Profitability

Maximization of profits is a frequently stated objective for many companies. Yet, this objective is difficult to implement. Profit maximization requires complete understanding of cost and demand relationships; and estimates of cost and demand for different price alternatives are difficult to obtain. If prices are set too low, marketers’ profits are insufficient; if set too high, no one will buy. Clearly, however, adequate profits are required, and companies are sensitive to changes in profits over time as indications of performance.

Increased prices can affect profitability three or four times more than increases in sales volume at constant prices. One consumer-durable-products company increased operating profits by nearly 30 percent with only a 2.5 percent increase in average prices. An industrial-equipment manufacturer boosted operating profits by 35 percent by raising prices only 3 percent.

Price skimming is a strategy often associated with profit maximization. It includes setting prices high initially to appeal to consumers who are not price sensitive. In sequential skimming, the firm subsequently lowers prices to appeal to the next most lucrative segments. This strategy allows companies to maximize profits across segments. Besides improving short-term profitability, price skimming lessens demand on production capacity, recoups R&D expenditures, and obtains profits before competitors enter the market. Moreover, consumers may associate product prestige and quality with the high introductory prices prevalent in a skimming approach. Du Pont and IBM are well known for using high introductory prices and skimming practices in marketing new products.

Profitability is often related to return on investment (ROI). ROI is the ratio of income before taxes to total operating assets associated with the product, such as plant and equipment and inventory. As for profitability objectives, the evaluation of the effects of alternative prices on ROI requires realistic estimates of cost and demand for a product or service at different prices. Firms attempting to obtain a desired ROI must take a longer-term, visionary view.

Comprehension questions:

1. What does profit maximization require?

2. How can increased prices affect profitability?

3. What is pricing skimming?

4. What is ROI?

Referring to Unit 13

The Importance of Marketing Channels

Since marketing channels determine how and where customers buy, the establishment of and any subsequent change in channels is indeed critical. Other marketing variables can be manipulated frequently, and changes are often easy to make. Marketers can raise and lower prices, vary advertising media and messages, and add and delete products from their market offerings without revolutionizing the way they do business.

Making major changes in marketing channels is not so easy. Marketing channels are harder to change because other parties, such as retailers and wholesalers, may play important roles in the channel.

Marketers are sometimes bound to their channels when significant sunk costs are involved. For example, the franchising system of McDonald’s and company-owned outlets such as Exxon’s convenience stores represent huge dollar investments. Such investments are made only after much forethought, and abandoning them is the last resort. For these reasons, marketing channels take on more of a sense of permanence – change is certainly an option, but one that is not so likely to be frequently exercised as with other marketing variables.

By performing five critical functions, marketing channels play an important role in accomplishing the key marketing activities. These functions include the management of marketing communications, inventory, physical distribution, market feedback, and financial risk. It is important to note that none of these functions can be eliminated, but thy can be shifted from one channel member to another.

The major alternatives available for structuring a marketing channel include direct and indirect channels, single and multiple channels, and vertical marketing systems.

A direct channel describes movement of the product from the producer to the user without intermediaries. An indirect channel requires intermediaries between the originator and the user to perform some functions related to buying or selling the product to make it available to the final user. A given company might employ both direct and indirect channels.

Some companies use a single-channel strategy to reach their customers; others rely on a multiple-channel strategy. Some companies with multiple products or brands may use a single-channel strategy in one situation and a multiple-channel strategy in another. A single-channel strategy involves only one means of reaching customers. More firms use a multiple-channel strategy to appeal to as many potential buyers as possible. The basic idea is to allow customers to buy the way they want to and where they want to.

Emphasis on the relationship perspective has contributed to the growth of vertical marketing systems. These systems are centrally coordinated, highly integrated operations that work together to serve the ultimate consumer. The word vertical refers to the flow of the product from the producer to the customer. This flow is usually thought of as “down the channel” or “downstream”, meaning that the product flows down from the producer to the customer. Vertical marketing systems are now used in a sizable majority of the total sales of consumer goods.

Comprehension questions:

1. Why are marketing channels so important?

2. Is making changes in marketing channels easy or not?

3. When are marketers bound to their channels?

4. What are the five critical functions of marketing channels?

5. What types of marketing channels do you know?