FREE MARKET ECONOMY

BUSINESS IN A FREE MARKET ECONOMY
The economy of the United States, as well as that of most developed nations, operates according to the principles of the free market. This differs from the economies of Socialist or Communist countries, where governments play a strong role in deciding what goods and services will be produced, how they will be distributed, and how much they will cost (see Socialism; Communism). Businesses in free-market economies benefit from certain fundamental rights or freedoms. All people in free-market societies have the right to own, use, buy, sell, or give away property, thus permitting them to own and operate their own businesses as private, profit-seeking enterprises. Business owners in free markets may choose to run their businesses however they like, within the limits of other, mostly non-business-oriented laws. This right gives businesses the authority to hire and fire employees, invest money, purchase machinery and equipment, and choose the markets where they want to operate. In doing so, however, they may not violate or infringe on the rights of other businesses and people. Free-market businesses also have the right to keep or reinvest their profits.

All free-market economies, however, keep the rights of businesses in check to some degree through laws and regulations that monitor business activities. Such laws vary from country to country, but they generally encourage competition by protecting small businesses and consumers from being hurt by more powerful, large enterprises. For example, in the United States the Sherman Antitrust Act, enacted in 1890, and the Clayton Antitrust Act of 1914 forbid business agreements that impede interstate and most international commerce. The Clayton Antitrust Act also protects against unfair business practices aimed at creating monopolies and guarantees the rights of labor to challenge management practices perceived as unfair. The U.S. Federal Trade Commission Act of 1914 prohibits businesses from attempting to control the prices of its products or services, among other provisions. Other laws prohibit mergers that decrease competition within an industry and require large merging companies to notify the Federal Trade Commission (FTC) for approval.

CURRENT TRENDS

CURRENT TRENDS
Business activities are becoming increasingly global as numerous firms expand their operations into overseas markets. Many U.S. firms, for example, attempt to tap emerging markets by pursuing business in China, India, Brazil, and Russia and other Eastern European countries. Multinational corporations (MNCs), which operate in more than one country at once, typically move operations to wherever they can find the least expensive labor pool able to do the work well. Production jobs requiring only basic or repetitive skills—such as sewing or etching computer chips—are usually the first to be moved abroad. MNCs can pay these workers a fraction of what they would have to pay in a domestic division, and often work them longer and harder. Most U.S. multinational businesses keep the majority of their upper-level management, marketing, finance, and human resources divisions within the United States. They employ some lower-level managers and a vast number of their production workers in offices, factories, and warehouses in developing countries. MNCs based in the United States have moved many of their production operations to countries in Central and South America, China, India, and nations of Southeast Asia.

Mergers and acquisitions are also becoming more common than in the past. In the United States, for example, America Online, Inc. (AOL) and Time Warner merged in 2000 to form AOL Time Warner, Inc., a massive corporation that brought together AOL’s Internet franchises, technology and infrastructure, and e-commerce capabilities with Time Warner’s vast array of media, entertainment, and news products. Internationally, a growing number of mergers and acquisitions have been taking place, including Daimler Benz’s acquisition of Chrysler to form DaimlerChrysler AG and Ford Motor Company’s acquisition of Volvo’s automobile line.

With large mergers and the development of new free markets around the world, major corporations now wield more economic and political power than the governments under which they operate. In response, public pressure has increased for businesses to take on more social responsibility and operate according to higher levels of ethics. Firms in developed nations now promote—and are often required by law to observe—nondiscriminatory policies for the hiring, treatment, and pay of all employees. Some companies are also now more aware of the economic and social benefits of being active in local communities by sponsoring events and encouraging employees to serve on civic committees. Businesses will continue to adjust their operations according to the competing goals of earning profits and responding to public pressures for them to behave in ways that benefit society.

Business Cycle

INTRODUCTION
Business Cycle, term used by economists to designate a periodic increase and decrease in an economy’s production and employment. Ever since the Industrial Revolution of the 1800s, the overall level of production in industrialized capitalist countries has varied from high output and employment to low output and employment. Economists study business cycles because they have a significant impact on all aspects of an economy.

BUSINESS CYCLE CHARACTERISTICS
A business cycle has a period of expansion and a period of contraction. Although each business cycle has its own unique characteristics, all business cycles share certain similarities. For example, in the expansion phase, production increases while employment, wages, and business profits also rise. During the contraction phase of the business cycle, production, employment, wages, and business profits all fall. These phases sometimes go by different names. Expansions are referred to as recoveries, booms, upturns, periods of prosperity, and upswings. Contractions are variously called recessions, downturns, downswings, and liquidations. The word “depression” also applies to business cycle contractions but is normally reserved for the worst or most severe contractions.

