

Capital adequacy norms extended to financial institutions.

DFIs such as IDBI and ICICI have entered other segments of financial services such

as commercial banking, asset management and insurance through separate ventures.

The move to universal banking has started.

Non-banking finance companies

In the case of new NBFCs seeking registration with the RBI, the requirement of

minimum net owned funds, has been raised to Rs.2 crores.

Until recently, the money market in India was narrow and circumscribed by tight

regulations over interest rates and participants. The secondary market was

underdeveloped and lacked liquidity. Several measures have been initiated and

include new money market instruments, strengthening of existing instruments and

setting up of the Discount and Finance House of India (DFHI).

The RBI conducts its sales of dated securities and treasury bills through its open

market operations (OMO) window. Primary dealers bid for these securities and also

trade in them. The DFHI is the principal agency for developing a secondary market

for money market instruments and Government of India treasury bills. The RBI has

introduced a liquidity adjustment facility (LAF) in which liquidity is injected through

reverse repo auctions and liquidity is sucked out through repo auctions.

On account of the substantial issue of government debt, the gilt- edged market

occupies an important position in the financial set- up. The Securities Trading

Corporation of India (STCI), which started operations in June 1994 has a mandate to

develop the secondary market in government securities.

Long-term debt market: The development of a long-term debt market is crucial to

the financing of infrastructure. After bringing some order to the equity market, the

SEBI has now decided to concentrate on the development of the debt market. Stamp

duty is being withdrawn at the time of dematerialisation of debt instruments in order

to encourage paperless trading.

The capital market

The number of shareholders in India is estimated at 25 million. However, only an

estimated two lakh persons actively trade in stocks. There has been a dramatic

improvement in the country's stock market trading infrastructure during the last few

years. Expectations are that India will be an attractive emerging market with

tremendous potential. Unfortunately, during recent times the stock markets have

been constrained by some unsavoury developments, which has led to retail investors

deserting the stock markets.

Mutual funds

The mutual funds industry is now regulated under the SEBI (Mutual Funds)

Regulations, 1996 and amendments thereto. With the issuance of SEBI guidelines,

the industry had a framework for the establishment of many more players, both

Indian and foreign players.

The Unit Trust of India remains easily the biggest mutual fund controlling a corpus

of nearly Rs.70,000 crores, but its share is going down. The biggest shock to the

mutual fund industry during recent times was the insecurity generated in the minds

of investors regarding the US 64 scheme. With the growth in the securities markets

and tax advantages granted for investment in mutual fund units, mutual funds

started becoming popular.

The foreign owned AMCs are the ones which are now setting the pace for the

industry. They are introducing new products, setting new standards of customer

service, improving disclosure standards and experimenting with new types of

distribution.

The insurance industry is the latest to be thrown open to competition from the

private sector including foreign players. Foreign companies can only enter joint

ventures with Indian companies, with participation restricted to 26 per cent of

equity. It is too early to conclude whether the erstwhile public sector monopolies will

successfully be able to face up to the competition posed by the new players, but it can

be expected that the customer will gain from improved service.

The new players will need to bring in innovative products as well as fresh ideas on

marketing and distribution, in order to improve the low per capita insurance

coverage. Good regulation will, of course, be essential.

Overall approach to reforms

The last ten years have seen major improvements in the working of various financial

market participants. The government and the regulatory authorities have followed a

step-by-step approach, not a big bang one. The entry of foreign players has assisted

in the introduction of international practices and systems. Technology developments

have improved customer service. Some gaps however remain (for example: lack of an

inter-bank interest rate benchmark, an active corporate debt market and a developed

derivatives market). On the whole, the cumulative effect of the developments since

1991 has been quite encouraging. An indication of the strength of the reformed

Indian financial system can be seen from the way India was not affected by the

Southeast Asian crisis.

However, financial liberalisation alone will not ensure stable economic growth. Some

tough decisions still need to be taken. Without fiscal control, financial stability

cannot be ensured. The fate of the Fiscal Responsibility Bill remains unknown and

high fiscal deficits continue. In the case of financial institutions, the political and

legal structures hve to ensure that borrowers repay on time the loans they have

taken. The phenomenon of rich industrialists and bankrupt companies continues.

Further, frauds cannot be totally prevented, even with the best of regulation.

However, punishment has to follow crime, which is often not the case in India.

Deregulation of banking system

Prudential norms were introduced for income recognition, asset classification,

provisioning for delinquent loans and for capital adequacy. In order to reach the

stipulated capital adequacy norms, substantial capital were provided by the

Government to PSBs.

Government pre-emption of banks' resources through statutory liquidity ratio (SLR)

and cash reserve ratio (CRR) brought down in steps. Interest rates on the deposits

and lending sides almost entirely were deregulated.

New private sector banks allowed to promote and encourage competition. PSBs were

encouraged to approach the public for raising resources. Recovery of debts due to

banks and the Financial Institutions Act, 1993 was passed, and special recovery

tribunals set up to facilitate quicker recovery of loan arrears.

Bank lending norms liberalised and a loan system to ensure better control over credit

introduced. Banks asked to set up asset liability management (ALM) systems. RBI

guidelines issued for risk management systems in banks encompassing credit,

market and operational risks.

A credit information bureau being established to identify bad risks. Derivative

products such as forward rate agreements (FRAs) and interest rate swaps (IRSs)

introduced.

Capital market developments

The Capital Issues (Control) Act, 1947, repealed, office of the Controller of Capital

Issues were abolished and the initial share pricing were decontrolled. SEBI, the

capital market regulator was established in 1992.

Foreign institutional investors (FIIs) were allowed to invest in Indian capital markets

after registration with the SEBI. Indian companies were permitted to access

international capital markets through euro issues.

The National Stock Exchange (NSE), with nationwide stock trading and electronic

display, clearing and settlement facilities was established. Several local stock

exchanges changed over from floor based trading to screen based trading.

Private mutual funds permitted

The Depositories Act had given a legal framework for the establishment of

depositories to record ownership deals in book entry form. Dematerialisation of

stocks encouraged paperless trading. Companies were required to disclose all

material facts and specific risk factors associated with their projects while making

public issues.

To reduce the cost of issue, underwriting by the issuer were made optional, subject to

conditions. The practice of making preferential allotment of shares at prices

unrelated to the prevailing market prices stopped and fresh guidelines were issued by

SEBI.

SEBI reconstituted governing boards of the stock exchanges, introduced capital

adequacy norms for brokers, and made rules for making client or broker relationship

more transparent which included separation of client and broker accounts.

Buy back of shares allowed

The SEBI started insisting on greater corporate disclosures. Steps were taken to

improve corporate governance based on the report of a committee.

SEBI issued detailed employee stock option scheme and employee stock purchase

scheme for listed companies.

Standard denomination for equity shares of Rs. 10 and Rs. 100 were abolished.

Companies given the freedom to issue dematerialised shares in any denomination.

Derivatives trading starts with index options and futures. A system of rolling

settlements introduced. SEBI empowered to register and regulate venture capital

funds.

The SEBI (Credit Rating Agencies) Regulations, 1999 issued for regulating new credit

rating agencies as well as introducing a code of conduct for all credit rating agencies

operating in India.

Consolidation imperative

Another aspect of the financial sector reforms in India is the consolidation of existing

institutions which is especially applicable to the commercial banks. In India the

banks are in huge quantity. First, there is no need for 27 PSBs with branches all over

India. A number of them can be merged. The merger of Punjab National Bank and

New Bank of India was a difficult one, but the situation is different now. No one

expected so many employees to take voluntary retirement from PSBs, which at one

time were much sought after jobs. Private sector banks will be self consolidated while

co-operative and rural banks will be encouraged for consolidation, and anyway play

only a niche role.

In the case of insurance, the Life Insurance Corporation of India is a behemoth, while

the four public sector general insurance companies will probably move towards

consolidation with a bit of nudging. The UTI is yet again a big institution, even

though facing difficult times, and most other public sector players are already exiting

the mutual fund business. There are a number of small mutual fund players in the

private sector, but the business being comparatively new for the private players, it

will take some time.

We finally come to convergence in the financial sector, the new buzzword

internationally. Hi-tech and the need to meet increasing consumer needs is

encouraging convergence, even though it has not always been a success till date. In

India organisations such as IDBI, ICICI, HDFC and SBI are already trying to offer

various services to the customer under one umbrella. This phenomenon is expected

to grow rapidly in the coming years. Where mergers may not be possible, alliances

between organisations may be effective. Various forms of bancassurance are being

introduced, with the RBI having already come out with detailed guidelines for entry

of banks into insurance. The LIC has bought into Corporation Bank in order to

spread its insurance distribution network. Both banks and insurance companies have

started entering the asset management business, as there is a great deal of synergy

among these businesses. The pensions market is expected to open up fresh

opportunities for insurance companies and mutual funds.

It is not possible to play the role of the Oracle of Delphi when a vast nation like India

is involved. However, a few trends are evident, and the coming decade should be as

interesting as the last one.

MARKETING

Evolution of marketing

A brief history:

As a field of study, marketing has not always been

viewed from a management perspective. At different

phases in its evolution, marketing thought leaders have

variously emphasized commodities, institutions, functions,

markets, consumers, management of firms, and society at

large. Four eras of marketing

thought development:

Era I: Founding the Field, 1900–1920.

Era II: Formalizing the Field, 1920–1950.

Era III: A Paradigm Shift—Marketing, Management, and the

Sciences, 1950–1980.

Era IV: The Shift Intensifies—A Fragmentation of the Mainstream,

1980–Present.

In the academic arena as reflected in its literature over the

past three decades or so (late Era III into Era IV), marketing

has trended from a managerial focus to an analytical one,

two perspectives that need not be but often are, in fact, in

competition. There is evidence that marketing has lost its

importance and relevance as a management function in

many companies . Perhaps marketing

thought development has lagged behind shifts in the

market environment and has become less relevant for managers,

particularly those who are responsible for strategy

and general management. Most recently, however, marketing

thought leaders have pointed the way toward a

customer-oriented, service-dominated concept of marketing

as the definition, development, and delivery of customer

value that focuses on marketing as a set of business processes

rather than as a separate management function.

Marketing as Management

A distinct view of marketing as a management discipline

(rather than an economic activity) emerged in the 1950s

though marketing management

had certainly been evolving as a practice for some

time, with origins as a form of support for the sales function.

This transition was marked by two major developments:

first was the perspective of the marketing concept as a management

philosophy emphasizing customer orientation, and

the second was the integration of quantitative methods and

behavioural science into the marketing discipline. Two significant environmental

trends drove this transition, one in

the marketplace and one in education.

In the economic and social environment, the post-World

War II marketplace offered huge business opportunities that

were created by pent-up demand, rapidly increasing consumer

affluence (with commensurate economic and political

power), and the dramatic development of television as a

low-cost mass medium. Marketing strategy came to rely

increasingly on statistical analysis of market research data.

Market segmentation strategy was entirely consistent with

the philosophy of customer orientation.

Marketing Management as an Optimization

Problem

Of equal importance as environmental forces, two path setting

studies of business education advocated a shift from a narrow vocational

and skills emphasis to a deeper and more rigorous

analytical approach based on quantitative analysis and the

behavioural sciences. The two lines of development—the marketing

(management) concept and quantitative analysis—can be

identified as equally important and influential at the outset of Era III, they have

developed in a very different fashion.

Rigorous analytical methods proved to have greater appeal

to many marketing educators than the “softer” and more

conceptual approaches of customer orientation and the marketing

concept and their managerial and organizational

implications. With the active support of their colleagues in

economics and finance, the dominant culture in most leading

business school faculties, marketing academics eagerly

adopted a price–theory-based view of marketing management

as essentially an optimization problem. Allocating resources until marginal returns

were equal across spending opportunities, if only the analyst

could accurately estimate the demand curve, could optimize

each of the four P’s.Aided by the availability of large-scale computers and

increasingly large and reliable databases, marketing scholars

were strongly encouraged by the academic culture to

emphasize empirical data, quantitative methods of data

analysis, and mathematical modelling in their research.

The Rise and Fall of the Strategic

Planning Empire

On the general management and business policy side of the

academic field, the area of formal strategic management was

emerging. An important element of this

approach was the famous DuPont model of management,

which was based on return on investment, by which large

companies could be effectively controlled through the careful

allocation of financial resources across strategic business

units (SBUs) competing for these limited funds. A central

feature of most of these formal strategic planning

approaches was the “product portfolio,” a matrix that

depicted firms’ SBUs on two dimensions: their position relative

to those of competitors (market share) in their respective

markets and the rate of growth in those markets. Return

on investment became the dominant criterion for evaluating

business performance and for budgeting expenditures

including marketing. Attributing revenue and profit results

to marketing expenditures is known to be especially difficult

because of multiple causation, lagged effects, and similar

measurement and estimation problems.

By the mid-1970s, the discipline of strategic planning was

in full bloom, evidenced by the proliferation of corporate

strategic planning departments. It was not uncommon for

the corporate marketing function to merge formally into

strategic planning, seeking two benefits: to make the marketing

concept and customer orientation strategically operational

and to make strategic planning more customer

focused and market driven.

These trends prompted strategists to contend that

with their bias toward marketing tactics and optimization,

marketers were unlikely to use their tools and concepts to

address strategic management issues because of their orientation

to methodological rigor. They questioned

whether marketers were interested in raising their level of

aggregation to the business unit or industry level and to their

time horizon over the long run, and he concluded that it

would be up to strategic management students to make the

transfer of marketing concepts and methods to strategic

issues. That appears to be what happened.

By the early 1980s, however, formal strategic planning as

an activity at the corporate level was in decline, and most

strategic planning departments were being dismantled.

The bureaucratic strategic planning process

had proved to be an expensive undertaking in management

time and organizational and administrative costs, often

causing serious lags in responding to a changing market

environment (“paralysis by analysis”). Measurement problems

in making operational such central constructs as market

share and the definition of “served market” also proved

to be difficult and a continuing source of disagreement and

debate between corporate analysts and SBU-level management

In many companies, responsibility for marketing strategy

was delegated to SBU managers. Corporate marketing

departments were also widely downsized or eliminated,

which left little or no customer advocacy or marketing management

competence at the top level of the organization,

unless the chief executive officer happened to come from

that background. Part of the rationale for eliminating marketing as a corporate

function was embedded in the fundamental assertion of the

marketing concept that customer orientation should pervade

the organization and, according to Drucker (1954), thus was

not a separate function at all but rather the entire business as

seen from the customer’s point of view.

Although strategic planning departments at the corporate

level have disappeared, the discipline of strategic management

and the related field of strategic management consulting

have continued to have the ear of practicing managers.

Today, it is a literature more widely read and valued by

managers than the marketing literature, evidenced by the

large number of management subscribers compared with

those of the marketing journals. Throughout the 1970s and

1980s, the marketing discipline continued to emphasize the

development of enhanced methodological sophistication

and analytical rigor, whereas the strategic management journals

were more likely to report interesting, new conceptual

developments and (perceived) best business practices.

The Changing Role of Marketing

There is no question that marketing management has experienced

significant changes during Era IV: “A Fragmentation

of the Mainstream.” Among the many environmental

forces that have reshaped the marketing function within the

firm during the past two decades are as follows:

•Evolution from bureaucratic to more flexible organizational

forms;

•Rapid diffusion of computer and telecommunications technology,

including the Internet;

•Dominance of large, low-cost retailers in most product

categories;

•The stock-market boom of the 1990s, followed by a dramatic

decrease in stock prices;

•Continued emphasis on quarterly earnings per share as a measure

of business performance and company value;

•Globalization and increased competitive pressures; and

•Outsourcing of many parts of value-creation and value-delivery

processes.

