Five Theories That All Marketers Should Understand
Fundamental theories to improve decision-making in business.
Really smart people come up with theories and frameworks to help us better understand how things work. Business is no different.
So as a business owner or marketer; if we know and understand these theories on the underlying processes behind how business works and how customer behave, the more objective we can be with our decision-making.
Meaning we have a better chance of success.
This article explores five theories and models that all business owners and marketers should understanding.
The Ansoff Matrix
The first theory is the Ansoff Matrix, a popular framework for decision-making about growth and expansion strategies. H. Igor Ansoff developed the framework, published by the Harvard Business Review in 1957.
The matrix is called the Product/Market Expansion Grid.
Ansoff’s thoughts were that firms must continuously grow and change to create a competitive advantage.
“Growth is essential to run a business for profit and, to study the growth, Ansoff Matrix is a planning technique used for deliberate judgment about firm growth through product and market extension networks.” (Hussain, Khattak, Rizwan, & Latif, 2013)
Ther are four components of the matrix:
- market penetration
- market development
- product development
By analysing their market through the matrix, firms can identify strategic alternatives to accomplish their growth objectives and analyse their risk.
Of the four strategies, market penetration hosts the least risk and diversification the most.
This strategy involves increasing the sales of existing products to an existing market. Firms aim to increase their market share, and they can achieve this in the following ways:
- A decrease in prices to attract new customers
- Increasing promotion and distribution
- Acquiring a competitor in the same marketplace
Often brands who are new to a marketplace engage a market penetration strategy through offering lower introductory prices.
The next strategy focuses on developing and introducing new products to existing markets, involving extensive research and development to expand its product range.
Firms usually use this method if a firm has a strong understanding of their current market, giving them the ability to meet the existing market’s needs by providing innovative solutions.
Characteristics of product development include:
- Investing in R&D to develop new products to cater to the existing market
- Acquiring a competitor’s product and merging resources to create a new product that better meets the need of the existing market
- Forming strategic partnerships with other firms to gain access to each partner’s distribution channels or brand
An example of this BMW and other premium automobile manufacturers adding an electric sports car model to their fleet of vehicles is to compete in the electric sports car market with Tesla and increase consumer demand for electric cars.
Entering a new market with existing products is called a market development strategy. This strategy could be expanding into new geographic areas, either domestically or internationally, or focusing on new customer segments (groups of buyers with similar needs).
Suppose a company holds a competitive advantage with a particular technology. In that case, firms can quickly transfer it to another marketplace with similar consumer behaviour characteristics, which should mean it is a profitable strategy.
For example, companies in New Zealand will often expand into neighbouring Australia if they are highly successful. Australia and New Zealand share similar consumer behaviour across many segments, meaning the product or service can remain virtually unchanged.
Using the introduction of new products as a strategy to enter a new market is called diversification.
This strategy is the riskiest in the Ansoff Matrix, as both market and product development is required. But it also offers the most significant potential for profitability by accessing consumer spending in a market they previously had no access to.
There are two types of diversification: related diversification and unrelated diversification.
Related diversification means there is an overlap between a business and the new product or market. For example, a company that produces plastic lunchboxes might start creating plastic bumpers for automobiles.
Unrelated diversification is where there is no overlap between the core business and the new product or market.
For example, if that same company producing plastic lunchboxes was to start manufacturing steel framing for construction.
That is the Ansoff Matrix. The next model I am going to discuss is Porter’s Five Forces.
Porter’s Five Forces
Firms commonly use Porter’s Five Forces to understand the market better and assess an industry’s competitiveness.
“According to Porter (1980), the collective strength of the forces determines the ultimate profit potential in the industry.” (Dobbs, 2014)
Michael E. Porter from the Harvard Business School created the model in 1979. He believed that a better understanding of an industry’s competitive intensity would help identify the attractiveness of entering that market.