All business cycles also have peaks and troughs, words that economists use for the turning points in a business cycle. A peak marks the end of an expansion and the beginning of a contraction, while a trough marks the end of a contraction and the beginning of an expansion.

In the typical business cycle expansion, business firms will exhibit optimism about the economic outlook. They will express this optimism by investing in facilities, thereby expanding their ability to produce goods and services. The firms will also hire more people to work in their stores, factories, and offices. Consumers will also be optimistic during an expansion. Their optimism leads them to increase their purchases, typically resorting to additional borrowing to finance the acquisition of more goods and services.

As the upswing continues, however, obstacles begin to develop that hinder further expansion. For example, production costs may increase, shortages of raw materials may develop, interest rates will start to rise, and prices will begin to increase, or, if already increasing, will start to rise more rapidly. Consumers react to higher prices and higher interest rates by buying less. As purchases begin to lag behind production, business firms begin to accumulate inventories (the merchandise or goods that a company or store has on hand). Producers begin to cut back on investment in facilities and reduce employment. Despite these adjustments, profits fall and further cutbacks are made. The economy now enters the contraction phase of the business cycle.

Several different factors can trigger a recovery from a contraction, including an increase in consumer demand, the depletion of inventories, or government action to stimulate the economy. Although generally slow and uneven at the start, the recovery soon gathers momentum. Production and employment begin to increase again, putting additional purchasing power into the hands of consumers. Investment expands in industries that make goods or machinery for sale to other businesses, rather than directly to consumers—industries that are known as capital goods industries. Optimism returns, old businesses expand, and new businesses are created. A new cycle has started.

Business cycles are important not just for their economic consequences but also for their broader social consequences. Several studies have shown that declines in economic activity coincide with declines in birth rates and increases in death and divorce rates. The higher unemployment rates caused by recessions are also associated with higher suicide rates and higher crime rates.

MEASURING THE BUSINESS CYCLE
Economists use contractions as a way to document the beginning and end of a business cycle. They can determine when a contraction, or recession, has begun by using a variety of measurements. The common definition of a recession is two consecutive quarterly declines in the gross domestic product (GDP, the total of all goods and services produced within a country). Many economists, however, regard this definition as simplistic because it measures national economic performance according to a single, although important, economic statistic. In short, by looking at only one aspect of national economic activity—the GDP—an evaluation is made of the whole economy.

A more detailed definition of a recession is the one used by the National Bureau of Economic Research (NBER), a nonprofit organization regarded as the official agency for the measurement of business cycles. According to the NBER, a recession is “a period of significant decline in total output, income, employment, and trade, usually lasting from six months to a year, and marked by widespread contractions in many sectors of the economy.”

Using this definition, the NBER has identified nine complete business cycles during the period from 1945 to 1991. The average duration of these business cycles, measured from trough to previous trough—that is, from the end of one recession to the end of the previous recession—is 53 months. During these cycles the average contraction lasted 18 months, and the average expansion lasted 35 months. For the current business cycle an expansion began in March 1991 and ended in March 2001. This expansion covering 120 months was the longest in United States economic history. As of November 2002, the NBER had not declared an official end to the recession that began in March 2001.

Besides differing in length, business cycles differ considerably in degree, especially in the severity of contractions. The most significant contraction in American economic history occurred during the 1930s. This contraction was so severe that it became known as the Great Depression. The NBER marks August 1929 as the start of the Great Depression with an initial contraction that lasted for 43 months. During this downturn the unemployment rate rose from about 3 percent to 25 percent while the production of goods and services fell by 30 percent. A very modest recovery began in March 1933, but the economy experienced another contraction that began in 1937 and lasted for another 13 months. A true economic recovery did not begin until 1941.

CAUSES OF BUSINESS CYCLES
A variety of explanations have been offered for business cycles. The Austrian American economist Joseph Schumpeter published his innovation theory in the late 1930s. He related upswings in the business cycle to new inventions, which stimulate investment in capital-goods industries. Because new inventions develop unevenly, business conditions alternate between expansion and contraction, according to Schumpeter’s theory.

In the early 1960s American economist Milton Friedman offered another explanation of the business cycle, known as a monetarist theory. In a careful review of American economic history Friedman and his collaborator Anna Schwartz found that turning points in the growth rate of the money supply (the total amount of money circulating in the economy) preceded business cycle turning points. They also found that the sources of the changes in the money supply’s growth rate—for example, the spread of commercial banking and the output of gold during the 19th century—were independent of the changes in economic activity. This finding indicated that the money supply was the primary cause of changes in business conditions.