As corporate structures have moved away from centralized

bureaucratic control to a stronger emphasis on SBUs

and strategic partnering, marketing at the corporate level has

become much less important. Either marketing management

responsibilities have been shifted outward to the field sales

organization or into SBUs, or they have simply been eliminated

as a distinct activity. Marketing communications dollars

have been reallocated to short-term price incentives and

other sales promotional activities and to the selling function,

to support increased field sales effort and larger discounts to

increasingly powerful resellers. For example, the product-level brand management

function in many consumer packaged-goods companies

has been redefined and relocated to the field sales

organization, with primary responsibility for working with

major resellers on in-store promotional activities, rather

than to the traditional roles of brand development in which

consumer advertising is heavily used. At the corporate level,

remaining marketing management positions tend to focus on

global brand strategy (across SBUs and geographies) and

marketing communications. Product and pricing strategy,

sales management, and channel strategy and management

are SBU-level responsibilities, often with a relatively short-term,

tactical focus. Innovation for long-range product

development tends to lose priority.

Production concept: It is the oldest concept. This concept came into being during the

industrial revolution when manufacturing started for the first time. The demand

exceeded the supply, therefore marketers expected their entire produce to be bought

by the consumers.

This concept simply suggests that customers

prefer inexpensive products that are readily available. In effect, "if

we make it, they will come." This orientation makes sense in developing countries,

where consumers are more interested in obtaining the product than in its features.

THE PRODUCTION CONCEPT WAS THE IDEA THAT A FIRM

SHOULD FOCUS ON THOSE PRODUCTS THAT IT COULD

PRODUCE MORE EFFICIENTLY AND AT A LOW COST,

WHICH IN THE END WOULD ITSELF CREATE THE DEMAND

FOR THE PRODUCT.

Their focus is to:

PRODUCE the product

PRODUCE enough OF the product / at the low cost.

MASS DISTRIBUTION

Product concept: It suggests that companies that build the "better mousetrap" will

gain

favour. The thinking here is that customers want products that have

higher quality, that offer better performance or do something unique.

Still demand was higher than the supply. Improvement in product quality as per the

notions and understanding of the seller and not the buyers. Changes were brought

about just to differentiate their own product from that of their consumers as

competition started making its way into the market.

This orientation holds that consumers will favor those products that offer the most

quality, performance, or innovative features. Managers focusing on this concept

concentrate on making superior products and improving them over time. They

assume that buyers admire well-made products and can appraise quality and

performance. However, these managers are sometimes caught up in a love affair with

their product and do not realize what the market needs. Management might commit

the “better-mousetrap” fallacy, believing that a better mousetrap will lead people to

beat a path to its door.

Developing products that are aligned with current or emerging customer needs .

Technology companies are often challenged to develop competitive new products

while meeting short windows of opportunity. Success requires effective decision

making about product features, packaging, positioning, and pricing.

Product CONCEPT involves:

Exploratory research

Needs Segmentation

Opportunity Assessment

Voice of the Customer

Concept Viability

Competitive Assessment

Concept Optimization

Ideation

Portfolio Management

Business Case Rationale

Product Retrieval

Market Research

Trend Monitoring

Selling concept: From the 1920's until the 1950's,

most firms had a sales orientation. Competition had grown, and there

was a need to pursue the scarce customer. Sales could mean everything

from sales people to advertising to public relations, but little effort

was made to coordinate any overall marketing function. What we often

saw in the Selling Concept was the "hard sell" and the belief that

consumers wouldn't purchase unless they were sold.

The firm sold what one produce and try to convince the customers

through advertising and personal selling.

It holds that consumers and businesses, if left alone, will ordinarily not buy enough

of the selling company’s products. The organization must, therefore, undertake an

aggressive selling and promotion effort. This concept assumes that consumers

typically sho9w buyi8ng inertia or resistance and must be coaxed into buying. It also

assumes that the company has a whole battery of effective selling and promotional

tools to stimulate more buying. Most firms practice the selling concept when they

have overcapacity. Their aim is to sell what they make rather than make what the

market wants.

Their focus is

-can we sell the product

-can we charge enough for the product.

Marketing concept: An organization with a market orientation focuses its efforts on

1)continuously collecting information about customers' needs and

competitors' capabilities, 2) sharing this information across

departments, and 3) using the information to create customer value.

The market orientation simply defines an organization that understands the

importance of customer needs, makes an effort to provide products of

high value to its customers, and markets its products and services in a

coordinated holistic program across all departments. In what we call

the "Marketing Concept," the company embraces a philosophy that the

"Customer is King."

The Marketing Concept is an attitude. It's a philosophy that is driven down

throughout the

organization from the very top of the management structure. The

Marketing Concept communicates that "the customer is king." Everything

that the company does focuses on the customer. Via the Marketing

Concept, a company makes every effort to best understand the wants and

needs of its target market and to create want-satisfying goods that

best fulfill the needs of that target market and to do this better than

the competition.

The term market refers to the place where buyers and sellers meet for the purpose of

satisfying their respective needs. Before industrial revolution, the market for goods

was very limited. People were almost self sufficient in their daily requirements for

goods. A few products which people needed were usually purchased from near their

houses either on barter system or on cash. The luxury products of that time such as

spices, furs, skins, expensive cloth were brought into the market on a very small scale

and these were purchased by the rich people. The goods in those days were produced

and sold with very little thought of the customers.

After the Industrial Revolution, the scope of the market has greatly widened due to

increase in production of goods, increase in competition, increase in population,

increase in income, increase in fashion, improvements in the means of

communication and transport etc. Goods are now produced to satisfy the needs of

the customers. Marketing here occupies an important position with the business

executives and is now an accepted feature of commerce.

In the early days of business the market concept was product oriented. In the 20th

century there is a mass production of goods and increased advertisement for their

sales.

It is the philosophy that the firm should analyze

the needs of their customers[ current /potential ] and then make

the decisions to satisfy those needs , better than the competition. It is the most

desirable orientation:

1) Understands existing and potential needs of the customers-meaningful direction

to business.

2) Selection of better market opportunities where they can give better

products/services than their customers.

3) Design an appropriate production capacity to suit the need of their chosen market.

4) Design an appropriate marketing program-distribution, pricing, servicing etc

5) Market the right values t the customers

6) Customer satisfaction along with profit for the firm

Its central tenets crystallized in the 1950s. It holds that the key to achieving its

organizational goals (goals of the selling company) consists of the company being

more effective than competitors in creating, delivering, and communicating

customer value to its selected target customers. The marketing concept rests on four

pillars: target market, customer needs, integrated marketing and profitability.

Distinctions between the Sales Concept and the Marketing Concept:

1. The Sales Concept focuses on the needs of the seller. The Marketing Concept

focuses on the needs of the buyer.

2. The Sales Concept is preoccupied with the seller’s need to convert his/her product

into cash. The Marketing Concept is preoccupied with the idea of satisfying the needs

of the customer by means of the product as a solution to the customer’s problem

(needs).

The Marketing Concept represents the major change in today’s company orientation

that provides the foundation to achieve competitive advantage. This philosophy is

the foundation of consultative selling.

Societal marketing concept: This is embraced in the 21st century results in

companies looking at their overall marketing efforts. This includes how their

marketing affects society, as a whole. Marketing is also done internally

within the company. Without customers, a company will quickly flounder

-- thus the importance of the relationship. Holistic marketing looks

at the connectivity of the company, its people, its customers, and the

society in which it operates.

The societal marketing concept can be defined as the organizations task which tries

to identify the needs and interests of the consumers and delivers quality services or

products as compared to its competitors and in a way that consumer's and society's

well being is maintained. In other words organizations have to balance consumer

satisfaction, company profits and long term welfare of society.

This is a new marketing philosophy and tries to reduce the inequalities at various

levels. This theory emphasizes that organizations should not only think of cut-throat

policies to achieve targets and jump ahead of competitors but should have ethical

and environmental policies and then back them up with action and regulation.

Societal marketing can be achieved by following a few principles. It should always be

remembered that consumer's needs are of paramount interest. Improvements in

products which are both real and innovative should be carried out to give long term

value to the product; do what is good for the society with a sense of mission and

trust. In this way the focus shifts from transaction to relationships. If a client 'repeats

business' a bond is created between him and the product and is worth its while for

the organization to nurture this bond.

It may sound appropriate and ethical, but societal marketing concept is hard to

implement as not all companies have a social conscience. Whether it is legal and

essential in industries like the tobacco and liquor industry needs analysis as they

have a tremendous influence on consumer welfare.

The societal marketing holds that the organization should determine the needs,

wants, and interests of target markets. It should then deliver superior value t

customers in a way that maintains or improves the consumer's and the society's well

being. The societal marketing concept is the newest of the five marketing

management philosophies.

The societal marketing concept questions whether the pure marketing concept is

adequate in an age of environmental problems, and neglected social services. It asks

if the firm that sense, serves and satisfies individual wants is always doing what's

best for consumers and society in the long run. According to the societal marketing

concept, the pure marketing concept overlooks possible conflicts between consumer

short run wants and consumer long run welfare.

Consider the fast food industry. Most people see today's giant fast food chains as

offering tasty and convenient food at reasonable prices. Yet many consumer and

environmental groups have voiced concerns. Critics point out that hamburger, fried

chicken, French fries and most other foods sold by fast food restaurants are high in

fat and salt. The products are wrapped in convenient packaging, but this leads to

waste and pollution.

This concept holds that the organization’s task is to determine the needs, wants, and

interests of target markets and to deliver the desired satisfactions more effectively

and efficiently than competitors (this is the original Marketing Concept).

Additionally, it holds that this all must be done in a way that preserves or enhances

the consumer’s and the society’s well-being.

This orientation arose as some questioned whether the Marketing Concept is an

appropriate philosophy in an age of environmental deterioration, resource shortages,

explosive population growth, world hunger and poverty, and neglected social

services.

Are companies that do an excellent job of satisfying consumer wants necessarily

acting in the best long-run interests of consumers and society?

The marketing concept possibly sidesteps the potential conflicts among consumer

wants, consumer interests, and long-run societal welfare. Just consider:

The fast-food hamburger industry offers tasty but unhealthy food. The hamburgers

have a high fat content, and the restaurants promote fries and pies, two products

high in starch and fat. The products are wrapped in convenient packaging, which

leads to much waste. In satisfying consumer wants, these restaurants may be hurting

consumer health and causing environmental problems.

Conclusion:

For the marketing educators eager for a rejuvenation of a

managerial point of view within the field, there is cause for

cautious optimism. The issue of the decline of relevance and

the relative lack of attention to important areas of marketing

strategy, such as new product development, channel strategy,

and sales force management, is increasingly recognized,

discussed, and written about by marketing thought

leaders. Fundamentally new paradigms of marketing management

are being offered that shift the core focus of the

field from firms to customers, from products to services and

benefits, from transactions to relationships, from manufacturing

to the co creation of value with business partners and

customers, and from physical resources and labour to knowledge

resources and the firm’s position in the value chain.

Properly developed and communicated, this new conceptualization

has the potential to bridge the gap between managers

and scholars, to integrate rigor and relevance, and to

reinvigorate a managerial view of marketing. The biggest

challenge in the future, as in the past, will be meaningful

communication among marketing scholars, marketing managers,

and general managers so that rigorous work becomes

more relevant while the practical becomes more analytical

and marketing decisions become better informed by better

marketing science

Core Concepts

Selling Vs Marketing

Selling Concept: The selling concept holds that consumers and businesses, if left

alone will ordinarily not buy enough of the organisation’s products. The organisation,

must therefore undertake an aggressive selling and promotion effort. The selling

concept is epitomised in the thinking of Sergio Zygman, Coca-Cola’s former Vice

President, Marketing: The purpose of marketing is to sell more stuff to more people

more often for more money in order to make more profit.

The selling concept is practised most aggressively, with unsought goods, goods that

buyers do not normally think of buying, such as insurance and encyclopaedia. Most

firms practise the selling concept when they have overcapacity. Their aim is to sell

what they make, rather than make what the market wants. However, marketing

based on hard selling carries high risks. It assumes that customers that are coaxed

into buying a product will like it and that if they do not, they will not return it or bad-

mouth it or complain to consumer organisations, or might even buy it again.

Marketing Concept: The marketing concept emerged in the mid 1950’s. Instead of a

product centred “make and sell” philosophy, business shifted to customer centred,

“sense and respond” philosophy. Instead of “hunting” marketing is “gardening”. The

job is not to find the right customers for your product, but the right product for your

customers. The marketing concept holds that the key to achieving organisational

goals consists of the company being more effective than the competitors in creating,

delivering and communicating superior customer value to its chosen target markets.

Theodore Levitt of Harvard drew a perceptive contrast between the selling and

marketing concepts: Selling focuses on the needs of the seller; marketing on the

needs of the buyer. Selling is pre-occupied with the seller’s need to convert his

product into cash; marketing with the idea of satisfying the needs of the customer by

means of the product and the whole cluster of things associating with creating,

delivering and finally consuming it.

Several scholars have found that companies who embrace the marketing concept

achieve superior performance. This was first demonstrated by companies practising

a reactive market orientation- understanding and meeting customers’ expressed

needs. Some critics say this means companies develop only low level innovation is

possible if the focus is on customer’s latent needs. He calls this a proactive marketing

orientation. Companies such as 3M, HP and Motorola have made a practise of

researching or imaging latent needs through a “probe and learn” process. Companies

that practise both reactive and proactive marketing orientation are implementing a

“total market orientation” and are likely to be the most successful.

In the course of converting to a marketing orientation, a company faces three

hurdles: organised resistance, slow learning and fast forgetting. Some company

departments (often manufacturing, finance and R&D) believe a stronger marketing

function threatens their power in the organisation. Initially, the marketing function

is seen as one of several equally important functions in a check-and-balance

relationship. Marketers argue that their function is more important. A few

enthusiasts go further and say that marketing is the major function of the enterprise,

for without customers at the centre of the company. They argue for a customer

orientation in which all functions work together to respond to, serve and satisfy the

customer.

Exchange, Transfer, Transaction

A person can obtain a product in one of four ways. One can self-produce the product

or service, as one hunts, fishes or gathers fruits. One can use force to get a product, as

in a holdup or burglary. One can beg, as happens when a homeless person asks for

food; or one can offer a product, a service or money in exchange for something he or

she desires.

Exchange, which is the core concept of marketing, is a process of obtaining a desired

product from someone by offering something in return. For exchange potential to

exist, five conditions must be satisfied:

1. There are atleast two parties.

2. Each party has something that may be of value to the other party.

3. Each party is capable to communication and delivery.

4. Each party is free to accept or reject the exchange offer.

5. Each party believes it is appropriate or desirable to deal with the other party.

Whether exchange actually takes place depends on whether the two parties can agree

on terms that will leave both better off (or atleast not worse off) than before.

Exchange is a value creating process because it normally leaves both parties better

off.

Two parties are engaged in exchange if they are negotiating- trying to arrive at

mutually agreeable terms. When an agreement is reached, we say a transaction takes

place. A transaction is a trade of valued between two or more parties. A gives X to B

and receives Y in return. Pratap sells a TV set to Samir and Samir pays Rs. 20,000 to

Pratap. This is a classic monetary transaction; but transactions do not require money

as one of the traded values. A barter transaction involves trading goods or services

for other goods or services, as when lawyer Jones writes a will for physician Smith in

return for a medical examination.

A transaction involves several dimensions: at least two things of value, agreed upon

conditions, a time of agreement, and place of agreement. A legal system supports and

enforces compliance on the part of the transactors. Without a law of contracts,

people would approach transactions with some distrust, and everyone would lose.

A transaction differs from a transfer. In a transfer, A gives X to B but does not receive

any thing tangible in return. Gifts, subsidies and charitable contributions are all

transfers. Transfer behaviour can also be understood through the concept of

exchange. Typically, the transferer expects to receive something in exchange for his

or her gift- for example, gratitude or changed behaviour in the recipient. Professional

fund raisers provide benefits to donors, such as thank you notes, donor magazines

and invitation to events. Marketers have broadened the concept of marketing to

include the study of transfer behaviour as well as transaction behaviour.