Attractive markets have few competitors, or there might be a gap in the market that a business can target with strategic positioning.
Emphasising the importance of identifying imperfect markets offering more profitable opportunities, the model provides useful information to direct a businesses’ strategic approach and marketing.
Suppose they are an existing firm and want a better understanding of the current market. In that case, they can analyse their current position and plan their future direction by aligning it with their strengths and addressing their weaknesses.
If a new business or entering a new industry, they can highlight how they are most likely to succeed.
“…Account for long-term variances in the economic returns of one industry versus another… distilling the complex micro-economic literature into five explanatory or causal variables to explain superior and inferior performance.” (Grundy, 2006)
Applying ‘systems thinking’, the model simplifies several complicated microeconomic theories into just five components that impact a market’s long-term profitability:
- The bargaining power of the buyers
- The threat of new entrants
- Competitive rivalry
- Threat of substitution
- Supplier power
Competitive rivalry is the main box of the model, a function of the other four forces. It identifies the importance of negotiating power and bargaining arrangements — this focus on external factors more prominent than in other market analysis theories such as a SWOT analysis.
In specific marketplaces, buyers have more power and can apply pressure on companies to lower prices. If competition is high and the customer has many choices, they have a higher power.
Buyers can also join to have a more substantial influence on changing the behaviour of a firm.
For example, for ethical reasons, consumers might boycott a brand.
The threat of new entrants
What is the likelihood of new entries in the market? If firms perceive an industry as attractive, increased competition is highly likely.
If too many new entrants enter that market, its potential profitability will decline.
If a marketplace has few but influential players in it, they will try and make it as difficult as possible for new companies to enter that market. Other barriers to entering that market also need to be considered to do exit barriers. Entry barriers include government policies, patents and technology.
The current competition within the marketplace is an important consideration.
Understanding competitive rivalry uncovers how many competitors there are and how much they spend on marketing, what competitive advantages they have (if any), the level of continuous innovation and any differences in quality between players.
Threat of substitution
Customers might be able to choose to substitute a product or service with another. The threat is not to a competitor’s product from the same market — but instead, switching product categories altogether.
For example, a person might stop purchasing fast food and buy pre-made frozen healthy meals instead.
The more substitute items there are, the more likely an alternative product will lure customers.
Firms must research and consider different alternatives for supply in the market. For example, raw materials can vary significantly in terms of price, quality, and whether.
The right supplier is critical.
- How much power does that supplier have?
- How many competitors do they have?
- Will their price be consistent, or are they likely to increase it?
The fewer suppliers there are, the more power they have. The cost of switching suppliers and the ease of distribution is also a consideration.
That was Porter’s Five Forces.
The next theory I discuss is prominent in the marketing of services, called the Expectancy Disconfirmation Theory (or model).
The Expectancy Disconfirmation Theory
Expectation confirmation theory is a popular model used in services marketing for measuring customer satisfaction, introduced by Richard L. Oliver in 1977.
“An individual’s expectations are (1) confirmed when a product performs as expected, (2) negatively disconfirmed when the product performs more poorly than expected, and (3) positively disconfirmed when the product performs better than expected.” (Churchill & Surprenant, 1982).
Customers base their measurement on the performance of a product or service on a comparison against their expectations.
Those expectations or desires for performance (or experience) are subjective to each person, based on their prior knowledge of that product.
The performance then mediates for a customer’s satisfaction.
A person’s prior experiences with that brand influence their evaluation. Consumers without any expectations base their satisfaction judgements solely on the product’s performance.
The resulting difference between expectations and performance form the basis for the disconfirmation, which can be positive or negative.
A negative disconfirmation of the service results in a dissatisfied customer. A positive disconfirmation means the outcome exceeded expectations, so they are satisfied with consumption.
The theory has been applied across multiple fields to understand better customer’s expectations and requirements, such as marketing and consumer behaviour, tourism, psychology, information technology, and the airline industry.