Some business cycle analysts, including statistician Edward Tufte, have argued that politics plays a major role in the business cycle. These analysts believe that elected officials manipulate monetary and fiscal policies in an effort to win reelection. According to this viewpoint, as a presidential election approaches, officeholders seek to stimulate the economy with reductions in taxes, increases in government spending, and decreases in interest rates. The elected officials do this because they believe voters, enjoying the favorable economic conditions, will reward them by reelecting them to office. But in the process they may be stimulating an expansion that cannot be sustained and so may lead soon to a contraction.

Still another explanation for business cycles, advanced by American economist Robert E. Lucas, Jr., and others, examines misperceptions about the movements of wages and prices. In this view producers mistakenly perceive an overall increase in the level of prices in the economy as increased demand for their products. They respond by expanding production and employment within their firms. If enough firms make the same mistake, overall business activity will accelerate, followed by a contraction when the firms realize that they were mistaken in perceiving a growing demand.

A fifth explanation for business cycles is known as real business cycle theory and was developed in the 1980s by American economist Edward C. Prescott and others. It looks beyond political, monetary, and perception considerations to “real” factors, such as significant changes in technology and productivity.

Some business cycle analysts believe that there is no single consistent cause of business cycles. Instead they study what might be called shocks to the economy—a positive shock promoting a business expansion and a negative shock pushing the economy into recession. World War II (1939-1945) might be considered a positive economic shock that ended the Great Depression, whereas the events leading up to the 1991 Persian Gulf War represented a negative shock that explained the recession of 1990-1991. Other negative shocks might include agricultural failures associated with droughts. Discoveries of precious resources such as oil or gold would represent positive shocks. So these economists view the history of business cycles as a history of alternating positive and negative shocks.

REGULATING THE BUSINESS CYCLE
Because of the severity of the Great Depression, action was taken during the 1930s to both promote recovery and to reduce the likelihood and severity of future business downturns. Legislation known as New Deal programs created federal unemployment insurance, the Social Security system, the Federal Deposit Insurance Corporation (FDIC), and the Securities and Exchange Commission (SEC).

Unemployment insurance provides workers with income when they are laid off. Social Security furnishes some income to retired or disabled persons. These two programs thus provide greater income stability because people retain some purchasing power even when they are no longer working. The FDIC gives consumers confidence in their financial institutions and helps prevent a repeat of the massive withdrawals of funds or bank panic that led to the collapse of several thousand banks during the Great Depression. The SEC helps prevent financial fraud by requiring corporations that publicly trade their stock to report accurate financial information.

Other aspects of New Deal legislation also helped promote economic stability. The New Deal’s National Industrial Recovery Act of 1933 enabled workers to bargain collectively in trade unions. Although not as powerful as they once were, labor unions help prevent spiraling wage declines that have worsened previous downturns. Similarly, government support of crop prices shields farmers from disastrous loss of income. Whether or not these changes represent all or part of the explanation, the fact remains that since the Great Depression all economic contractions have been significantly less severe.

Beyond these structural changes, the government can also engage in direct intervention to counter a recession. Two main counter-cyclical policy options are available: monetary policy and fiscal policy. Economists disagree on the effectiveness of these options.

Monetary policy involves control of the money supply and interest rates by a central bank. In the United States the central bank is known as the Federal Reserve System, or simply the Fed. These controls determine the amount of credit available to businesses and consumers and the cost of that credit. By reducing the rate of money supply growth and allowing interest rates to rise, the Fed reduces the amount of available credit and increases the cost of borrowing in order to slow an economic expansion. This practice is known as contractionary monetary policy. Alternatively, expansionary monetary policy involves increasing the rate of growth in the money supply and lowering interest rates. In this fashion the Fed increases the availability of credit and lowers the cost of borrowing in an effort to stimulate the economy.

Fiscal policy consists of changes in government spending or taxation or both. If the government seeks to constrain an economic expansion by engaging in contractionary fiscal policy, it can lower its purchases of goods and services, reduce the amount of money it spends on social services and subsidies, or increase taxes. Expansionary fiscal policy involves the opposite actions—namely, increases in purchases of goods and services, increases in social service spending and subsidies, or reductions in taxes—in an effort to stimulate production and employment.

In discussing the relative merits of monetary and fiscal policies as counter-cyclical tools, economists often argue over which policy to pursue. Some economists note that changes in monetary policy can be implemented quickly whereas changes in fiscal policy take much longer. The Fed’s Open Market Committee, for example, makes decisions regarding the money supply and interest rates. All that is needed to change monetary policy is a vote by this committee. Fiscal policy, on the other hand, typically requires the approval of both the legislative and executive branches of the federal government. For example, a lowering of taxes needs approval from both the U.S. House of Representatives and Senate as well as the approval of the U.S. president, approvals that sometimes may take longer than a year to secure.