In the most generic sense, marketers seek to elicit a behavioural response from

another party. A business firm wants a purchase, a political candidate wants a vote, a

church wants an active member, and the social group wants the passionate adoption

of some cause. Marketing consists of actions undertaken to elicit desired responses

from a target audience.

To make successful exchanges, marketers analyse what each party expects from the

transaction. Simple exchange situations can be mapped by showing the two actors

and the wants and offerings flowing between them. Mahindra & Mahindra is a leader

in the tractor market in India. Suppose its farm-equipment division researches the

benefits that a typical farmer wants when he buys a tractor. These benefits include

high quality equipment, a fair price, timely delivery, good financing terms, and

reliable parts and service. The items on this want list are not equally important and

may vary from buyer to buyer. One of M&M’s tasks is to discover the relative

importance of these different wants to the buyer.

M&M also has a want list. It wants a good price for the tractor, on-time payment and

positive word of mouth. If there is sufficient match or overlap in the want lists, a

basis of transaction exists. M&M’s task is to formulate an offer that motivates the

farmer to buy an M&M tractor. The farmer might in turn make a counter offer. The

process of negotiation leads to mutually acceptable terms for a transaction.

Value & satisfaction

The offering will be successful if it delivers value and satisfaction to the target buyer.

The buyer chooses between different offerings on the basis of which is perceived to

deliver the most value. Value reflects the perceived tangible and intangible benefits

and costs to customers. Value can be seen as primarily a combination of quality,

service and price (QSP), called the “customer value triad.” Value increases with

quality and service and decreases with price, although other factors can also play an

important role.

Value is a central marketing concept. Marketing can be seen as the identification,

creation, communication, delivery and monitoring of customer value. Satisfaction

reflects a person’s comparative judgements resulting from a product’s perceived

performance (or outcome) in relation to his or her expectations. If the performance

falls short of expectations, the customer is dissatisfied and disappointed. If the

performance matches the expectations, the customer is satisfied. If the performance

exceeds the expectations, the customer is highly satisfied or delighted.

Needs, Wants and demands

The marketer must understand the target market’s needs, wants and demands.

Needs are the basic requirements. People need food, air, water, clothing and shelter

to survive. People also have strong needs for recreation, education and

entertainment. These needs become wants when they are directed to specific objects

that might satisfy the need. An American needs food, but may want a hamburger,

French fries and a soft drink. A person in Mauritius needs food but may want mango,

rice, lentils and beans. Wants are shaped by one’s society. Demands are wants for

specific products backed by an ability to pay. Many people want a Mercedes; only a

few are willing and able to buy one. Companies must measure not only how many

people want their product but also how many would actually be willing and able to

buy it.

These distinctions shed light on the frequent criticism that “marketers create needs”

or “marketers get people to buy things they don’t want.” Marketers do not create

needs: Needs pre-exist marketers. Marketers, along with other societal factors,

influence wants. Marketers might promote the idea that a Mercedes would satisfy s

person’s needs for social status. They do not however create the need for social

status.

Understanding customer needs and wants is not always simple. Some customers

have needs of which they are not fully conscious, or they can not articulate these

needs or they use words that require some interpretation. What does it mean when

customers ask for a powerful lawnmower, a fast lathe or an attractive bathing suit or

a restful hotel? Consider the customer who says he wants an inexpensive car. The

marketer must probe further. We can distinguish among 5 types of needs:

1. State Needs (the customer wants an inexpensive car)

2. Real Needs (the customer wants a car whose operating cost, not its initial price, is

low)

3. Unstated needs (the customer expects good service from the dealer)

4. Delight needs (the customer would like the dealer to include onboard navigation

system)

5. Secret Needs (the customer wants to be seen by friends as a savvy consumer)

Responding only to the stated need may short-change the customer. Many

consumers did not know what they want in a product. Consumers did not know

much about Cellular phones when they were first introduced. Nokia and Ericsson

fought to shape consumer perceptions of cellular phones. Consumers were in a

learning mode and the companies’ forger strategies to shape their wants. As stated by

Carpenter, “Simply giving customers what they want isn’t enough anymore- to gain

an edge companies must help customers what they want”

In the past, “responding to customer needs” meant studying customer needs and

making a product that fits these needs on the average, but some of today’s companies

respond to each customer’s individual needs. Dell computer does not prepare a

perfect computer for its target market. Rather, it provides product platforms on

which each person customises the features he or she desires in the computer. This is

a change from a “make-and-sell” philosophy to philosophy of “sense-and-respond.”

THE MARKETING ENVIRONMENT- MACRO & MICRO

The marketing environment surrounds and impacts upon the organization. There are

three key perspectives on the marketing environment

- Macro-environment

- Micro-environment

- Internal environment.

MACRO ENVIRONMENT:

Macro Environment refers to the external factors that affect an organization’s

planning and performance. Successful companies recognize and respond to

profitably to unmet needs and trends that shape opportunities and pose threats.

These forces represent the “uncontrollables”, which the company must monitor. It is

constantly changing and the company needs to be flexible to adapt to it.

Globalization means that there is always the threat of substitute products and new

entrants. The wider environment is also ever changing, and the marketer needs to

compensate for changes in culture, politics, economics and technology.

Companies conduct what is known as the “PESTEL” study which covers the six

arenas of the macro environment namely:

- Political

- Economic

- Socio- cultural

- Technological

- Environmental

- Legal

POLITICAL- LEGAL ENVIRONMENT

Marketing decisions are strongly affected by developments in the political and legal

environment. This environment is composed of laws, government agencies, and

pressure groups that influence and limit various organizations and individuals.

Sometimes these laws also create opportunities. The companies have to keep up with

the changing political environment in order to utilize these opportunities to their full

potential. To many companies, domestic political considerations are likely to be of

prime concern. However, firms involved in international operations are faced with

the additional dimension of international political developments. Many firms export

and may have joint ventures or subsidiary companies abroad. In many countries,

particularly in the ‘Developing Nations’, the domestic political and economic

situation is usually less stable than in the developed countries. Marketing firms

operating in such volatile conditions clearly have to monitor the local political

situation very carefully.

ECONOMIC ENVIRONMENT:

Markets require purchasing power as well as people. The available purchasing power

in an economy depends on current income, prices, savings, debt, and credit

availability. Marketers must pay careful attention to trends affecting purchasing

power because they can have a strong impact on business, especially the companies

whose products are geared to high income and price- sensitive consumers. Political

and economic forces are often strongly related to the economic environment. A much

quoted example in this context is the ‘oil crisis’ caused by the Middle East War in

1973 which produced economic shock waves throughout the Western world, resulting

in dramatically increased crude oil prices. This, in turn increased energy costs as well

as the cost of many oil-based raw materials such as plastics and synthetic fibres. This

contributed significantly to a world economic recession, and it all serves to

demonstrate how dramatic economic change can upset the traditional structures and

balances in the world business environment. As mentioned earlier, an understanding

of economic changes and forces in the domestic economy is also of vital importance

as such forces have the most immediate impact. Economic changes pose a set of

opportunities and threats, and by understanding and carefully monitoring the

economic environment, firms should be in a position to guard against potential

threats and to capitalize on opportunities.

SOCIO- CULTURAL ENVIRONMENT

Purchasing power is directed towards certain goods and services and away from

others according to people’s tastes and preferences. Society shapes the beliefs, values

and norms that largely define these tastes and preferences. Core cultural values are

firmly established within a society and are therefore difficult to change. They are

perpetuated through family, the church, education and the institutions of society and

act as relatively fixed parameters within which marketing firms are forced to operate.

Secondary cultural values, however, tend to be less strong and therefore more likely

to undergo change. Marketers have some chance of changing the latter than the

former. For example, Mothers against drunk drivers (MADD) does not try to stop the

sale of alcohol, but it does promote the idea of appointing a designated driver who

will not drink that evening. Changes in attitudes towards working women have led to

an increase in demand for convenience foods, ‘one-stop’ shopping and the

widespread adoption of such time-saving devices as microwave cookers. Marketing

firms have had to react to these changes to be successful.

TECHNOLOGICAL ENVIRONMENT:

One of the most dramatic forces shaping people’s lives is technology. Technology is a

major macro-environmental variable which has influenced the development of many

of the products we take for granted today, for example, television, calculators, video

recorders and desk-top computers. Marketing firms themselves play a part in

technological progress, many having their own research department or sponsoring

research through universities and other institutions, thus playing a part in innovating

new developments and new applications.

One example of how technological change has affected marketing activities is in the

development of electronic point of sale (EPOS) data capture at the retail level. The

‘laser checkout’ reads a bar code on the product being purchased and stores

information that is used to analyze sales and re-order stock, as well as giving

customers a printed readout of what they have purchased and the price charged.

Manufacturers of fast-moving consumer goods, particularly packaged grocery

products, have been forced to respond to these technological innovations by

incorporating bar codes on their product labels or packaging. In this way, a change in

the technological environment has affected the products and services that firms

produce and the way in which firms carry out their business operations.

ENVIRONMENTAL FACTORS

The deterioration of the natural environment is a major global concern. In many

world cities, air and water pollution have reached dangerous levels. There is a great

concern about “green house gases”. Organizations have to be responsible towards the

environment in order to protect it. Other environmental factors to be considered are

shortage of raw materials, increased energy costs, anti- pollution pressures, etc.

MICRO ENVIRONMENT

The term micro-environment denotes those elements over which the marketing firm

has control or which it can use in order to gain information that will better help it in

its marketing operations. In other words, these are elements that can be

manipulated, or used to glean information, in order to provide fuller satisfaction to

the company’s customers. The objective of marketing philosophy is to make profits

through satisfying customers. This is accomplished through the manipulation of the

variables over which a company has control in such a way as to optimize this

objective. The marketing manager has to build relationships with customers and this

is done by creating customer values and satisfaction. However this cannot be done

alone. Marketing success will require building relationships with the following

microenvironments:

- The company

- Suppliers

- Marketing intermediaries

- Customers

- Competitors

- Publics

COMPANY

The company aspect of microenvironment refers to the internal environment of the

company. This includes all departments, such as management, finance, research and

development, purchasing, operations and accounting. Each of these departments has

an impact on marketing decisions. For example, research and development have

input as to the features a product can perform and accounting approves the financial

side of marketing plans and budgets. Purchasing worries about getting supplies and

materials whereas operations are responsible for producing and distributing the

desired quality of products. Accounting has to measure revenues and costs to help

marketing know how well it is achieving its objectives. The marketing department

has to work closely with the all these departments because together all these

departments have an impact on the marketing department’s plan and actions.

SUPPLIERS

Suppliers form an important link in the company’s overall customer value delivery

system. The suppliers of a company are an important aspect of the

microenvironment because even the slightest delay in receiving supplies can result in

customer dissatisfaction. Marketing managers must watch supply availability and

other trends dealing with suppliers to ensure that product will be delivered to

customers in the time frame required in order to maintain a strong customer

relationship. In other words, supply shortage, labor strikes and other events can cost

sales in the short run and damage customer satisfaction in the long run. Most

marketers today treat their suppliers as partners in creating and delivering customer

value. Wal-Mart goes to great length to test new products in its stores.

MARKETING INTERMEDIARIES

Marketing intermediaries refers to resellers, physical distribution firms, marketing

services agencies, and financial intermediaries. These are the people that help the

company promote, sell, and distribute its products to final buyers. Resellers are those

that hold and sell the company’s product. They match the distribution to the

customers and include places such as Wal-Mart, Target, and Best Buy. Physical

distribution firms are places such as warehouses that store and transport the

company’s product from its origin to its destination. Marketing services agencies are

companies that offer services such as conducting marketing research, advertising,

and consulting. Financial intermediaries are institutions such as banks, credit

companies and insurance companies.

CUSTOMERS

Customers are the most important publics of the organization. There are different

types of customer markets including consumer markets, business markets,

government markets, international markets, and reseller markets. The consumer

market is made up of individuals who buy goods and services for their own personal

use or use in their household. Business markets include those that buy goods and

services for use in producing their own products to sell. This is different from the

reseller market which includes businesses that purchase goods to resell as is for a

profit. These are the same companies mentioned as market intermediaries. The

government market consists of government agencies that buy goods to produce

public services or transfer goods to others who need them. International markets

include buyers in other countries and includes customers from the previous

categories.

COMPETITORS

The basic rule in marketing is that to be successful, a company has to offer a better

value and customer satisfaction than its competitors. Thus marketers must do more

than simply adapt to the needs of target customers. The company has to first discover

their competitors and then adapt a strategy that would put them in a better position

as compared to their competitors in the minds of the consumers.

PUBLICS

A public is any group that has an interest in or impact on the organization’s ability to

meet its goals. Every organization has two publics- internal and external.

Internal public includes all those who are employed by the company and deal with

the organization and construction of the company’s product.

External public can further be divided into the following:

- Financial public- Can hinder a company’s ability to obtain funds affecting the level

of credit a company has.

- Media public- Include newspapers and magazines that can publish articles of

interest regarding the company and editorials that may influence customers’

opinions.

- Government public- Can affect the company by passing legislation and laws that

put restrictions on the company’s actions.

- Citizen action public- Include environmental groups and minority groups and can

question the actions of a company and put them in the public spotlight.

- Local publics- Includes neighborhood and community organizations who will

question a company’s impact on the local area and the level of responsibility of their

actions.

- General public- Can greatly affect the company as any change in their attitude,

whether positive or negative, can cause sales to go up or down because the general

public is often the company’s customer base.

MARKET SEGMENTATION

LEVELS OF MARKET SEGMENTATION-

In Mass Marketing, the seller engages in the mass production, mass distribution and

mass promotion of one product from all buyers. Example- Coca cola practiced Mass

marketing when it sold only one kind of coke in a 6.5 ounce bottle.

An argument for mass marketing is that it creates the largest potential market, which

leads to lowest costs, which may lead to lower prices or higher profits. However,

splintering of markets, proliferation of advertising media and distribution channels

are making it difficult and increasingly expensive to reach a mass audience. Thus,

more companies are turning to ‘micro marketing’ at one of the four levels: Segments,

Niches, local areas and individuals.

Segment Marketing-

A market segment consists of a group of customers who share a similar set of needs

and wants. The marketer’s task is to identify them and decide which one(s) to target.

Segment marketing offers key benefits over mass marketing. The company can offer

better design, price, disclose, and deliver the product or service. It can also fine- tune

the marketing programs and activities for the product/ service according to the needs

and attitudes of the segment.

A perfect market segment should be Homogenous. However reality differs. Everyone,

even within the same segment may not want the same thing.

Thus, Business-to-business marketing experts Anderson and Narus have urged

marketers to present ‘flexible market offerings’ to all members of a segment. A

Flexible market offering consists of two parts-

- The basic product or service elements that all segment members value.

- Some discretionary options that some members value. Each option may have an

additional charge.

Example- Automobile companies in India offer different versions of the same car.

The versions have different features. The basic version may not have power steering

or power windows. For the models that have these features the buyer has to pay a

higher price.

Similarly, Domestic Airlines in India offer business and executive class for travelers.

The price, business class passengers have to pay is higher as they get extra facilities

such as more comfortable seats, better menu, etc.

Niche Marketing-

A niche is more narrowly defined customer group seeking distinctive mix of benefits.

Marketers usually define niches by dividing market segments into sub- segments.

Examples-

1) By focusing on ‘Ayurvedic’ medicines and health supplements, The Himalaya Drug

Company serves a niche market.

2) Ezee, the liquid detergent from Godrej, is a fabric washing product for woolen

clothes. Because of its mildness, customers use it to wash delicate clothes, which may

get damaged by harsh and strong detergents.