The expectancy disconfirmation theory involves four primary variables: expectations, perceived performance, disconfirmation of beliefs, and satisfaction.
Consumers associate specific attributes or characteristics with a brand which that person anticipates. These expectations form the basis of comparison judgement — they directly influence both perceptions of performance and disconfirmation of beliefs and indirectly affect their post-purchase evaluations and feelings.
The basis for expectations of a brand, product, or service is feedback from friends and family, online reviews, marketing material, salespeople, and previous consumption experiences.
“First, customers have an initial expectation according to their previous experience with using a specific product or service. Second, new customers that don’t have a first-hand experience about performance of product or services.” (Elkhani, & Bakri, 2012)
After consumption, the consumer forms perceptions of the performance of a product, service or experience. These perceptions are influenced by their pre-purchase expectations, then affecting the disconfirmation judgement.
The basis for performance subjective depending on the product, service or experience — for example, for a mobile phone, one performance factor is how long the battery lasts.
Perceived performance can also indirectly influence customer satisfaction.
The judgments or evaluations that a person makes regarding a product, service or experience is called the disconfirmation of beliefs. Consumers make these in comparison to their original expectations.
If it outperforms expectations, the disconfirmation is positive. If it underperforms, the disconfirmation is negative. Thus, increasing or decreasing post-purchase satisfaction.
Disconfirmation mediates the relationship between performance and satisfaction.
Post-purchase satisfaction is the extent to how pleased, contented or unhappy a person is after consumption.
The consumer’s disconfirmation of a product or service’s perceived performance directly influences their satisfaction. Their expectations of performance influence this process.
How satisfied or dissatisfied a consumer has influenced their post-purchase behaviour, including their attitude towards the brand, their loyalty and whether they repeat purchase, and their word of mouth intent.
If people are happy, they are more likely to purchase again and tell friends about their positive experience.
That was the Expectancy Disconfirmation model. The fourth theory is the Product Life Cycle.
The Product Life Cycle
The lifecycle of a product is its length of time on the market. It begins when it is introduced into the market and lasting until firms take it off the shelves.
Demand increases with the successful introduction of a product to the market. Then, as new successful products enter the market, they push more dated ones from the market and replace them.
This concept is commonly used in marketing management, helping inform business decision-making, such as pricing, when to increase spending on advertising, expand to new markets, redesign packaging and cost-cutting.
This life cycle has four or five stages, depending on the source. The original model used four — market development, growth, maturity, and decline.
Other versions have added a fifth introduction, which is the second phase.
Where a product is in its life cycle impacts its marketing, new products have educational and informative marketing, whilst mature products have marketing which differentiates it from the alternatives.
Large manufacturers often have products each in various stages of the product life cycle at any given time.
Each stage has unique costs, opportunities and risks, and individual products with different lengths of time when they remain at any life cycle stages.
Stage 1 — Market Development & Introduction
When a firm brings a new product to market, typically, there will be some research and development behind it to make sure it fits a need and proven demand.
Before launching a product into the market, it accumulates costs with no sales. It could take years and a considerable investment of capital to develop and test some products. Therefore, a firm loses money before making money, so the launch is crucial.
Then comes the introduction to the market, where the goal is to build awareness of the product.
Marketing costs here are high. Firms often make a substantial investment in advertising to reach out to new potential customers. Marketing focuses on making consumers aware of the product and its benefits.
Pricing can sometimes be higher to recover costs associated with product development.
“Unit sales are low in introduction, because few consumers are aware of the new good (or service). With consumer recognition and acceptance, unit sales begin to increase… the start of the growth stage. …As more competitors enter the industry and the market becomes smaller… Unit sales reach a plateau, and the product is in the maturity stage.” (Rink, & Swan 1979)
Stage 2 — Growth
If a product launch is successful and customers accept the product, it enters the market growth phase as demand increases. The total market size inflates, sometimes called the ‘Take-off Stage’, because it aims to increase market share. The firm expands production, distribution and availability.