However, many economists also note that it takes fiscal policy less time than monetary policy to have an impact on the economy once a specific action has been implemented. For example, a fiscal-policy reduction in the personal income tax will show up immediately in higher take-home pay for workers. By contrast, consumers and business firms may take awhile before they modify their spending in response to a monetary-policy change, such as a reduction in interest rates. For example, not everyone goes out to buy a new car just because the interest rate on car loans has decreased.

Recognition of the delays involved with both monetary and fiscal policies has led some economists to conclude that policy actions may actually contribute to economic instability and make the business cycle worse. According to these economists, the best strategy for monetary policy is the provision of steady growth in the money supply and credit, and the best strategy for fiscal policy is efficient and effective tax and spending programs.

Inflation and Deflation

INTRODUCTION
Inflation and Deflation, in economics, terms used to describe, respectively, a decline or an increase in the value of money, in relation to the goods and services it will buy.

Inflation is the pervasive and sustained rise in the aggregate level of prices measured by an index of the cost of various goods and services. Repetitive price increases erode the purchasing power of money and other financial assets with fixed values, creating serious economic distortions and uncertainty. Inflation results when actual economic pressures and anticipation of future developments cause the demand for goods and services to exceed the supply available at existing prices or when available output is restricted by faltering productivity and marketplace constraints. Sustained price increases were historically directly linked to wars, poor harvests, political upheavals, or other unique events.

Deflation involves a sustained decline in the aggregate level of prices, such as occurred during the Great Depression of the 1930s; it is usually associated with a prolonged erosion of economic activity and high unemployment. Widespread price declines have become rare, however, and inflation is now the dominant variable affecting public and private economic planning.


KINDS OF INFLATION

When the upward trend of prices is gradual and irregular, averaging only a few percentage points each year, such creeping inflation is not considered a serious threat to economic and social progress. It may even stimulate economic activity: The illusion of personal income growth beyond actual productivity may encourage consumption; housing investment may increase in anticipation of future price appreciation; business investment in plants and equipment may accelerate as prices rise more rapidly than costs; and personal, business, and government borrowers realize that loans will be repaid with money that has potentially less purchasing power.

A greater concern is the growing pattern of chronic inflation characterized by much higher price increases, at annual rates of 10 to 30 percent in some industrial nations and even 100 percent or more in a few developing countries. Chronic inflation tends to become permanent and ratchets upward to even higher levels as economic distortions and negative expectations accumulate. To accommodate chronic inflation, normal economic activities are disrupted: Consumers buy goods and services to avoid even higher prices; real estate speculation increases; businesses concentrate on short-term investments; incentives to acquire savings, insurance policies, pensions, and long-term bonds are reduced because inflation erodes their future purchasing power; governments rapidly expand spending in anticipation of inflated revenues; and exporting nations suffer competitive trade disadvantages forcing them to turn to protectionism and arbitrary currency controls.

In the most extreme form, chronic price increases become hyperinflation, causing the entire economic system to break down. The hyperinflation that occurred in Germany following World War I, for example, caused the volume of currency in circulation to expand more than 7 billion times and prices to jump 10 billion times during a 16-month period before November 1923. Other hyperinflations occurred in the United States and France in the late 1700s; in the USSR and Austria after World War I; in Hungary, China, and Greece after World War II; and in a few developing nations in recent years. During a hyperinflation the growth of money and credit becomes explosive, destroying any links to real assets and forcing a reliance on complex barter arrangements. As governments try to pay for increased spending programs by rapidly expanding the money supply, the inflationary financing of budget deficits disrupts economic, social, and political stability.


CAUSES OF INFLATION
Demand-pull inflation occurs when aggregate demand exceeds existing supplies, forcing price increases and pulling up wages, materials, and operating and financing costs. Cost-push inflation occurs when prices rise to cover total expenses and preserve profit margins. A pervasive cost-price spiral eventually develops as groups and institutions respond to each new round of increases. Deflation occurs when the spiral effects are reversed.

To explain why the basic supply and demand elements change, economists have suggested three substantive theories: the available quantity of money; the aggregate level of incomes; and supply-side productivity and cost variables. Monetarists believe that changes in price levels reflect fluctuating volumes of money available, usually defined as currency and demand deposits. They argue that, to create stable prices, the money supply should increase at a stable rate commensurate with the economy's real output capacity. Critics of this theory claim that changes in the money supply are a response to, rather than the cause of, price-level adjustments.