3) Exclusive sports channels like Ten Sports, ESPN, STAR sports, and STAR cricket

tend to the audiences who have very high interest in sports.

4) Magazines like ‘Better Photography’ which target niche segment of serious

amateur photographic enthusiasts.

An attractive niche has customers with distinct set of needs; they will pay a premium

to the firm that best satisfies them; the niche is fairly small but has size, profit and

growth potential and is unlikely to attract many other competitors.

Niche marketers aim to understand their customers’ needs so well that they are

willing to pay a premium. Revolution Clothing Pvt. Ltd. pioneered the concept of

‘plus sized women’ and name the apparel size categories as -2, -1, 0, 1, 2, 3, 4 instead

of L, XL, XXL. The concept gave women pride and self confidence.

Local Marketing-

Target marketing is leading to marketing programs tailored to the needs and wants

of local customer groups in trading areas, neighborhoods and even individual stores.

Examples-

1) Many banks in India have specialized ‘NRI branches’ to cater to the needs of

families whose relatives remit money from abroad.

2) The movie Spiderman 3 was released in five different languages in India, including

Bhojpuri- A regional dialect.

3) Bharatmatrimony.com is a successful matrimony website. It realized that in India,

marriages are mostly community based. Thus, it emphasized on offering customized

services addressing to specific requirements of customers. Thus, the service provider

has initiated 15 regional websites such as punjabimatrimony.com,

bengalimatromony.com, etc.

Individual marketing-

The ultimate level of segmentation leads to ‘segments of one’, ‘customized marketing’

or ‘one-to-one marketing’. Today, customers are taking initiative in determining

what and how to buy. They log onto internet, look up for information and evaluations

of product; talk with suppliers, users, critics, etc.

Wind and Rangaswamy see a movement towards ‘Customerizing’ the firm. It

combines operationally driven mass customization with customized marketing in a

way that empowers consumers to design the product and service offering of their

choice.

Customization is not for every company as it may be difficult to implement for

complex products like automobiles. It can raise cost, and many customers want to

see the product before they buy it.

But Customization has worked well for some products like Paint Companies (Asian

paints, Nerolac, Berger paints) follow the mass customization strategy in paint

retailing. They facilitate customers to mix and match colors of their choice from

catalogue, and the desired colors are mixed in quantities as per the requirement of

customer using equipment installed in retail points- thus providing a wide range of

colors to customers to choose from.

BASIS FOR SEGMENTING CONSUMER MARKETS:

There are two broad groups of variables to segment consumer markets.

- Descriptive Characteristics: Geographic, Demographic, psychographic.

- Behavioral Segmentation: Consumer responses to benefits, use occasions

Geographic Segmentation:

Division of market into different geographical units such as nations, states, regions,

cities and villages. Geographical segments vary in logistics, product requirement,

size, culture and food habits.

Example- In arid regions of India and Pakistan, during hot and dry summer seasons,

air coolers are used. But, this product is ineffective where climate is hot and humid.

Thus, Air Conditioners are preferred.

Demographic Segmentation:

Division of market into groups on the basis of variables such as age, family size,

gender, income, occupation, education, nationality and social class.

Age and life cycle stage- Consumers wants and abilities change with age. Thus these

are important variables to define segments. Example- Johnson and Johnson’s baby

soap and talcum powder are classic examples of products for infants and children.

Channels like Aastha and Sanskar are focused on older generation.

Life Stage- It defines a person’s major concern, such as getting married, deciding to

marry their children, sending child to school, planning to retire and so on. These life

stages help marketers who can help the consumers cope with their major concerns.

Example- When a person gets married and shifts in a new home, many services such

as furniture, cooking gas, utensils become necessary. Many marketers develop

schemes for such people. Similarly, there are insurance-cum-savings schemes to help

young parents plan for their children’s education.

Gender- Men and women have different attitudes and behave differently based on

their genetic make-up and socialization. Some traditionally male oriented markets

like two wheeler markets are beginning to recognize gender discrimination. They

have come up with women oriented two wheelers like scooty pep, Bajaj Wave DTSi,

etc.

Income- determines the ability of consumers to participate in market exchange.

Example- Nirma washing powder was launched as the lowest priced detergent in

India primarily targeted at middle income segment.

Psychographic segmentation:

Psychographics is the science of using psychology and demographics to better

understand consumers. Even when the consumers belong to same demographics

they may differ according to their Lifestyle, values and personality.

Example- In India even non-vgetarian Indians avoid Beef. Thus, McDonalds

removed beef items from their menu and also introduced vegetarian burgers in

India.

BEHAVIORAL SEGMENTATION-

Decision Roles: People play five role in buying decision: Initiator, Influencer,

Decider, Buyer and user. Understanding roles is vital for marketers. Example:

Doctors prescribe medicines, pharmacy companies influence doctors’ prescription

behavious by providing technical information about product. Patients’ relatives buy

and patient uses product.

Behavioral Variables: Many marketers use behavioral variables- occasions, benefits,

etc. See the following points:

Occasions- Festivals and anniversaries require greeting cards. Companies like

Archies and Hallmark provide them. Special gift packs are provided by chocolate

companies like Cadburys at occasions.

Benefits- Customers can be classified by the benefits they seek. Example- Liril soap

offers freshness, Dettol soap provides total protection.

User Status- Ex- user, non-user, potential user, first time user or regular user?

Mothers to be are potential users for infant product companies.

Usage rate- light, medium or heavy usage rate? Heavy users offer small percentage of

market but high percentage of revenue. Example- In mobile services, heavy users

account for high revenue. Mobile services target these users by special schemes.

Loyalty stage- There are four kinds of loyalty groups:

1) Hard core loyals- Who buy only one brand every time.

2) Split Loyals- Loyal to two or three brands.

3) Shifting loyals- shift loyalty from one brand to another.

4) Switchers- No loyalty to any brand.

Hard core loyals help identify the company its products’ strength. Split loyals show

which companies are in competition. Likewise companies can identify the

weaknesses and strengths in its products. Many services like clubs, retails provides

loyalty schemes to retain customers.

BASIS FOR SEGMENTING BUSINESS MARKETS:

Some variables used in consumer markets can be used here also like geography,

benefits sought, usage rate, but business marketers also use other variables

Demographic-

1) Industry: which industry should we serve?

2) Company size: What size company should we serve?

3) Location: What area should we serve?

Operating Variables-

4) Technology: what customer technologies should we focus on?

5) User Status: should we serve heavy users, medium users, light users or nonusers?

6) Customer capabilities: Should we serve customers needing many or few services?

Purchasing approaches-

7) Purchasing- function organization- Should we serve companies with highly

centralized or decentralized purchasing organization?

8) Power Structure: should we serve companies that are engineering dominated,

financially dominated and so on?

9) General Purchasing Policies: should we prefer companies that prefer leasing or

service contract or sealed bidding and so on.

10) Purchasing Criteria: Should we serve companies that are seeking quality, service

or price.

Situational Factors-

11) Urgency: should we serve companies that need quick and sudden delivery?

12) Size or order: Should we focus on large or small orders?

Personal Characteristics-

13) Attitude risk: Should we serve risk taking or risk avoiding customers?

14) Loyalty: Should we serve companies that show high loyalty to their suppliers?

15) Should we serve companies whose people and values are similar to us?

A rubber tire company can sell tires to manufacturers of automobiles, trucks,

tractors, aircraft, etc. Within the chosen segment the company can further segment

by company size.

MARKET TARGETING

Market segmentation - why segment markets?

There are several important reasons why businesses should attempt to segment their

markets carefully. These are summarised below

Better matching of customer needs

Customer needs differ. Creating separate offers for each segment makes sense and

provides customers with a better solution

Enhanced profits for business

Customers have different disposable income. They are, therefore, different in how

sensitive they are to price. By segmenting markets, businesses can raise average

prices and subsequently enhance profits

Better opportunities for growth

Market segmentation can build sales. For example, customers can be encouraged to

"trade-up" after being introduced to a particular product with an introductory, lower-

priced product

Retain more customers

Customer circumstances change, for example they grow older, form families, change

jobs or get promoted, change their buying patterns. By marketing products that

appeal to customers at different stages of their life ("life-cycle"), a business can retain

customers who might otherwise switch to competing products and brands

Target marketing communications

Businesses need to deliver their marketing message to a relevant customer audience.

If the target market is too broad, there is a strong risk that (1) the key customers are

missed and (2) the cost of communicating to customers becomes too high /

unprofitable. By segmenting markets, the target customer can be reached more often

and at lower cost

Gain share of the market segment

Unless a business has a strong or leading share of a market, it is unlikely to be

maximising its profitability. Minor brands suffer from lack of scale economies in

production and marketing, pressures from distributors and limited space on the

shelves. Through careful segmentation and targeting, businesses can often achieve

competitive production and marketing costs and become

Once the firm has decided its market segments, it must decide how many and which

ones to target. However, to be useful, market segments must rate favourably on five

key criteria:

Measurable- Size, purchasing power and characteristics of the segments can be

measured.

Substantial- segments should be large and profitable enough to serve. Example- It

may not be useful for an automobile company to make cars for people who are less

than 4 feet tall.

Accessible- segments should be reachable.

Differentiable- The segment should be homogenous within itself and different from

others. Example- if married and unmarried woman respond similarly to a perfume’s

sales program, they may be in a same segment.

Actionable- Effective programs can be formulated for attracting and serving

segments.

EFFECTIVE SEGMENTATION

Even after applying segmentation variables to a consumer or business market,

marketers must realize that not all segmentations are useful. For example, table salt

buyers could be divided into blond and brunette customers, but hair colour is not

relevant to the purchase of salt. Furthermore, if all salt buyers buy the same amount

of salt each month, believe all salt is the same, and would pay only one price for salt,

this market would be minimally segmentable from a marketing perspective.

To be useful, market segments must be:

• Measurable: The size, purchasing power, and characteristics of the segments can be

measured.

• Substantial: The segments are large and profitable enough to serve. A segment

should be the largest possible homogeneous group worth going after with a tailored

marketing program.

• Accessible: The segments can be effectively reached and served.

• Differentiable: The segments are conceptually distinguishable and respond

differently to different marketing mixes. If two segments respond identically to a

particular offer, they do not constitute separate segments.

• Actionable: Effective programs can be formulated for attracting and serving the

segments.

Evaluating and Selecting Market Segments:

For evaluation, the firm should look at- the segment’s overall attractiveness; and the

objectives and resources with firm. It should see how well the segment scores on the

above stated five point criteria and also see if investing in that segment makes sense

with firm’s objectives, competition and resources.

After evaluating different segments, company can consider five patterns of target

market selection:

1) Single Segment Concentration- the Zodiac Shirts focus on formal shirts for

executives and professionals. Specialty hospitals may focus on cardiology or cancer

care. This is also known as concentrated marketing, through which firm gains strong

knowledge about needs of segment and achieves strong market presence. One market

segment is served with one marketing mix.

2) Selective specialization- firm select number of objectives, each objectively

attractive and appropriate. There may be little or no synergy between products.

3) Product Specialization- firm specializes in one product and tailors it to different

market segments. Example- A microscope manufacturer can sell the product to

universities, government, labs, etc.

4) Market specialization- firm specializes in serving many needs of a market group.

Example- firm can sell an assortment of products only to university laboratories.

Firm gains good reputation and becomes a channel for additional products for this

customer group.

5) Full market Coverage- Firm attempts to serve all customer groups with all the

products they might need. Example- Microsoft company for softwares, General

Motor Company for vehicle marketing. It can reach segments by undifferentiated

marketing (ignores segments, goes after whole market) or differentiated marketing(

operates in different segments and offers different products)

POSITIONING

In marketing, positioning has come to mean the process by which marketers try to

create an image or identity in the minds of their target market for its product, brand,

or organization. It is the 'relative competitive comparison' their product occupies in a

given market as perceived by the target market.

The marketer would draw out the map and decide upon a label for each axis. They

could be price (variable one) and quality (variable two), or Comfort (variable one)

and price (variable two). The individual products are then mapped out next to each

other Any gaps could be regarded as possible areas for new products.

The term 'positioning' refers to the consumer's perception of a product or service in

relation to its competitors. You need to ask yourself, what is the position of the

product in the mind of the consumer?

Re-positioning involves changing the identity of a product, relative to the identity of

competing products, in the collective minds of the target market.

De-positioning involves attempting to change the identity of competing products,

relative to the identity of your own product, in the collective minds of the target

market.

Positioning is a concept in marketing which was first popularized by Al Ries and Jack

Trout in their bestseller book " Positioning - a battle for your mind". They iterate that

any brand is valued by the perception it carries in the prospect or customer's mind.

Each brand has thus to be 'Positioned' in a particular class or segment. For example,

Mercedes is positioned as a luxury brand, and Volvo is positioned for safety.

The position of the brand has to be carefully maintained. When Marlboro reduced its

prices, sales dropped immediately because its customers began associating it with the

generic segment. Rolex watches are even more dramatically positioned as a luxury

items, and have become a symbol for accomplishment in life. If Rolex reduces its

prices, it will reduce brand cachet and sales.

Developing and Communicating a positioning Strategy-

Competitive frame of reference: The firm may decide the category membership of its

products- the products with which brand competes and which function as close

substitutes. Deciding to target a certain type of consumer can also define

competition.

To understand competitive frame of reference, marketers need to understand

consumer behaviour and how they choose products.

Example- paras pharmaceuticals launched Moov as a balm for relieving joint pains

that trouble older people. Later, based on consumer research, repositioned brand as

‘backache specialist’ that addresses the problems of backache that housewives

encounter. The brand communicates the pain relieving promise of “ek minute moov

ki malish” in ads that go with tagline “ah se aaha tak” (from pain to relief).

Points of Difference and Points of Parity:

PODs are attributes or benefits consumers strongly associate with a brand, positively

evaluate, and believe they could not find same extent’s benefit with competitive

brand. They are points unique to a brand. Example Apple has design as its POD.

POPs are associations that are not necessarily unique to a brand but may be shared

with other brands.

Dettol dominated antiseptic market in India. It had attributes of stinging when

applied, turning cloudy when poured in water and strong smell. Consumers

associated these attributes with efficiency of antisepic. When Savlon was introduced,

it had none of these attributes. No strong smell, no sting. Thus, to obtain consumer

satisfaction it had to counter the perception by communication. It advertised the

superior efficacy of product and highlighted the ‘no-sting’ property, which is its key

POD.

Dove has established itself as a very gentle soap having ¼ moisturizing cream, thus

promising soft skin.

MARKETING MIX

Marketing decisions generally fall into the following four controllable categories:

• Product

• Price

• Place (distribution)

• Promotion

The term "marketing mix" became popularized after Neil H. Borden published his

1964 article, The Concept of the Marketing Mix.

The ingredients in Borden's marketing mix included product planning, pricing,

branding, distribution channels, personal selling, advertising, promotions,

packaging, display, servicing, physical handling, and fact finding and analysis. E.

Jerome McCarthy later grouped these ingredients into the four categories that today

are known as the 4 P's of marketing, depicted below:

1. PRODUCT

This is an object an idea or a service that is mass produced or manufactured on a

large scale with a specific volume of units. A good product makes its marketing by

itself because it gives benefits to the customer.

Suppose now that the competitors products offer the same benefits, same quality,

same price. You have then to differentiate your product with design, features,

packaging, services, warranties, return and so on. In general, differentiation is

mainly related to:

-The design: It can be a decisive advantage but it changes with fads. For example,

Nokia has to keep changing the designs of the cellphones to surpass customer

expectations.

-The packaging: It must provide a better appearance and a convenient use. In food

business, products often differ mainly by packaging.

-The safety: It matters a lot for products used by kids.

-The "green": A friendly product to environment gets an advantage among some

segments.