If innovation on a product is high and there’s little competition, pricing can remain high. Marketing aimed at a broad audience as demand and profits is both increasing.
Stage 3 — Maturity
As demand and sales levels off, a product enters the market maturity stage. Sales are the highest at this phase, and the costs of production decline as manufacturing become more efficient. There is also a reduction in marketing costs.
More alternative options become available to customers as competition increases.
Firms may look at updated product features to stay ahead of competitors and maintain market share. Prices also tend to decline to stay competitive.
Stage 4 — Decline
When products start to lose their appeal with consumers and sales reduce, they enter the market decline phase.
Market share is lost, often because of increased competition as new products enter the market, with other firms trying to emulate their success. These can be more suited towards customer needs with advancements in technology, such as lower prices.
Firms can choose to discontinue the product and remove it from the market, find new product uses to position it differently in the market, or perhaps by exporting the product into new markets.
In any case, the firm by now should be into the research and development phase for their next product.
That was the Product Lifecycle. The final theory I will discuss, and the most well-known because of its wide application, is the 80/20 rule.
The 80/20 rule
The 80/20 rule suggests that 80% of sales come from 20% of customers.
This theory dates to 1896, conceived by Italian economist Vilfredo Pareto, to explain wealth distribution when he noticed that approximately 20% of Italy’s total population owned 80% of Italy’s land.
It is thought that his initial observation was that 20% of the pea pods in his garden produced 80% of the peas!
“The Pareto Principle, which is sometimes called the 80/20 rule, states that a small proportion (e.g., 20 percent) of products in a market often generate a large proportion (e.g., 80 percent) of sales.” (Brynjolfsson, Hu & Simester, 2011).
The Pareto Principle
In the 1940s, Joseph M. Juran developed Pareto’s principle for strategic business management, naming it after Pareto — the Pareto Principle.
The underlying belief that the relationship between inputs and outputs is imbalanced and unequal. For many phenomena, 20% of the input/causes produce 80% of the output /consequences.
The rule transcends disciplines, with an application for numerous purposes across the business, including sales, marketing, economics, management and even computer sciences. 20% of athletes win 80% of the time, 20% of patients consume 80% of healthcare resources, and 20% of society holds 80% of the world’s wealth.
When applied to business, the underlying assumption is that 80% of the outcomes or results come from 20% of the effort. Other variations of this rule in a business context are:
- 80% of profits or revenue come from 20% of customers
- 80% of product sales from 20% of products
- 80% of sales from 20% of advertising
- 80% of customer complaints from 20% of customers
- 80% of sales from 20% of the sales team
However, this ‘rule’ is an observation rather than a law or science. The two numbers don’t have to add to 100% — it is a rule of thumb.
It could be 80–20, 90–10, or even 90–20.
We learn from this principle to focus your efforts by working harder on the things that matter — that 20% of activities provide 80% of results.
Do not worry about the small stuff if it does not change the overall effect.
“It helps to realize that often the majority of results comes from a minority of inputs.” (Dunford, Su, and Tamang, 2014)
Individuals and businesses should focus most of their time and energy on accomplishing the tasks with the largest investment return. They can do this by recognising how and where they achieve results.
Similarly, the focus on sales should be developing strong relationships with the best and most profitable clients.
That is the conclusion of the five theories and models that all marketers and business owners should understand.
The theories discussed are:
- The Ansoff Matrix
- Porter’s Five Forces
- The Expectancy Disconfirmation Model
- The Product Lifecycle, and
- The 80/20 Rule
That was a fair bit of information; I hope you can digest it all and learn something that will benefit you and/or your business.
Marketers and business owners, in general, should always be looking for opportunities to increase their understanding of how customers think and behave.
The better we understand our customers, the better we can please them.
Thank you for reading.
You can watch the video explanation below.
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