The aggregate level of income theory is based on the work of the British economist John Maynard Keynes, published during the 1930s. According to this approach, changes in the national income determine consumption and investment rates; thus, government fiscal spending and tax policies should be used to maintain full output and employment levels. The money supply, then, should be adjusted to finance the desired level of economic growth while avoiding financial crises and high interest rates that discourage consumption and investment. Government spending and tax policies can be used to offset inflation and deflation by adjusting supply and demand according to this theory. In the U.S., however, the growth of government spending plus “off-budget” outlays (expenditures for a variety of programs not included in the federal budget) and government credit programs have been more rapid than the potential real growth rate since the mid-1960s.

The third theory concentrates on supply-side elements that are related to the significant erosion of productivity. These elements include the long-term pace of capital investment and technological development; changes in the composition and age of the labor force; the shift away from manufacturing activities; the rapid proliferation of government regulations; the diversion of capital investment into nonproductive uses; the growing scarcity of certain raw materials; social and political developments that have reduced work incentives; and various economic shocks such as international monetary and trade problems, large oil price increases, and sporadic worldwide crop disasters. These supply-side issues may be important in developing monetary and fiscal policies.


EFFECTS OF INFLATION
The specific effects of inflation and deflation are mixed and fluctuate over time. Deflation is typically caused by depressed economic output and unemployment. Lower prices may eventually encourage improvements in consumption, investment, and foreign trade, but only if the fundamental causes of the original deterioration are corrected.

Inflation initially increases business profits, as wages and other costs lag behind price increases, leading to more capital investment and payments of dividends and interest. Personal spending may increase because of “buy now, it will cost more later” attitudes; potential real estate price appreciation may attract buyers. Domestic inflation may temporarily improve the balance of trade if the same volume of exports can be sold at higher prices. Government spending rises because many programs are explicitly, or informally, indexed to inflation rates to preserve the real value of government services and transfers of income. Officials may also anticipate paying larger budgets with tax revenues from inflated incomes.

Despite these temporary gains, however, inflation eventually disrupts normal economic activities, particularly if the pace fluctuates. Interest rates typically include the anticipated pace of inflation that increases business costs, discourages consumer spending, and depresses the value of stocks and bonds. Higher mortgage interest rates and rapidly escalating prices for homes discourage housing construction. Inflation erodes the real purchasing power of current incomes and accumulated financial assets, resulting in reduced consumption, particularly if consumers are unable, or unwilling, to draw on their savings and increase personal debts. Business investment suffers as overall economic activity declines, and profits are restricted as employees demand immediate relief from chronic inflation through automatic cost-of-living escalator clauses. Most raw materials and operating costs respond quickly to inflationary signals. Higher export prices eventually restrict foreign sales, creating deficits in trade and services and international currency-exchange problems. Inflation is a major element in the prevailing pattern of booms and recessions that cause unwanted price and employment distortions and widespread economic uncertainty.

The impact of inflation on individuals depends on many variables. People with relatively fixed incomes, particularly those in low-income groups, suffer during accelerating inflation, while those with flexible bargaining power may keep pace with or even benefit from inflation. Those dependent on assets with fixed nominal values, such as savings accounts, pensions, insurance policies, and long-term debt instruments, suffer erosion of real wealth; other assets with flexible values, such as real estate, art, raw materials, and durable goods, may keep pace with or exceed the average inflation rate. Workers in the private sector strive for cost-of-living adjustments in wage contracts. Borrowers usually benefit while lenders suffer, because mortgage, personal, business, and government loans are paid with money that loses purchasing power over time and interest rates tend to lag behind the average rate of price increases. A pervasive “inflationary psychology” eventually dominates private and public economic decisions.

STABILIZATION MEASURES
Any serious antiinflation effort will be difficult, risky, and prolonged because restraint tends to reduce real output and employment before benefits become apparent, whereas fiscal and monetary stimulus typically increases economic activity before prices accelerate. This pattern of economic and political risks and incentives explains the dominance of expansion policies.

Stabilization efforts try to offset the distorting effects of inflation and deflation by restoring normal economic activity. To be effective, such initiatives must be sustained rather than merely occasional fine-tuning actions that often exaggerate existing cyclical changes. The fundamental requirement is stable expansion of money and credit commensurate with real growth and financial market needs. Over extended periods the Federal Reserve System can influence the availability and cost of money and credit by controlling the financial reserves that are required and by other regulatory procedures. Monetary restraint during cyclical expansions reduces inflation pressures; an accommodative policy during cyclical recessions helps finance recovery. Monetary officials, however, cannot unilaterally create economic stability if private consumption and investment cause inflation or deflation pressures or if other public policies are contradictory. Government spending and tax policies must be consistent with monetary actions so as to achieve stability and prevent exaggerated swings in economic policies.

Since the mid-1960s the rapid growth of federal budget spending plus even greater percentage increases in off-budget outlays and a multitude of federal lending programs have exceeded the tax revenues almost every year, creating large government deficit borrowing requirements. Pressures to provide money and credit required for private consumption and investment and for financing the chronic budget deficits and government loan programs have led to a rapid expansion of the money supply with resulting inflation problems. Effective stabilization efforts will require a better balance and a more sustained application of both monetary and fiscal policies.