In business to business and for expensive items, the best mean of differentiation are

warranties, return policy, maintenance service, time payments and financial and

insurance services linked to the product.

2. PRICE

The price is the amount or a consideration a customer pays for the product. It is

determined by a number of factors including market share, competition, material

costs, product identity and the customer's perceived value of the product. The

business may increase or decrease the price of product if other stores have the same

product.

Pricing strategies

-Competitive pricing: If your product is sold at the lowest price amongst all your

competitors, you are practicing competitive pricing. Sometimes, competitive pricing

is essential. For instance, when the products are basically the same, this strategy will

usually succeed. The success of competitive pricing strategy depends on achieving

high volume and low costs.

-Cost-plus-profit pricing: It means that you add the profit you need to your cost. So

the profit is decided first. It is also called cost-orientated strategy and is mainly used

by the big contractor of public works. The authority may have access to the costing

data and should like to check if the profit added to the cost is not too high. In fact,

this strategy is only good for a business whose customers are public bodies or

government agencies.

-Value pricing: It means that you base your prices on the value you deliver to

customers. For example, when a new technology has a very large success, you can

charge high prices to the customer. This practice is also called skimming. Value

pricing is also common in luxury items. Sometimes, the higher the price, the more

you sell: Fashionable clothing or restaurants for the snobbish appeal.

3. PLACE

Place represents the location where a product can be purchased. It is often referred

to as the distribution channel. It can include any physical store as well as virtual

stores on the Internet. A crucial decision in any marketing mix is to correctly identify

the distribution channels.

4. PROMOTION

Promotion represents all of the communications that a marketer may use in the

marketplace. Advertising, public relations and so on are included in promotion and

consequently in the 4Ps.

Advertising:

It takes many forms: TV, radio, internet, newspapers, yellow pages, and so on.

Public Relations:

Public relations are more subtle and rely mainly on your own personality. It is an

unpaid form of promotion. For example, you can deliver public speeches on subjects

such as economics, geo-economics, futurology to several organizations (civic groups,

political groups, fraternal organizations, professional associations). It is the

relationship maintained with these various organisations.

Sales Promotion:

It includes fair trades, coupons, and discounts and is linked to the sales strategy.

In a customer-centric era where organisations aim at gaining competitive advantage

by creating and managing excellent customer relationships the emphasis is as much

on customer retention as customer acquisition. These four P's are the parameters

that the marketing manager can control, subject to the internal and external

constraints of the marketing environment. The goal is to make decisions that center

the four P's on the customers in the target market in order to create perceived value

and generate a positive response.

The following table summarizes the marketing mix decisions, including a list of some

of the aspects of each of the 4Ps.

Summary of Marketing Mix Decisions

Product Price Place Promotion

Functionality/ Features

Appearance

Quality

Style

Size

Options

Packaging

Brand

Warranty

Returns

Service/Support List price

Discounts

Allowances

Financing

Payment Period

Credit Terms Channel members

Channel motivation

Market coverage

Locations

Logistics

Inventory

Transport Advertising

Personal selling

Public relations

Sales Promotion

Message

Media

Budget

The marketing mix is the combination of marketing activities that an organisation

engages in so as to best meet the needs of its targeted market as it helps to create and

communicate the differential advantage effectively.

Traditionally the marketing mix consisted of just 4 Ps.

For example, for a motor vehicle manufacturer like Audi:

• Produces products that are of the highest quality and fit for the needs of different

groups of consumers,

• Offers a range of cars at value for money prices, depending on the market

segmented they are targeted at,

• Sells the cars through appropriate outlets such as dealerships and showrooms in

prime locations, i.e. in the right places, and

• Supports the marketing of the products through appropriate promotional and

advertising activity.

Getting the mix of these elements right enables the organisation to meet its

marketing objectives and to satisfy the requirements of customers.

In addition to the traditional four Ps it is now customary to add some more Ps to the

mix to give us Seven Ps. The additional Ps have been added because today marketing

is far more customer oriented than ever before, and because the service sector of the

economy has come to dominate economic activity in this country. These 3 extra Ps

are particularly relevant to this new extended service mix.

The three extra Ps are:

1. PHYSICAL LAYOUT / PHYSICAL EVIDENCE

Today consumers typically come into contact with products in retail units - and they

expect a high level of presentation in modern shops - e.g. record stores, clothes shops

etc. Not only do they need to easily find their way around the store, but they also

often expect a good standard or presentation.

The importance of quality physical layout is important in a range of service

providers, including:

• Students going to college or university have far higher expectations about the

quality of their accommodation and learning environment than in the past. As a

result colleges and universities pay far more attention to creating attractive learning

environments, student accommodation, shops, bars and other facilities.

• Air passengers expect attractive and stimulating environments, such as interesting

departure lounges, with activities for young children etc.

• Hair dressing salons are expected to provide pleasant waiting areas, with attractive

reading materials, access to coffee for customers, etc.

• Physical layout is not only relevant to stores, which we visit, but also to the layout

and structure of virtual stores, and websites.

2. PEOPLE

Customers are likely to be loyal to organisations that serve them well - from the way,

in which a telephone query is handled, to direct face-to-face interactions. Although

the 'have a nice day' approach is a bit corny, it is certainly better than a couldn't care

less approach to customer relations. Call centre staff and customer interfacing

personnel are the front line troops of any organisation and therefore need to be

thoroughly familiar with good customer relation's practice.

3. PROCESSES

Associated with customer service are a number of processes involved in making

marketing effective in an organisation e.g. processes for handling customer

complaints, processes for identifying customer needs and requirements, processes

for handling orders, etc.

The 7 Ps - price, product, place, promotion, physical evidence, people and processes

comprise the modern marketing mix that is particularly relevant in service industry,

but is also relevant to any form of business where meeting the needs of customers is

given priority.

Consumers are constantly being interrupted by thousands of marketing messages,

making it easy for one message to get lost in the overwhelming clutter of

communications. Plus, consumers no longer have a well-defined set of products and

vendors that they will consistently seek out to fulfill a need.

The four Ps represent the seller’s view of the marketing tools available for influencing

buyers. From a buyer’s point of view, each marketing tool is designed to deliver a

customer benefit. In the words of Philip Kotler, parity can be established between

how the 4 P's of marketing deliver a customer benefit and can pave way for the 4 C's

of marketing

Four P's vs Four C's

Product=Customer Solution/ Value

Price=Customer Cost

Place=Convenience

Promotion=Communication

Winning companies are those that can meet customer needs economically and

conveniently and with effective communication.

Success will arrive at a company's doorstep when it uses the correct combination of

the 4 C's and by developing products as per customer needs, provides economically

viable options conveniently to it's customers through the appropriate means of

communication.

CONSUMER BEHAVIOUR

Consumer Psychology:

Consumer psychology can be defined as the scientific study of the behaviour of

consumers. A consumer is an individual who uses the products, goods, or services of

some organization. It decides the personality, taste, attitudes of individuals or

groups, life style, preferences especially on occasions like marriage. The

demonstration influence is also dependent upon psychology of an individual.

Psychology of consumers is commonly known as study of lifestyle of consumers.

Study of consumer psychology is the most important part of the consumer behaviour

research, because it helps to know the attitude of the customers, his level of learning,

knowledge, perceptions, personality, his motivation of buying a particular product or

service. It helps to understand the psychology of different types of customers based

on age, sex, income level, , education , their rural or urban buy ace. For instance a

person living in Mumbai or Delhi thinks differently from person living in Bihar,

Jharkhand or Chhattisgarh, their psychology is different, their thinking about

product and services are different and their needs and perceptions are different from

urban elite. The study of psychology helps marketers to segment markets and

produce goods according to their requirement rather than thrusting same product on

all. For instance, psychology of rural population of older generation is to wear only

dhoti, they will not buy trousers whatever efforts are made. Similarly, large

percentages of them do not wear shoes or chappals. Similarly, they do not use

toothpaste to clean their teeth. Many of them depend on Neem or babul stick (Datun)

for cleaning teeth and some use tooth powder. Why they have thinking and practice

as they have can be understood only by studying their psychology and there after

draw a sales promotion or marketing strategy accordingly. If this is not done

marketing efforts will go waste and will not give results expected from

advertisements and other sales promotion offers.

The study of consumer psychology will make us understand, “How do we make the

market work better so that customers can make better decisions about what to buy”.

If for social purpose , India has to reduce consumption of alcohol one has to find out

through research why people drink? When in our country number of states

prohibited drinking from time to time it was utter failure because prohibition was

imposed without studying the psychology of the drinkers. However, in case of

cigarettes, when it was told that smoking is injurious to health and can cause cancer,

it had some impact and the absolute consumption of cigarettes has declined. If

prohibition was imposed after studying how often and what problems are faced by

discontinuing drinking alcohol and what have been their responses to their problems

and their solutions might have been found, the result would have been more

encouraging.

Children are psychologically vulnerable to specific advertisements but before making

such advertisements, their psychology will have to be studied first to market products

and services needed by them and secondly by the state to protect them against

misuse of their psychology.

Study od psychology is an important tool for researchers and if one does not have

resources to go in depth, study of consumer psychology can help in great deal. For,

eg, the psychology of rural masses in our country is to like bright colours especially

red, blue and yellow. Therefore its intelligent to manufacture fabrics in these colours

for the rural area.

But, at the same tie, psychology is to try a product out which is advertised because TV

has reached every corner of the country. It seems that villagers are as much

concerned about commercials as the urban dwellers. Therefore in north India, many

milkmen have purchased motorbikes to deliver milk. Farmers have adopted tractors,

thrashers, for cultivation.

Psychographics is another discipline which has to be used for study of consumer

behaviour. Psychographic research- studies life style of consumers to find out

markets for certain products like items of personal health care, cosmetics, items of

daily consumption like TV, car, drawing room furniture.

The stimulus situation is the complex of conditions that collectively act as a stimulus

to elicit responses from the consumer. This suggests that consumer behaviour is not

typically thought of

as being elicited by a single stimulus. Rather, consumer behaviour is considered to be

the consequence of patterns or constellations of stimuli. For example, when the

consumer purchases a can of "Coca-cola" brand beverage, that consumer behaviour

was not merely the result of the cost of the product. Instead, we would have to

consider the cost of the product, the characteristics of the advertisement of the

product, the packaging of the product, the individual's past experiences

with the product, the placement of the product on the shelf, and so on.

At first glance, this might appear frustrating to the budding consumer psychologist;

the stimulus situation that impacts upon the consumer seems to be unman¬

age ably complex. However, it is important to recognize that the world in which

consumers behave is, in reality, extremely complex, filled with continual

commer¬cials, pretty packaging, and confusing choices.

Studies have shown that More than 90% of learning and advertisement is incidental.

Advertisement does its job in the human brain and human brain does it in the

memories.

Consumer has a conscious and a sub conscious mind. Consciously he becomes aware

of a product or company, creates a perception, then he thinks and acts accordingly.

Sub consciously, a customer follows his stimulus.

Advertising is all about playing with the consumers emotions which are loosely

termed as expression of feelings. Emotions are result of priori assumption or

instincts. Moods are of less psychological urgency and are less intensive.

Perception is typically defined as the psychological processing of information

received by the senses. The result of the internal process of perception is aware¬ness

of the product, or awareness of attributes of the product. Cognition refers

to the processes of knowing or thought. The result of cognition is a collection of

beliefs about or evaluations of the product. Memory refers to the retention of

information regarding past events or ideas. The result of this process is the

acquisition, retention, and remembering of product information. Learning de¬

scribes a relatively permanent change in responses as a result of practice or

experience. The result of this internal process is the formation of associations

between stimuli or between stimuli and responses. Emotion is a state of arousal

involving conscious experience and visceral changes. The result of this internal

process is feelings about the product. Motivation is a state of tension within the

individual that arouses, directs, and maintains behaviour toward a goal. The result

of this internal process is desire or need for the product.

Belief:

Belief is based on cognition and knowledge as opposed to to affective (based on

feelings). Reebok shoes are aerodynamic and Volvo cars are safe. The stronger the

association of features or attributes with the product or brand, the stronger the

consumer’s belief. In terms of brand associations that brands are organised in the

consumer’s memory. Brand equity is a measure of the strength of those associations

in the marketplace. The stronger a brand is, the more readily it is retrieved from

memory, the more likely it is to be purchased, and, in most cases, the higher the level

of continuing loyalty it experiences. It is through positioning brands in the minds of

consumers that marketers attempt to establish or change consumer beliefs about

them. The marketers use the following positioning strategies thereby strengthening

or weakening beliefs, thereby increasing brand equity and market share.

Broadly there are three kinds of beliefs – central belief, central free belief, and

derived belief.

Central beliefs are based on the core rigid beliefs in life like health, discipline, etc.

Derived belief is any belief that stems out of central belief like Ftv should not be

banned (core belief is freedom of choice)

Central free belief is not an exclusive category and constantly keeps overlapping into

the rest two. Like cold milk cures acidity. It stays inspite of the rest of factors.

Product attributes –

The simplest and most common way of positioning products is through association of

specific attributes with a brand. Some marketers aim to make their products

synonymous with, for example, performance attributes that make consumers buy.

This differentiates them from private labels commonly found in chain supermarkets.

Consumer benefits –

Marketers attempt to influence consumer beliefs about brands by associating them

with important consumer benefits. A brand of shampoo with natural protein (an

attribute) is positioned to highlight the fact that it’s the only shampoo that will not

damage hair, no matter how frequently it is used (a benefit). A computer with touch

– screen entry (an attribute) attracts consumers looking for ease of use (a benefit).

Intangible attributes -

Product quality, technological leadership, and value for money are all intangibles –

non-functional factors or bundles of factors the consumer associates with a brand.

Car advertising typically relies on the power of intangibles to build brand equity. In

an interesting study of consumer beliefs, subjects were shown two brands of cameras

described in terms of intangible attributes – one was technically sophisticated and

the other easy to use. Detailed information was provided clearly showing that the

easy – to – use brand was, in fact, technically superior. When asked to recollect each

brand two days later, subjects simply remembered one as easy to use and the other as

technically sophisticated. They recalled not the detailed specifications they had read,

but the advertising they had read, but the advertising claims, demonstrating the

power of intangible attributes to influence consumer beliefs.

Price -

Consumers associate certain brands with a particular price or price range. Price,

particularly price relative to that of competitors, influences the way we retrieve brand

information from memory.

Application -

Consumers associate particular uses or applications with different brands. By

discovering the most common use of the product, marketers position brands to gain

market share. Eg: coffee is a drink to start the day, a break between meals, a break

with friends, a lunch or supper drink, etc.

Celebrity recognition -

We perceive celebrities in terms of their personalities and the values they represent.

Through celebrity recognition, marketers associate brands with a celebrity endorser

and so connect the celebrity’s personality and values with them. Consumers

ultimately respond to the brand in the same positive way in which they respond to

the brand in the same positive way in which they respond to the celebrity.

Brand personality -

Several successful campaigns manufacture a “personality’ with which to associate

brands. In a long and enduring rivalry, Coke is associated with a strong, family-

oriented, all- American image, whereas Pepsi is positioned as exciting, innovavtive,

fast-growing, and somewhat brash and pushy.

Product category -

Marketers create identifies for brands through strong association with a particular,

sometimes unexpected, product category. The most obvious example is the

positioning of 7up soft drink as the ‘uncola’ - the logical alternative to colas but with

better taste.

Competitors -

Marketers can purposely associate their brands with competitors in order to share

the consumer perceptions enjoyed by market leaders. A market follower tries to

capitilize on the well- established image of the market – leader, hoping this well

persuade consumers to make positive inferences about its product.

Country or Geographic area -

Brands can be associated with a particular country or geographic locale with a

reputation for quality. Japan, for example, is associated with high quality cars and

electronic goods, France with perfumes and fashion, Germany with cars, etc.