Important supply-side actions are also required to fight inflation and avoid the economic stagnation effects of deflation. Among the initiatives that have been recommended are the reversal of the serious deterioration of national productivity by increasing incentives for savings and investment; enlarged spending for the development and application of technology; improvement of management techniques and labor efficiency through education and training; expanded efforts to conserve valuable raw materials and develop new sources; and reduction of unnecessary government regulation.

Some analysts have recommended the use of various income policies to fight inflation. Such policies range from mandatory government guidelines for wages, prices, rents, and interest rates, through tax incentives and disincentives, to simple voluntary standards suggested by the government. Advocates claim that government intervention would supplement basic monetary and fiscal actions, but critics point to the ineffectiveness of past control programs in the United States and other industrial nations and also question the desirability of increasing government control over private economic decisions. Future stabilization policy initiatives will likely concentrate on coordinating monetary and fiscal policies and increasing supply-side efforts to restore productivity and develop new technology.

Marketing

INTRODUCTION
Marketing, the process by which a product or service originates and is then priced, promoted, and distributed to consumers. In large corporations the principal marketing functions precede the manufacture of a product. They involve market research and product development, design, and testing.

Marketing concentrates primarily on the buyers, or consumers. After determining the customers’ needs and desires, marketers develop strategies that are designed to educate customers about a product’s most important features, persuade them to buy it, and then to enhance their satisfaction with the purchase. Where marketing once stopped with the sale, today businesses believe that it is more profitable to sell to existing customers than to new ones. As a result, marketing now also involves finding ways to turn one-time purchasers into lifelong customers.

Marketing includes planning, organizing, directing, and controlling the decision-making regarding product lines, pricing, promotion, and servicing. In most of these areas marketing has overall authority; in others, as in product-line development, its function is primarily advisory. In addition, the marketing department of a business firm is responsible for the physical distribution of the products, determining the channels of distribution that will be used, and supervising the profitable flow of goods from the factory or warehouse.

TAILORING THE PRODUCT
Merchandise that is generally similar in style or design, but may vary in such elements as size, price, and quality is collectively known as a product line. Most marketers believe that product lines must be closely correlated with consumer needs and wants.

Firms tend to change product items and lines after a period of time to gain a competitive advantage, to respond to changes in the economic climate, or to increase sales by encouraging consumers to buy a new model. For example, if the economy weakens, a manufacturer might use cheaper parts to make a product more affordable. Sometimes, however, manufacturers will alter the style rather than the quality of the item. Hemlines on dresses, for example, might go up or down, or the appearance or functionality of an automobile might be altered. The practice of changing the appearance of goods or introducing inferior parts or poor workmanship in order to motivate consumers to replace products is known as planned obsolescence. Some people object that this practice leads to waste or can be unethical. Manufacturers reply that consumers are conditioned to expect such changes and welcome the variety they offer, or they deny that poor quality was intentional.

The popularity of all products eventually wanes. In fact, successful products go through what is called a product life cycle, which describes the course of a product’s sales from its introduction and growth through maturity and decline. Some fad products such as Beanie Babies go through all four stages in a very short period. For others, such as phonograph records, the stages extend over decades.

Because products are always aging and sales of even the most successful products eventually decline, firms must continually develop and introduce new items. One study found that over 13,000 new products are introduced each year. But despite the millions of dollars that United States and Canadian companies invest in product research and consumer testing, it is estimated that more than 30 percent of new products fail at launch and 60 percent are never fully accepted by consumers and disappear after a few years. The high failure rate influences the pricing of successful products because profits from these products must help cover the development costs of products that fail.


PRICING THE PRODUCT
The two basic components that affect product pricing are costs of manufacture and competition in selling. It is unprofitable to sell a product below the manufacturer’s production costs and unfeasible to sell it at a price higher than that at which comparable merchandise is being offered. Other variables also affect pricing. Company policy may require a minimum profit on new product lines or a specified return on investments, or discounts may be offered on purchases in quantity.

Attempts to maintain resale prices were facilitated for many years in the United States under federal and state fair trade laws. Since 1975, however, these laws have been nullified, thereby prohibiting manufacturers from controlling the prices set by wholesalers and retailers. Such control can still be maintained if the manufacturers wish to market directly through their own outlets, but this is seldom feasible except for the largest manufacturers.

Attempts have also been made, generally at government insistence, to maintain product-price competition in order to minimize the danger of injuring small businesses. Therefore, the legal department of a marketing organization reviews pricing decisions.

PROMOTING THE PRODUCT
Advertising, personal (face-to-face) or direct selling, sales promotion, and relationship building are the primary methods companies use to promote their products.

Advertising

Advertising is often used to make consumers aware of a product’s special low price or its benefits. But an even more important function of advertising is to create an image that consumers associate with a product, known as the brand image. The brand image goes far beyond the functional characteristics of the product. For example, a soft drink may have a particular taste that is one of its benefits. But when consumers think of it, they not only think of its taste, but they may also associate it with high energy, extreme action, unconventional behavior, and youth. All of those meanings have been added to the product by advertising. Consumers frequently buy the product not only for its functional characteristics but also because they want to be identified with the image associated with the brand.

By adding meaning to a product, advertising also adds value. For example, when Philip Morris Companies Inc. purchased Kraft Foods, Inc. in 1988 for nearly $13 billion, Philip Morris paid 600 percent more than Kraft’s factories and inventory were worth. Over 80 percent of the purchase price was for the current and future value of the Kraft brand, a value that was created in large part by advertising. Advertising plays such an important role in promoting products and adding value to brands that most companies spend considerable sums on their advertising and hire specialized firms, known as advertising agencies, to develop their advertising campaigns.

Advertising is most frequently done on television, radio, and billboards; in newspapers, magazines, and catalogs; and through direct mail to the consumers. In recent years, numerous advertising agencies have joined forces to become giant agencies, making it possible for them to offer their clients a comprehensive range of worldwide promotion services.

DIRECT SELLING

Where advertising reaches a mass audience, personal or direct selling focuses on one customer at a time. That kind of individual attention makes direct selling expensive, but it also makes it effective. As the costs of personal selling have risen, the utilization of salespeople has changed. Simple transactions are completed by clerks. Salespeople are now used primarily where the products are complex and require detailed explanation, customized application, or careful negotiation over price and payment plan. But whether the sale involves an automobile or a customized computer network, personal selling involves much more than convincing the customer of the product’s benefits. The salesperson helps the customer identify problems, works out a variety of solutions, assists the buyer in making decisions, and provides arrangements for long-term service. Persuasion is only part of the job. A much more important part is problem solving.

Because the selling process has become much more complicated, most companies now provide extensive training for the sales force. The average length of the initial training program is four months. A training program for new members of the sales force teaches them about such matters as company history, selling and presentation techniques, listening skills, the manufacture and use of the company’s products, and the characteristics of both the industry and its customers. Moreover, because the sales force plays such a critical role in the marketing process, most companies provide on-going training for all members of the sales force to help them deepen their product knowledge and improve their interpersonal and negotiating skills.

With the increasing complexity of business problems and products, effective sales solutions often require more knowledge than any one person can master. As a result many companies now use sales teams to service their largest and most complicated accounts. Such teams might include personnel from sales, marketing, manufacturing, finance, and technical support.

SALES PROMOTION

SALES PROMOTION
The purpose of sales promotion is to supplement and coordinate advertising and personal selling; this has become increasingly important in marketing. While advertising helps build brand image and long-term value, sales promotion builds sales volume. Sales promotions are designed to persuade consumers to purchase immediately by providing special incentives such as cash rebates, prizes, extra product, or gifts. Promotions are an effective way to spur sales, but because they involve discount coupons and contests with valuable prizes, they are also expensive and so reduce profits.

RELATIONSHIP BUILDING
In the past, most advertising and promotional efforts were developed to acquire new customers. But today, more and more advertising and promotional efforts are designed to retain current customers and to increase the amount of money they spend with the company. Consumers see so much advertising that they have learned to ignore much of it. As a result, it has become more difficult to attract new customers. Servicing existing customers, however, is easier and less expensive. In fact, it is estimated that acquiring a new customer costs five to eight times as much as keeping an existing one.

To retain current customers, some companies develop loyalty programs such as the frequent flyer programs used by many airlines. A marketer may also seek to retain customers by learning a customer’s individual interests and then tailoring services to meet them. Amazon.com, for example, keeps a database of the types of books customers have ordered in the past and then recommends new books to them based on their past selections. Such programs help companies retain customers not only by providing a useful service, but also by making customers feel appreciated. This is known as relationship building.

DISTRIBUTING THE PRODUCT

Some products are marketed most effectively by direct sale from manufacturer to consumer. Among these are durable equipment such as computers, office equipment, industrial machinery and supplies, and consumer specialties such as vacuum cleaners and life insurance. The direct marketing of products such as cosmetics and household needs is very important. Formerly common “door to door products,” these are now usually sold by the more sophisticated “house party” technique.