Value

Values are what are imbibed in us from childhood as a function of our surroundings,

our parents, family and friends, and our environment at schooling and college.

Indians and value

• High degree of value orientation has labeled Indians as the most discerning

consumers in the world. Even luxury brands like Swatch have to design a unique

pricing strategy for India.

• High degree of family orientation. This extends to extended family and friends as

well. Brands with identities that support family values tend to b strong. E.g. Colgate

• Values of nurturing and care are far more dominant than values of ambition and

achievement. Hence communication with feelings and emotions will gel better with

the consumers.

The value element attempts the marketer to build a personality for the product or

create an image of the product user.

Values differ from beliefs-

1. They are fewer in number

2. They are enduring and difficult to influence

3. They orient the individual towards beahaviour which is acceptable to his/ her

culture

4. They are not tied to specific situations

5. They are accepted by members of a society

Attitude

An attitude expresses how a person feels towards an object.

An attitude is primarily a learned predisposition to respond in a consistently

favorable or unfavorable manner with respect to a given object. Thus, an attitude is

the way we think, feel, and act towards some aspect of our environment, such as a

product (teabags), a brand (Tata tea), an advertisement for it, etc.

Characteristics of attitude

• Attitudes have an object

Attitudes must have a focal point. It could be a physical object (say, a Maruti), or a

service (ex. Customer care of ICICI Bank), or an action (ex. smoking)

• They have direction, intensity and degree

- Direction : the person is either for or against (favorably or unfavorably inclined

towards) an object

- Degree : the extent of like or dislike towards the object

- Intensity : how strongly a person feels about his conviction.

The direction, degree and intensity of a persons attitude towards an product provide

marketers with an estimate of how ready the customer is as far as purchase of a

product is concerned.

• They have a structure

Attitudes display a certain amount of organization. This implies that they have

internal consistency, are fairly stable, have varying degrees of salience and are

generalisable.

• They are learned.

Learning precedes attitude formation and change. They are also derived from both

direct and indirect experiences in life.

Components of attitude

1. Cognitive component

it primarily consists of a consumers belief about an object. These may or may not

conform to reality.

2. Affective component

A consumers feelings or emotional reactions towards an object represent the

affective component. It could be a vague, general feeling or something as a result of

cognitive evaluation.

3. Behavioural component

It is ones tendency to respond in a certain manner towards an object or activity. A

series of decisions to purchase or not to purchase a brand reflects this component of

attitude.

Habit

Often we find a convenient way of doing things, we tend to repeat it without really

thinking. A habitual decision making is characterized by-

a. Little or no information seeking, and

b. Little or no evaluation of alterbnatives.

Habit does not require a strong preference for an offering; rather, it is simply

repetitive behaviour and regular purchase.

Habit helps a consumer because-

a. He does not have to evaluate the brand every time, it saves time and effort for him.

b. It reduces risk for him.

Behaviour

There are three important implications for a marketer

• He should try to develop a repeat purchase behaviour among users

• He should try to wean away habitual purchasers of other brands.

• He should make sure that habitual purchasers of his own brand continue to do so.

Personality

Research into over the last decade has been dominated by semiotics, the study of

signs and their meanings. Consumer semiotics focuses on issues such a how

consumers use symbols to interpret the world, how those symbols are chosen and

given meaning, and how they provide insight into certain aspects of consumer’s life.

Consumer semioticians study not only immediate, spontaneous consumer actions or

response, they research the reasons behind such responses behind such responses,

they research the reasons behind thus, introspection, and repressed attitudes and

motives are all a part of consumer semiotics.

By understanding the relationship between the personality for consumers and their

purchase behaviour, marketers are better equipped to target and promote their

products effectively. Psychologists use two approaches : the state approach and the

trait approach.

State approach - it advocates understanding the individual in the context of the

whole. It is the study of personality that allows us to predict what a person will do in

a given situation.

Trait approach – the fundamental assumption of this approach is that we all share

the same traits, but they are expressed at different levels, resulting in different

personalities. Researchers analyze market segments to ascertain the extent of

influence of specific personality trait or combination of traits on the behaviour of

consumers in that segment.

An important fact to be taken into account when a consumer buys a brand is that he

is likely to select a brand which is in congruence with his/ her personality. Now,

though a brand is built on a functional platform, it is possible to develop a

personality for the brand using appropriate imagery. E.g. In the category of scooters,

LML Vespa created a personality around itself when the scooter category was

dominated by Bajaj. LML projected its personality as ‘ suave, sophisticated and

standing apart from the crowd”.

Self concept

In almost any category in consumer products, symbolism makes sue of the concept of

‘self’. Self- concept is the image an individual holds of himself or herself.

Consumers are likely to buy brands which enhance his or her self- image. These

possessions may be bought for functional or symbolic purposes, or both. For eg. A

young executive about to build his career in the corporate world may choose from

Van Heusen if he believes that the brand is likely to enhance his self-image.

There are a variety of self-concepts which are useful in marketing communication.

They are-

1. Actual self-concept: this is the way the individual perceives himself or herself. A

group of consumers may perceive themselves as rebellious non- conformists who

seek individuality and freedom in their lifestyles. Thus a line of “Born Free” will

appeal to them.

2. Ideal self-concept: This is concerned with how an individual would ideally like to

perceive himself. The thin line of difference is that the ideal self-concept is based on a

future aspiration, deeper than the active self-image. The individual may use status to

impress others, but will resist from doing so ina situation where he feels others do

not matter

3. Expected self-concept: this is midway between the actual and ideal self- images. It

is more likely to be useful to marketers because changing the actual self-image

radically to the ideal image is difficult. The expected self- image is the one that the

consumer can actually identify with.

.

Consumer Decision Process

The decision-making process consists of a series of steps which the consumer

undergoes. First of all, the decision is made to solve a problem of any kind. For this,

information search is carried out. This leads to the evaluation of alternatives and a

cost benefit-analysis is made to decide which product and brand image will be

suitable, and can take care of the problem suitably and adequately. Thereafter the

purchase is made and the product is used by the consumer. The constant use of the

product leads to the satisfaction or dissatisfaction of the consumer, which leads to

repeat purchases, or to the rejection of the product.

The marketing strategy is successful if consumers can see a need which a company’s

product can solve and, offers the best solution to the problem. For a successful

strategy, the marketer must lay emphasis on the product/brand image in the

consumer’s mind. Position the product according to the customers’ likes and dislikes.

The brand which matches the desired image of a target market sells well.

Sales are important and sales are likely to occur if the initial consumer analysis was

correct and matches the consumer decision process. Satisfaction of the consumer,

after the sales have been effected, is important for repeat purchase. It is more

profitable to retain existing customers, rather than looking for new ones. The figure

below gives an idea of the above discussion.

The Process of Decision Making

.

Problem recognition:

Problem recognition is that result when there is a difference between one's desired

state and one's actual state. Consumers are motivated to address this discrepancy

and therefore they commence the buying process.

Sources of problem recognition include:

• An item is out of stock

• Dissatisfaction with a current product or service

• Consumer needs and wants

• Related products/purchases

• Marketer-induced

• New products

The relevant internal psychological process that is associated with problem

recognition is motivation. A motive is a factor that compels action.

Information Search:

Once the consumer has recognised a problem, they search for information on

products and services that can solve that problem. Consumers undertake both an

internal (memory) and an external search.

Sources of information include:

• Personal sources

• Commercial sources

• Public sources

• Personal experience

The relevant internal psychological process that is associated with information

search is perception. Perception is defined as 'the process by which an individual

receives, selects, organises, and interprets information to create a meaningful picture

of the world'

Selective exposure consumers select which promotional messages they will expose

themselves to. Selective attention consumers select which promotional messages

they will pay attention to. Selective comprehension consumer interpret messages in

line with their beliefs, attitudes, motives and experiences. Selective retention

consumers remember messages that are more meaningful or important to them.

Understanding the consumers’ perception is essential for the development of an

effective promotional strategy. First, which sources of information are more effective

for the brand and second, what type of message and media strategy will increase the

likelihood that consumers are exposed to our message, that they will pay attention to

the message, that they will understand the message, and remember our message.

Information evaluation:

Consumers evaluate alternatives in terms of the functional and psychological benefits

that they offer. The marketing organization needs to understand what benefits

consumers are seeking and therefore which attributes are most important in terms of

making a decision.

The relevant internal psychological process that is associated with the alternative

evaluation stage is attitude formation. Attitudes are 'learned predispositions' towards

an object. Attitudes comprise both cognitive and affective elements - that is both

what you think and how you feel about something. The multi-attribute attitude

model explains how consumers evaluate alternatives on a range of attributes. The

marketing organisation should know how consumers evaluate alternatives on salient

or important attributes and make their buying.

Purchase decision:

Once the alternatives have been evaluated, the consumer is ready to make a purchase

decision. Sometimes purchase intention does not result in an actual purchase. The

marketing organization must facilitate the consumer to act on their purchase

intention. The provision of credit or payment terms may encourage purchase, or a

sales promotion such as the opportunity to receive a premium or enter a competition

may provide an incentive to buy now. The relevant internal psychological process

that is associated with purchase decision is integration.

Post purchase evaluation:

This is an important stage as this will let the marketer know whether the consumer

was satisfied with the product. A feedback mechanism is thus considered so as to

understand the needs of the consumers and improve the product accordingly.

Creating satisfied customers

CONSUMER BUYING ENVIRONMENT

Almost all of us are involved in taking decisions related to the various aspects of our

lives. The process by which a person is required to make a choice from various

alternative options is referred to as decision making.

For firms, providing consumers with alternatives is a good business strategy and can

also result in substantial increase in sales. While, the consumer will be pleased when

able to choose and decide on the best from the alternatives available.

Different Views on Consumer Decision Making

An Economical View or Model

Economists believe that consumers derive some utility (feeling of satisfaction) from

consuming a particular product and so their consumption activity will be directed

towards pursuing maximisation of utility. This the reason why if given a certain

amount of purchasing power, and a set of needs and tastes, a consumer will allocate

his expenditure over different products at given prices rationally so as to maximise

utility.

A Cognitive View or Model

This model of a man as a thinker, views consumer as an information processor. And

all the focus is on the processes by which consumers seek and evaluate information

about the concerned brands and the respective retail outlets. The consumer will

finally take the decision based on his satisfaction of the information received. In

other words, this model talks about a person who, in the absence of the total

information or knowledge of the available product alternatives, would actually seek

‘satisfactory information’ and thereby attempt to make satisfactory decisions

accordingly.

An Impulsive or Economic View of Consumer

Consumers can be emotional or impulsive while taking purchase decisions.

Consumers are involved in purchases by impulse or by whim. For such emotional

buying, the consumer may not undergo the usual process of carefully searching,

evaluating and then deciding on the brand or outlet to purchase from. Rather he is

most likely to purchase the product (brand) based on a whim or an impulse. Such

consumer decisions are said to be emotionally driven.

For emotional or impulsive purchases, it is the absence of a search for pre-purchase

information, it is the mood and feelings of the consumer which decide on the

emotional purchase decision. Emotional decisions could be rational to some extent

also. That is, the consumer may take an emotional decision to purchase a product but

he will be rational while deciding or choosing one brand over the other.

Even when consumers are purchasing various types of products, they may not be

rational in their decision making. For instance, very often when purchasing apparel

or dresses, more than rationality it the feeling (emotion) which will make the

consumer purchase a particular brand of designer clothing. Hence the consumer will

make the decision based on the name of the particular brand which will add to his

feeling of status.

Related to consumer emotions and feelings is the ‘mood’ of the person. Mood may be

defined as a feeling or a state of mind. The basic difference between an emotion and a

mood is that the former is a response to a particular environment, while mood is an

unfocused, pre-existing state already present, when the consumer gets motivated or

experiences a positive feeling about an advertisement, or the retail brand or outlet or

product.

CONSUMER NEEDS AND MOTIVATION

Marketers want to know what motivates the consumers. Basically, this is needed so

that they can shape and influence human behavior.

Concept of Motivation

Motivation asks the question 'why' about human behavior. For example, why do they

prefer McDonald's hamburgers than Nirula's Burgers?, Why are you reading this

book?, Why he buys only from Bigjos? etc.

Very few answers to question “why?” are simple and straightforward. No one

observing your behavior knows for sure why you are behaving in a particular

manner.

"A person is said to be motivated when his or her system is energized (aroused),

made active and behavior is directed towards a desired goal".

Components of Motivation are:

Before we go in deep, let us know the place of motivation in Buying Behavior.

Following diagram shows that a given instance of buying behavior is the result of

three factors multiplied by each other, the ability to buy something, the opportunity

to buy it and the motivation i.e. the wish, the need or the desire to do so.

It is important for marketers to realize that motivation is only one of the essential

elements that contribute to buying behavior as given above. No amount of love or

money or other incentive could motivate the person who is not able to walk.

Similarly, if a shopkeeper is offering sale on all the items but he / she is open on

weekdays only up to 6.00 p.m., even if people are motivated the shopkeeper is giving

very little opportunity to act on their motivation.

Similarly, suppose a company is offering a new product line and spending much on

heavy advertisement but not ensuring that the products are available in all the

outlets.

Needs, Goals and Motives

Motivation can also be described as the driving force within individuals that impels

them to action. As shown in the figure, this driving force is the result of tension,

which in turn is because of unfulfilled needs. To reduce tension, every individual

strives for fulfilling his or her needs. This basi¬cally, depends on each individual how

he or she fulfills his or her needs i.e. individual thinking and learning (experiences).

Therefore, marketers try to influence the consumer's cognitive processes.

Needs

Every individual has needs; they are innate and acquired. Innate needs are also

called physiological needs or primary needs, which include food, water, air, shelter or

sex, etc. Acquired needs are those needs that we learn from our surroundings /

environment or culture. These may include need for power, for affection, for prestige,

etc. These are psychological in nature; therefore they are also called as secondary

needs.

Goals

Goals are the end result of motivated behavior. As in the above diagram every

individual's behavior is goal-oriented. From marketer point of view, there are four

types of goals.

(a) Generic goals — General classes of goals that consumers select to fulfill their

needs. For example, need for washing hands.

(b) Product specific goals — For washing hands what kind of product is used. For

example, use soap, liquids etc.

(c) Brand specific goals — For example, which soap - Lux, Pears etc., to be purchased.

(d) Store specific goals — From where that product must be purchased.

Goal Selection — The goals selected by individuals depend on their personal

experiences, physi¬cal capacity, goal's accessibility in the physical and social

environment and above all the individual's cultural norms and values.

For example, if a person has a strong hunger need, his/her goal will depend on what

is available at that moment, in which country he is i.e., if in India cannot eat steak, as

it is against his values and beliefs. He will have to select a substitute goal that is more

appropriate to the social environment. An individual's own perception of his/her also

influence the selection of the goal. The products a person owns, would like to own, or

would not like to own are often perceived in terms of how closely they are congruent

with the person's self image. It is seen that usually that product is selected by an

individual that has a greater possibility of being selected than one that is not.

Needs and goals are interdependent; existence of one is impossible without the other.

For example, sometimes people join a club but is not consciously aware of his social

needs, a woman may not be aware of her achievement needs but may strive to have

the most successful boutique in town. One reason for this can be that individuals are

more aware of their physiological needs than they are of their psychological needs.

Motives

Consumer researchers have given two types of motives-rational motives and

irrational (emotional) motives. They say, that consumers behave rationally when

they consider all alternatives and choose those that give them the greatest utility.

This is also known as economic man theory. Marketers meaning of rationality is

when consumers select goals based on totally objective criteria such as size, weight or

price, etc. Emotional motives imply the selection of goals according to personal or

subjective criteria. For example, desire for status, individuality, fear of owning the

product (from society), pride, affection, etc.

It is assumed that consumers always attempt to select alternatives that in their view

serve to maximize satisfaction. The measurement of satisfaction is a very personal

process, based on the individual's own needs structure as well as on past behavioral

and social experiences. It is seen that what may appear irrational to others may be

perfectly rational in consumer's opinion. For example, if an individual purchases a

product to enhance self-image and considers this to be a rational decision and if

behavior does not appear rational to the person at the time of purchasing then he

would have not purchased. Therefore, it is very difficult to distinguish between

rational and emotional consumption motives.

Can Needs be Created?

This is a very ancient question about marketing and motivational research can help

us provide an answer to it. Like the products ‘Hit’ spray for cockroaches and ‘Hit’ for

mosquitoes. The consumers decided for themselves that the psychological

satisfaction obtained from using the cockroach spray was more important to them

than the need for a cleaner and more efficient product.

People say that needs are created for them by the marketer through subliminal. To

some extent one can influence the consumer through subliminal percep¬tion, the

effects are probably not very great or very specific. So, there is no evidence

whatsoever that anyone can create a need in a consumer.

Marketers and advertisers can only try to stimulate an existing need or can channel

consumers need in a certain direction towards one product or brand rather than

another, but the results are unpredictable.

Nature of Motivation

Motivation means the driving force within individuals that impels them to action. It

is considered to be dynamic in nature as is constantly changing in reaction to life

experiences.

Needs and goals are constantly changing because of an individual's physical

condition, social circle, environment and other experiences. When one goal is

achieved, an individual tries to attain the new ones. If they are unable to attain,

either they keep striving for them or finds out the substitute goal. Psychologists have

given certain reasons to support the statement "Needs and goals are constantly

changing"—

(1) An individual's existing needs are never completely satisfied, they continually

impel them to attain or maintain satisfaction.

(2) As one need is satisfied, the next need emerges.

(3) An individual who achieves their goals set new and higher goals for themselves.

Needs are never fully satisfied— Most of the human needs are never permanently

satisfied. For example, most people need continuous approval from others to satisfy

their social needs. There are various examples in our surroundings that show

temporary goal achievement does not fully satisfy the need for power and every

individual keeps striving to satisfy the need more fully. Some re¬searchers say that

new needs emerge as old needs are satisfied. In motivational theories, researcher

McGuire's Psychological Motives

The classification of motives by McGuire is more specific and used more in

marketing.

1. Need for consistency

People try to buy things that are consistent with their liking and taste. A

sophisticated person will be consistent in his choice of colors of clothing, paintings

on the wall, color of rooms. He would prefer sophisticated instead of flashy objects.

2. Need to attribute causation

We often attribute the cause of a favorable or unfavorable outcome to ourselves or to

some outside element. You can buy shoes by your choice and may not like them. It

can be attributed to you. If you buy a dress by the advise of your friends and

companions, and do not like it, the causes are attributed to other factors.

3. Need to categorize

The objects are categorized in a number of ways. The most popular is the price. Cars

can be classified around Rs. 2 lakhs or above Rs. 5.5 lakhs. Many products are

categorized at 499.00 to keep them under Rs. 500. This is practiced in shoes mainly

by Bata and others.

4. Need for cues

These are hints or symbols that affect our feelings, attitudes, impressions, etc. For

instance, clothing can be a cue to adopt a desired lifestyle. Providing proper cues to

the purchasers can enhance the use of products.

5. Need for independence

Consumers like to own products that give them a feeling of independence; symbols

like a white bird flying may predict one to be free and independent.

6. Need for novelty

We sometimes want to be different in certain respects and want to be conspicuous.

This is evident in impulse purchasing or unplanned purchasing. We go in for novelty

products, novelty experiences. A different kind of travel with many novelties offered

by a traveling agency.

7. Need for self-expression

We want to identify ourselves and go in for products that let others know about us.

We may buy a suit not only for warmth but also for expressing our identity to others.

8. Need for ego defense

When our identity is threatened or when we need to project a proper image, we use

products in our defense, Deodorants are used for ego defense. Mouthwash for fresh

breath or, false teeth to protect our image. We use hair dye to look younger better,

etc. We rely on well-known brands to give a correct social image of ourselves.

9. Need for assertion

Engaging in those kinds of activities that bring self esteem and esteem in the eyes of

others fulfills these needs. We can buy an expensive car, which may be for esteem,

but, if it does not perform well, we tend to complain bitterly. Individuals with a

strong need for self-esteem tend to complain more with the dissatisfaction of the

product.

10. Need for reinforcement

When we buy a product that is appreciated by others, it reinforces our views, our

behavior, our choice and we go in for repeat purchases. More products can be sold if

their reinforcement is greater by their purchases.

11. Need for affiliation

We like to use products that are used by those whom we get affiliated to. If one's

friend appreciates and wears a certain brand then one also tries to use the same

brands or objects for affiliation. It is the need to develop mutually helpful and

satisfying relationships with others. Marketers use the-affiliation themes in

advertisements that arouse emotions and sentiments in the minds of the consumers

for their children and families.

12. Need for modeling

We try to copy our heroes and our parents and those we admire. We base our

behavior on the behavior of others. Marketer's use these themes for selling their

product, i.e. "Lux is used by heroines". "Sportsman rely on boost for their energy"

and such captions are used regularly and repeatedly.

13. Utilitarian and Hedonic Needs

Utilitarian needs are to achieve some practical benefit such as durability economy,

warmth etc that define product performance. Hedonic needs achieve pleasure from

the product they are associated with Emotions & fantasies is derived from consuming

a product.

A Hedonic Need is more experiential—The desire to be more masculine or feminine

etc. Hedonic advertising appeals are more symbolic & emotional. For utilitarian

shoppers the acquiring of goods is a task whereas for Hedonic shoppers it is a

pleasurable activity. Shopping Malls may be considered as gathering places and

consumers/buyers derive pleasure from these activities besides the selection of

goods.

Murray's List of Psychogenic Needs

1. Needs Associated With Inanimate Objects

Acquisition

Conservancy

Order

Retention

Construction

2. Needs That Reflect Ambition, Power, Accomplishment, And Prestige

Superiority

Achievement

Recognition

Exhibition

Inviolacy (inviolate attitude)

Infavoidance (to avoid shame, failure, humiliation, ridicule)

Defendance (defensive attitude)

Counteraction (counteractive attitude)

3. Needs Concerned With Human Power

Dominance

Deference

Similance (suggestible attitude)

Autonomy

Contrariance (to act differently from others)

4. Sadomasochistic Needs

Aggression

Abasement

5. Needs Concerned With Affection Between People

Affiliation

Rejection

Nurturance (to nourish, aid, or protect the helpless)

Succorance (to seek aid, protection, or sympathy)

6. Needs Concerned With Social Intercourse (The Needs To Ask And Tell)

Cognizance (inquiring attitude)

Exposition (expositive attitude)

Maslow's Hierarchy of Needs

Human needs tend to be diverse in content as well as in length. Dr. Abraham Maslow

has formu¬lated a widely accepted theory of human motivation based on hierarchy

of human needs, which is universally accepted. He has stated five basic levels of

human needs which rank in order of importance from lower level (psychological)

needs to highest level (physiological) needs. This theory suggests that all individuals

try to satisfy the lower level needs before higher level needs emerge. The lower level

of unsatisfied needs that an individual experiences serves to motivate his or her

behavior. When this needs is satisfied, then a higher level need emerges and again

tension appears. To reduce this tension, the individual gets motivated and fulfills it.

When this need is satisfied, a new i.e., higher need emerges and the process goes on

in the life span of an individual.

Maslow's hierarchy of needs in diagrammatic form

(1) Physiological — housing, food, drink, clothing.

(2) Safety — insurance, burglar alarms, fire alarms, cars with air bags.

(3). Social — greeting cards, holiday packages, team sports equipment.

(4) Self-esteem — high status brands, goods or services like owning microwave etc

(5) Self-actualization — educational services etc.

According to this theory, however, there is some overlap between each level, as no

need is ever completely satisfied. For this reason, though all levels of need below the

dominant level continue to motivate behavior to some extent, the prime motivator—

the major driving force within the individual is the lowest level of needs that remains

largely unsatisfied.

1. Physiological Needs

Products in this category include, foods, health foods, medicines, drinks, house

garments, etc.

This is the first and most basic level of needs, which are called Physiological needs.

These needs are also called primary needs, which are required for sustenance for

example, food, water, air, shelter, clothing, sex (all biogenic needs).

According to Maslow, physiological needs are dominant when they are chronically

unsatisfied. For example, a man who is very hungry, then no other thing interests

him than food. He dreams food, he remembers food, he perceives only food.

2. Safety Needs

Products are locks, guns, insurance policies, burglar alarms, retirement investments,

etc.

After the physiological needs are fulfilled, safety and security needs become the

driving force behind an individual's behavior. These are concerned with physical

safety, for example, order, stability, familiarity, routine, control over one's life and

environment, and certainty, etc. This means a person will eat lunch not only that day

but also every day far into the future. Safety means not only healthwise but

individual needs, other securities like need for saving accounts, insurance.

3. Social Needs

Products are general grooming, entertainment, clothing cosmetics, jewellery, fashion

garments.

The third level of Maslow's hierarchy includes such needs as love, affection,

belonging and acceptance. Advertisers of personal care products often emphasize all

these social motives in their advertisements.

4. Egoistic Needs

Products are furniture, clothing, liquor, hobbies, fancy cars.

This is the fourth level of Maslow's hierarchy of needs. According to Maslow, this

becomes operative when the social needs of a person are more or less satisfied.

Egoistic needs can be inward or outward or both oriented. An individual with inward

-directed ego needs reflect need for self-acceptance, for self-esteem, for success,

independence etc. An outward-directed ego needs includes need for reputation, for

status, for recognition from others.

5. Self-Actualization

Products are education, art, sports, vacations, garments, foods.

This was not coined by Maslow but was done by Gestalt theorist called Kurt

Goldstein but he popularized it. Maslow explained the term in brief, by saying that

individual at this stage has need to actualize or realize all of one's unique potential

and what one can be. This need can rarely be fulfilled; moreover, very few of the

people reached this level. The more self-actualized people become, the more they

want to become. This is a motivation with its own inner dynamic.

Maslow did not say these five levels to form a totally rigid hierarchy. He says that the

same person can experience more than one level of need at the same time. Marketers

have generally found Maslow's hierarchy to be conceptually stimulating in

understanding consumer motivation and for framing out advertising strategies.

Specific products are often targeted at specific level of need, like

An Evaluation of the Need Hierarchy and Marketing Applications

Maslow's hierarchy-of-needs theory postulates a five-level hierarchy of prepotent

human needs Higher-order needs become the driving force behind human behavior

as lower-level needs are satisfied The theory says, in effect that dissatisfaction, not

satisfaction, motivates behavior

The need hierarchy has received wide acceptance in many social discipline because it

appears to reflect the assumed or inferred motivations of many people in our society.

The five levels of need postulated by the hierarchy are sufficiently generic to

encompass most lists of individual needs The major problems with this theory are

(1) Concepts are too general: It is said that hunger and self-esteem are considered to

be similar needs but the former is urgent and involuntary in nature whereas latter is

a conscious and voluntary type.

(2) This theory cannot be tested empirically: This means that there is no way to

measure precisely how satisfied one need must be before the next higher need

becomes active.

Need hierarchy is also used for the basis of market segmentation with specific

advertising appeals directed to individuals on one or more need levels. For example-

cigarette ads, soft drink ads etc., often stress a social appeal by showing a group of

young people sharing good times as well as the product advertised. It is also used for

positioning products policies, education and vocational training etc.

Consumer choice is very important in satisfying all these needs, even the

physiological ones is of particular importance to marketing. We can see that how the

cola companies have replaced themselves with tap water to quench people's thirst.

And in particular why choose coke rather than Pepsi or vice versa. It is also

important to note that many products can be used to satisfy several different levels of

needs for example- a car, a book, telephone etc.

Marketing Strategies Based On Motivation

Consumers do not buy products. They buy motive satisfaction or problem solutions.

A person does not buy a sofa set but he buys comfort. A person does not buy

cosmetics but he buys hope for looking good. Marketers therefore try to find the

motives for buying, and build their products and marketing mixes around these

motives. A person may buy a product for a number of motives. One of them could be

reward for oneself or to self indulge in them or for a gift. Multiple motives are

involved in consumption. Therefore a marketer tries to find out:

(a) The motive for buying,

(b) How to formulate a strategy to fulfill these motives

(c) How to reduce conflict between motives.

How to discover motives

This is found out by asking questions from the respondent. Some motives are

disclosed by the respondent, others are not divulged or are hidden. For instance, you

ask a lady why she wears designer jeans. She can say that (a) they are in style (b) they

fit well (c) they are worn by her friends. These motives are disclosed. Latent motives

may not be disclosed. These may be (d) they show that I have money (e) they make

one look sexy and desirable (f) they show I am young (g) they project my slimness,

etc.

Manifest and latent motives

Another important method to find out the motives may be by "Motivational

Research" where indirect questions are asked to elicit the information from the

respondents. This is done by unstructured disguised interviews or questionnaires.

Once the motives have been known, the marketing strategy is designed around the

appropriate set of motives. While designing the strategy, the target market has to be

decided and the communication has to be chosen for the said target market. Since

there is more than one motive, more than one benefit should be communicated by

advertising and other methods of promotion.

In case of a Maurti car as shown in the figure the benefit of economy,

maneuverability, modern ideology must all be communicated. Usually, direct appeals

are used for manifest motives and, indirect appeals for latent motives. Sometimes

dual appeals are used and the target market has to be kept in mind.

Motivational conflicts

A consumer wants to fulfill a variety of needs by using a product, therefore, there are

conflicts in his mind as to which motive must be given more importance. It is a

conflict that has to be resolved. There are three types of motivational conflicts.

a. Approach-approach motivational conflict

There may be two acts of equally attractive choices to make. This can be reduced by

the timely release of an advertisement, so that both alternatives can be given

importance. A consumer may want a spacious car that is not large—Uno. A consumer

may want a medium size fridge with a lot of space inside or, a fridge with a

deepfreeze—double door fridge. These two choices create a conflict in the minds of

the consumers.

b. Approach avoidance motivational conflict

In this the consumer is faced both by positive and negative consequences in the

purchase of a particular products. If one likes chocolates and is diabetic. This conflict

can be resolved by taking sugar free chocolate, or in the case of Coca Cola-Diet free

Coke may resolve the conflict.

c. Avoidance-avoidance conflict

It faces the consumer with two undesirable consequences. Taking an injection once

or, taking a bitter medicine a number of times. This can be avoided by choosing a

lesser painful alternative according to the convenience of the consumer.