Many types of products and services now use direct mail catalogs or have a presence on the World Wide Web. Because many people are extremely busy, they may find it simpler to shop in their leisure hours at home by using catalogs or visiting Web sites. Comparison shopping is also made easier, because both catalogs and e-commerce sites generally contain extensive product information. For retailers, catalogs and the Web make it possible to do business far beyond their usual trading area and with a minimum of overhead. More than 95 percent of the leading 1,000 companies in the United States sell products over the Internet.

Television is a potent tool in direct marketing because it facilitates the demonstration of products in use. Direct sale of all kinds of goods to the public via home-shopping clubs broadcasting on cable television channels is gaining in popularity. Some companies also use telephone marketing, called telemarketing, a technique used in selling to businesses as well as to consumers. Most consumer products, however, move from the manufacturer through agents to wholesalers and then to retailers, ultimately reaching the consumer. Determining how products should move through wholesale and retail organizations is another major marketing decision.

Wholesalers distribute goods in large quantities, usually to retailers, for resale. Some retail businesses have grown so large, however, that they have found it more profitable to bypass the wholesaler and deal directly with the manufacturers or their agents. Wholesalers first responded to this trend by changing their operations to move goods more quickly to large retailers and at lower prices. Small retailers fought back through cooperative wholesaling, the voluntary banding together of independent retailers to market a product. The result has been a trend toward a much closer, interlocking relationship between wholesaler and independent retailer.

Retailing has undergone even more changes than wholesaling. Intensive preselling by manufacturers and the development of minimum-service operations, such as self-service in department stores, have drastically changed the retailer’s way of doing business. Supermarkets and discount stores have become commonplace not only for groceries but for products as diversified as medicines and gardening equipment. More recently, warehouse retailing has become a major means of retailing higher-priced consumer goods such as furniture, appliances, and electronic equipment. The emphasis is on generating store traffic, speeding up the transaction, and rapidly expanding the sales volume. Chain stores—groups of stores with one owner—and cooperative groups have also proliferated. Special types of retailing, such as vending machines and convenience stores, have also developed to fill multiple needs.

Transporting and warehousing merchandise are also technically within the scope of marketing. Products are often moved several times as they go from producer to consumer. Products are carried by rail, truck, ship, airplane, and pipeline. Efficient traffic management determines the best method and timetable of shipment for any particular product.

SERVICES AND MARKETING

SERVICES AND MARKETING
Marketing efforts once focused primarily on the selling of manufactured products such as cars and aspirin. But today the service industries have grown more important to the economy than the manufacturing sector. Services, unlike products, are intangible and involve a deed, a performance, or an effort that cannot be physically possessed. Currently, more people are employed in the provision of services than in the manufacture of products, and this area shows every indication of expanding even further. In fact, more than eight in ten U.S. workers labor in such service areas as transportation, retail, health care, entertainment, and education. In the United States alone, service industries now account for more than 70 percent of the gross national product (GNP, the total of all goods and services produced by a country) and are expected to provide 90 percent of all new jobs by 2012.

Services, like products, require marketing. Usually, service marketing parallels product marketing with the exception of physical handling. Services must be planned and developed carefully to meet consumer demand. For example, in the field of temporary personnel, a service that continues to increase in monetary value, studies are made to determine the types of employee skills needed in various geographical locations and fields of business. Because services are more difficult to sell than physical products, promotional campaigns for services must be even more aggressive than those for physical commodities.

MARKETING RESEARCH

MARKETING RESEARCH
Marketing research helps businesses identify consumer needs and wants so a company can develop and promote products more successfully. Such research also provides the information upon which important advertising and marketing decisions are based.



There are two types of research: qualitative and quantitative. To gain a general impression of the market, consumers, or the product, companies generally start with qualitative research. This approach asks open-ended rather than yes or no questions in order to enable people to explain their thoughts, feelings, or beliefs in detail. One of the most common qualitative research techniques is the focus group in which a moderator leads a discussion among a small group of consumers who are typical of the target market. The discussion usually involves a particular product, service, or marketing situation. Focus groups can yield insights into consumer perceptions and attitudes, but the findings cannot be applied to the whole market, because the sample size is too small. Focus group results, then, are suggestive rather than definitive.

The insights generated by a focus group are often explored further through quantitative research, which provides reliable, hard statistics. This type of research uses closed-ended questions, enabling the researcher to determine the exact percentage of people who answered yes or no to a question or who selected answer a, b, c, or d on a questionnaire. One of the most common quantitative research techniques is the survey in which researchers sample the opinions of a large group of people. If the sample group is large enough and is representative of a particular group, such as executives who use cell phones, statisticians consider the findings statistically valid, which means that if all consumers in that particular category could be surveyed, the findings would still be the same. This means that quantitative findings are conclusive in a way that qualitative findings cannot be.