Positive And Negative Motivation

Motivation can be positive or negative in direction We may feel a driving force

toward some object or condition or a driving force away from some object or

condi¬tion For example, a person may be impelled toward a restaurant to fulfill a

hunger need, and away from motorcycle transportation to fulfill a safety need

Some psychologists refer to positive drives as needs, wants, or desires and to

negative drives as fears or aversions However, although positive and negative

motivational forces seem to differ dramatically in terms of physical (and some¬times

emotional) activity, they are basically similar in that both serve to initiate and sustain

human behavior For this reason, researchers often refer to both kinds of drives or

motives as needs, wants, and desires Some theorists distinguish wants from needs by

defining wants as product-specific needs Others differentiate between desires, on the

one hand, and needs and wants on the other Thus, there is no uniformly accepted

distinction among needs wants, and desires

Needs wants, or desires may create goals that can be positive or negative A pos¬itive

goal is one toward which behavior is directed, thus, it is often referred to as an

approach object. A negative goal is one from which behavior is directed away and is

referred to as an avoidance object. Because both approach and avoidance goals are

the results of motivated behavior, most researchers refer to both simply as goals

Consider this example A middle aged woman may have a positive goal of fitness and

joins a health club to work out regularly Her husband may view getting fat as a

negative goal, and so he starts exercising as well In the former case, the wife s actions

are designed to achieve the positive goal of health and fitness, in the latter case, her

husband's actions are designed to avoid a negative goal—a flabby physique

Sometimes people become motivationally aroused by a threat to or elimination of a

behavioral freedom, such as the freedom to make a product choice This

motiva¬tional state is called psychological reactance A classic example occurred in

1985 when the Coca-Cola Company changed its traditional formula and introduced

"New Coke " Many people reacted negatively to the notion that their "freedom to

choose" had been taken away, and they refused to buy New Coke Company

management responded to this unexpected psychological reaction by reintroducing

the original formula as Classic Coke and gradually developing additional versions of

Coke

RATIONAL VERSUS EMOTIONAL MOTIVES

Some consumer behaviorists distinguish between so-called rational motives and

emotional motives. They use the term rationality in the traditional economic sense

which assumes that consumers behave rationally by carefully considering all

alterna¬tives and choosing those that give them the greatest utility In a marketing

context, the term rationality implies that consumers select goals based on totally

objective criteria such as size, weight, price, or miles per gallon Emotional motives

imply the selection of goals according to personal or subjective criteria (e g, pride,

fear, affection, or status)

The assumption underlying this distinction is that subjective or emotional criteria do

not maximize utility or satisfaction However, it is reasonable to assume that

consumers always attempt to select alternatives that, in their view, serve to

maxi¬mize their satisfaction Obviously, the assessment of satisfaction is a very

personal process, based on the individual's own need structure, as well as on past

behavioral and social (or learned) experiences What may appear irrational to an

outside observer may be perfectly rational in the context of the consumer's own

psycholog¬ical field For example, a person who pursues extensive plastic facial

surgery in order to appear younger is using significant economic resources, such as

the surgical fees, time lost in recovery, inconvenience, and the risk that something

may go wrong To that person, the pursuit of the goal of looking younger and

utilization of the resources involved are perfectly rational choices However, to many

other persons within the same culture who are less concerned with aging, and

certainly to persons from other cultures that are not as preoccupied with personal

appearance as Westerners are, these choices appear completely irrational

Consumer researchers who subscribe to the positivist research perspective tend to

view all consumer behavior as rationally motivated, and they try to isolate the causes

of such behavior so that they can predict and, thus, influence future behavior

Experientialists are often interested in studying the hedonistic pleasures that certain

consumption behaviors provide, such as fun, or fantasy, or sensuality They study

consumers in order to gain insights and understanding of the behaviors consumers

display m various unique circumstances

The Dynamics of Motivation

Motivation is a highly dynamic construct that is constantly changing in reaction to

life experiences Needs and goals change and grow in response to an individual's

physical condition, environment interactions with others, and experiences As

individuals attain their goals, they develop new ones If they do not attain their goals,

they continue to strive for old goals or they develop substitute goals. Some of the

reasons why need-driven human activity never ceases include the following

(1) Many needs are never fully satisfied, they continually impel actions designed to

attain or maintain satisfaction

(2) As needs become satisfied, new and higher-order needs emerge that cause

tension and induce activity

(3) People who achieve their goals set new and higher goals for themselves

A. Needs Are Never Fully Satisfied

Most human needs are never fully or permanently satisfied For example, at fairly

regular intervals throughout the day individuals experience hunger needs that must

be satisfied Most people regularly seek companionship and approval from others to

satisfy their social needs Even more complex psychological needs are rarely fully

satisfied For example, a person may partially satisfy a power need by working as

administrative assistant to a local politician, but this vicarious taste of power may not

sufficiently satisfy her need, thus, she may strive to work for a state legislator or even

to run for political office herself In this instance temporary goal achievement does

not adequately satisfy the need for power and the individual strives harder in an

effort to satisfy her need more fully

B. New Needs Emerge As Old Needs Are Satisfied

Some motivational theorists believe that a hierarchy of needs exists and that new,

higher-order needs emerge as lower-order needs are fulfilled For example, a man

who has largely satisfied his basic physiological needs (e g, food, housing, etc.) may

turn his efforts to achieving acceptance among his new neighbors by joining their

political clubs and supporting their candidates Once he is confident that he has

achieved acceptance, he then may seek recognition by giving lavish parties or

build¬ing a larger house

C. Success And Failure Influence Goals

A number of researchers have explored the nature of the goals that individuals set for

themselves Broadly speaking, they have concluded that individuals who successfully

achieve their goals usually set new and higher goals, that is, they raise their level of

aspiration. This may be due to the fact that their success in reaching lower goals

makes them more confident of their ability to reach higher goals Conversely, those

who do not reach their goals sometimes lower their levels of aspiration Thus, goal

selection is often a function of success and failure For example, a college senior who

is not accepted into medical school may try instead to become a dentist or a

podiatrist

The nature and persistence of an individual's behavior are often influenced by

expectations of success or failure in reaching certain goals Those expectations, in

turn are often based on past experience A person who takes good snapshots with an

inexpensive camera may be motivated to buy a more sophisticated camera in the

belief that it will enable her to take even better photographs In this way, she

even¬tually may upgrade her camera by several hundred dollars On the other hand,

a person who has not been able to take good photographs is just as likely to keep the

same camera or even to lose all interest in photography

These effects of success and failure on goal selection have strategy implications for

marketers Goals should be reasonably attainable Advertisements should not promise

more than the product will deliver Products and services are often evalu¬ated by the

size and direction of the gap between consumer expectations and objec¬tive

performance Thus, even a good product will not be repurchased if it fails to live up to

unrealistic expectations created by ads that "over-promise " Similarly, a con¬sumer

is likely to regard a mediocre product with greater satisfaction than it war¬rants if its

performance exceeds her expectations

D. Substitute Goals

When an individual cannot attain a specific goal or type of goal that he or she

antic¬ipates will satisfy certain needs, behavior may be directed to a substitute goal.

Although the substitute goal may not be as satisfactory as the primary goal, it may be

sufficient to dispel uncomfortable tension Continued deprivation of a primary goal

may result in the substitute goal assuming primary-goal status For example, a

woman who has stopped drinking whole milk because she is dieting may actually

begin to prefer skim milk A man who cannot afford a BMW may convince himself

that a Mazda Miata has an image he clearly prefers

E. Frustration

Failure to achieve a goal often results in feelings of frustration At one time or

another, everyone has experienced the frustration that comes from the inability to

attain a goal The barrier that prevents attainment of a goal may be personal to the

individual (e g limited physical or financial resources) or an obstacle in the physical

or social environment (e g a storm that causes the postponement of a long-awaited

vacation) Regardless of the cause, individuals react differently to frustrating

situa¬tions Some people manage to cope by finding their way around the obstacle or,

if that fails, by selecting a substitute goal Others are less adaptive and may regard

their inability to achieve a goal as a personal failure Such people are likely to adopt a

defense mechanism to protect their egos from feelings of inadequacy

G. Defense Mechanisms

People who cannot cope with frustration often mentally redefine their frustrating

situ¬ations in order to protect their self-images and defend their self-esteem For

example, a young woman may yearn for a European vacation she cannot afford The

coping individual may select a less expensive vacation trip to Disneyland or to a

national park The person who cannot cope may react with anger toward her boss for

not paying her enough money to afford the vacation she prefers, or she may persuade

herself that Europe is unseasonably warm this year These last two possibilities are

examples respectively, of aggression and rationalization, defense mechanisms that

people some¬times adopt to protect their egos from feelings of failure when they do

not attain their goals. Other defense mechanisms include regression, withdrawal,

projection, autism, identification, and repression This listing of defense mechanisms

is far from exhaustive, because individuals tend to develop their own ways of

redefining frustrating situations to protect their self-esteem from the anxieties that

result from experiencing failure Marketers often consider this fact in their selection

of advertising appeals and construct advertisements that portray a person resolving a

particular frustration through the use of the advertised product

H. Multiplicity Of Needs

A consumer's behavior often fulfills more than one need In fact, it is likely that

spe¬cific goals are selected because they fulfill several needs We buy clothing for

protection and for a certain degree of modesty; in addition, our clothing fulfills a

wide range of personal and social needs, such as acceptance or ego needs Usually,

however there is one overriding (pre-potent) need that initiates behavior For

example, a young woman may consider joining a health club because she has nothing

special to do most evenings, she wants to wear midriff-baring clothes, and she wants

to meet men outside a bar setting If the cumulative amount of tension produced by

each of these three reasons is sufficiently strong, she will probably join a health club

However, just one of the reasons (e g , the desire to meet new men) may serve as the

triggering mechanism, that would be the prepotent need.

I. Needs and Goals Vary Among Individuals

One cannot accurately infer motives from behavior People with different needs may

seek fulfillment through selection of the same goal, people with the same needs may

seek fulfillment through different goals Consider the following examples Five people

who are active in a consumer advocacy organization may each belong for a different

reason The first may be genuinely concerned with protecting consumer interests, the

second may be concerned about an increase in counterfeit merchandise; the third

may seek social contacts from organizational meetings, the fourth may enjoy the

power of directing a large group, and the fifth may enjoy the status provided by

membership in an attention-getting organization

Similarly, five people may be driven by the same need (e g an ego need) to seek

fulfillment in different ways The first may seek advancement and recognition

through a professional career, the second may become active in a political

organization, the third may run in regional marathons, the fourth may take

professional dance lessons, and the fifth may seek attention by monopolizing class

room discussions

The Measurement of Motives

How are motives identified? How are they measured? How do researchers know

which motives are responsible for certain kinds of behaviors? These are difficult

questions to answer because motives are hypothetical constructs—that is, they

can¬not be seen, touched, handled, smelled or otherwise tangibly observed. For this

reason, no single measurement method can be considered a reliable index Instead

researchers usually rely on a combination of various qualitative research techniques

to establish the presence and / or the strength of various motives. Some

psychologists are concerned that many measurement techniques do not meet the

crucial test criteria of validity and reliability (Remember, validity ensures that the

test measures what it purports to measure; reliability refers to the consis¬tency with

which the test measures what it does measure.) Constructing a scale that measures a

specific need, while meeting both criteria, can be complex. For example, a recent

research project employed six different studies to develop and validate a seemingly

simply five-item scale to measure status consumption (defined as the ten¬dency to

purchase goods and services for the prestige that owning them bestows).

Respondents are asked to indicate their level of agreement or disagreement (a Likert

scale) on the following five items

1. I would buy a product just because it has status

2 I am interested in new products with status

3 I would pay more for a product if it had status

4 The status of the product is irrelevant to me

5 A product is more valuable to me if it has some snob appeal

The findings of qualitative research methods are highly dependent on the analyst,

they focus not only on the data themselves but also on what the analyst thinks they

imply By using a combination of assessments (called triangulation) based on

behavioral data (observation), subjective data (self-reports), and qualitative data

(projective tests, collage research, etc), many consumer researchers feel confident

that they are achieving more valid insights into consumer motivations than they

would by using any one technique alone Though some mar¬keters are concerned

that qualitative research does not produce hard numbers that objectively "prove" the

point under investigation, others are convinced that qualita¬tive studies are more

revealing than quantitative studies However there is a clear need for improved

methodological procedures for measuring human motives

Motivational Research

The term motivational research, which should logically include all types of research

into human motives, has become a "term of art" used to refer to qualitative research

designed to uncover the consumer's subconscious or hidden motivations Based on

the premise that consumers are not always aware of the reasons for their actions,

motivational research attempts to discover underlying feelings, attitudes, and

emo¬tions concerning product, service, or brand use

The Development of Motivational Research

Sigmund Freud's psychoanalytic theory of personality pro¬vided the foundation for

the development of motivational research This theory was built on the premise that

unconscious needs or drives—especially biological and sexual drives—are at the heart

of human motivation and personality Freud con¬structed his theory from patients'

recollections of early childhood experiences, analysis of their dreams, and the

specific nature of their mental and physical adjust¬ment problems

Dr Ernest Dichter, formerly a psychoanalyst in Vienna, adapted Freud's

psychoanalytical techniques to the study of consumer buying habits Up to this time

marketing research had focused on what consumers did (i.e. quantitative, descriptive

studies) Dichter used qualitative research methods to find out why they did n

Marketers were quickly fascinated by the glib, entertaining, and usually surprising

explanations offered for consumer behavior, especially since many of these

expla¬nations were grounded in sex For example, marketers were told that cigarettes

and Lifesaver candies were bought because of their sexual symbolism, that men

regarded convertible cars as surrogate mistresses, and that women baked cakes to

fulfill their reproductive yearnings Before long, almost every major advertising

agency in the country had a psychologist on staff to conduct motivational research

studies

By the early 1960s, however, marketers realized that motivational research had a

number of drawbacks Because of the intensive nature of qualitative research,

samples necessarily were small, thus, there was concern about generalizing findings

to the total market Also, marketers soon realized that the analysis of protective tests

and depth interviews was highly subjective The same data given to three different

analysts could produce three different reports, each offering it< own explanation of

the consumer behavior examined Critics noted that many of the projective tests that

were used had originally been developed for clinical purposes rather than for studies

of marketing or consumer behavior (One of the basic criteria for test development is

that the test be developed and validated for the specific purpose and on the specific

audience profile from which information is desired )

Other consumer theorists noted additional inconsistencies in applying Freudian

theory to the study of consumer behavior First, psychoanalytic theory was

struc¬tured specifically for use with disturbed people, whereas consumer

behaviorists were interested in explaining the behavior of "typical" consumers

Second, Freudian theory was developed in an entirely different social context

(nineteenth-century Vienna), whereas motivational research was introduced in the

1950s in postwar America Finally, too many motivational researchers imputed highly

exotic (usually sexual) reasons to rather prosaic consumer purchases Marketers

began to question their recommendations (e g , Is it better to sell a man a pair of

suspenders as a means of holding up his pants or as a "reaction to castration

anxiety"? Is it easier to persuade a woman to buy a garden hose to water her lawn or

as a symbol of "geni¬tal competition with males?")

Though they are not usually identified as motivational research techniques, there are

a number of associated qualitative research techniques that are used to delve into the

consumer's unconscious or hidden motivations These include collage research,

metaphor analysis, means-end analysis, and laddering All of these qualitative

research techniques provide invaluable insights to marketers who want to

understand the motives underlying consumer behavior

Evaluation Of Motivational Research

Despite its criticisms, motivational research is still regarded as an important tool by

marketers who want to gain deeper insights into the whys of consumer behav¬ior

than conventional marketing research techniques can yield Since motiva¬tional

research often reveals unsuspected consumer motivations concerning product or

brand usage, its principal use today is in the development of new ideas for

promotional campaigns, ideas that can penetrate the consumer's conscious

awareness by appealing to unrecognized needs For example, m trying to discover

why women bought traditional roach sprays rather than a brand packaged in lit¬tle

plastic trays, researchers asked women to draw pictures of roaches and write stones

about their sketches They found that, for many of their respondents roaches

symbolized men who had left them feeling poor and powerless The women reported

that spraying the roaches and "watching them squirm and die" allowed them to

express their hostility toward men and gave them feelings of greater control

Motivational research also provides marketers with a basic orientation for new

product categories and enables them to explore consumer reactions to ideas and

advertising copy at an early stage to avoid costly errors. Furthermore, as with all

qualitative research techniques, motivational research findings provide consumer

researchers with basic insights that enable them to design structured, quantitative

marketing research studies to be conducted on larger, more representative samples

of consumers.

Despite the drawbacks of motivational research, there is new and compelling

evidence that the unconscious is the site of a far larger portion of mental life than

even Freud envisioned Research studies show that the unconscious mind may

understand and respond to nonverbal symbols, form emotional responses, and guide

actions largely independent of conscious awareness.