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Market Modeling

The new Business Gesso*

The new Business Gesso*

As long as there has been business there has been market modeling. Everyone building or offering a product or service for sale does it to maximize the return on their investment. Initial models typically had to do with telling prospective customers that products are ‘sold here’. Henry Ford’s successful model was to sell an affordable, mass-produced automobile as long as you wanted the same features as your neighbor.

As the world got more complex the messages were tuned to their marketplaces:

Pricing, product features and messages were adjusted. Now businesses needed marketing to help them get the word out to drive increasing revenue at higher and higher levels of sales. Competition stiffened and a detailed, analytical understanding of the market was required. Market modeling moved from infancy to mainstream.

The Evolution of Market Modeling

Economists began using statistical regression analysis almost 70 years ago to try to correlate economic factors (e.g. taxes and interest rates) with GDP growth. About 15 years ago, marketers realized that they, too, could use statistical regression analysis to build effective market models. They kept the moniker, “econometric models” and were able to correlate time series data of their 4-Ps – advertising (promotion), pricing, product features and distribution (place), as well as exogenous factors (e.g. weather, seasonality and interest rates) with sales volume. More robust econometric models included the creative campaign and the actions taken by the competition. The most sophisticated models are taking a whole new approach.

They start bottom-up, developing a model of the consumer and delivering a forward-looking capability unmatched with traditional econometric models. With these new models a whole new world of marketing decision-making unfolds.

The First Steps of Market Modeling

Statistical models were effective but didn’t handle change very well, and left out the most important aspect of the marketplace – the consumer. And marketers had difficulty understanding the model. To them the statistical engine was just a black box. It didn’t represent the way consumers think and marketers act. It led to a rift between the statistical analysts and the brand managers. This rift is now being bridged.

Over the last three to four years marketers have begun to correct this glaring hole in statistical modeling techniques by building customer response models based on agent- based modeling. Agent-based modeling (ABM) defines consumers, products, competitors and distributors as ‘agents’. These agents are virtual representations (in a computer) of the corresponding objects in the real world. Using simple and easily understood rules, each agent generates “computed” responses to market inputs. Because the way consumers make decisions is very consistent over time, the results delivered by ABM are very robust, even when there are major changes in the marketplace. Just as

*Gesso - A preparation of plaster of Paris and glue used as a base for low relief or as a surface for painting. That is, the stuff you make sculpture out of. Source: The American Heritage® Dictionary of the English Language, Fourth Edition Copyright © 2000 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved.

Market Modeling The New Business Gesso* For most companies modeling is becoming a strategic imperative.

Market Modeling

The New Business Gesso*

For most companies modeling is becoming

a strategic imperative.

It is a tactical capability within marketing driving strategic advantage in the marketplace.

price elasticity and share emerge in the marketplace by the actions and interactions among consumers, and among competitors, so, too, do behaviors in an agent-based model emerge as the agents – virtual consumers and competitors – each act and interact. Emergent behaviors include share, price elasticity, the build of awareness, trial and repeat purchasing, brand equity, fads, and competitive interactions such as price wars. In addition, the last and probably most important consumer communications component - consumer-to-consumer communications, i.e. social networks, word-of-mouth and buzz - can now be modeled. With new product launches and products falling into the considered purchase category, consumer- to-consumer communications is especially important. No other modeling tool can make this claim.

How is ABM used in the market?

Models of business and marketing strategy abound. Among the most familiar

are the “Four Ps” (product, price, place and promotion), the Five Forces model

developed by Porter , and the models defined by Moore in Crossing the Chasm and Inside the Tornado 2 . This paper will not explore these strategy models in depth;

it is not written to help marketers to develop a strategy, but to explore how the chosen strategy impacts return on marketing investment (ROMI). Clearly, a company executing a good strategy will achieve better results from its marketing activities than would be delivered by the same activities executed within the context of a poor strategy.

1

Agent-based modeling has been used to answer complex business questions in a number of different categories:

n

What is the optimal marketing plan to drive a product launch?

n

What is the optimal response to an exogenous event (natural disaster, economic

shock, new regulation, new technology, etc.)?

n What is the value of word-of-mouth and when should its support supplant heavy

advertising?

n How can a failing brand be turned around and how can it be done to minimize

cannibalization of related products?

n How can prescription drug providers most effectively target their communications

to doctors?

ABM replicates consumer behavior in the marketplace. A consumer has variables with which purchase choices are made. These include budget, media types preferred, messages received, brands previously chosen and purchased, channels shopped, frequency of purchase and many more. These values are not spread out randomly among the individual consumers; instead in a real market these variables interrelate—a consumer’s history of brands chosen, for example, will have been influenced by whether that person shops at Wal-Mart or Target. By modeling individuals, the relationships of the variables in the model develop in a way that

1 by Dr. Michael Porter of the Harvard Business School, http://www.strategy-software.com/fiveforces.html

2 Moore, Geoffrey A. “Crossing the Chasm: Marketing and Selling High-Tech Products to Mainstream Customers”, Harper Business; Rev edition (July 1, 1999); “Inside the Tornado: Marketing Strategies from Silicon Valley’s Cutting Edge”, Harper Business; Reprint edition (July 1, 1999)

mirrors the real world—the agent level variable distribution would look like your panel data, not

mirrors the real world—the agent level variable distribution would look like your panel data, not like a random distribution. This results in a highly realistic (and adaptive) understanding of your consumer’s behavior. ABM integrates everything you know about your market. It includes time series data, panel data, experience, and data-driven intuition. ABM is a fully competitive model. It takes into account what you and your competitors do, and how consumers will choose you and your competitors.

Other types of modeling

MARKETING MIX MODELING usually refers to a statistical approach to building a model of your marketing mix elements. It is a misnomer, because the industry knows it as the statistical regression analysis technique, when in reality, there are many techniques that can provide a model of a company’s marketing mix. Marketing mix modeling (MMM) when it refers to statistical regression analysis generates correlations between independent variables, such as, price, promotion, distribution and advertising (the 4-Ps), and a dependent variable, such as sales in dollars or in unit volume.

MMMs based on statistical regression analysis deliver an answer that assumes that the future is like the past. They use only the time series data, and therefore don’t allow your knowledge of your consumers to influence your decision process. If there are changes in the marketplace, such as a new competitor or even simply a competitive price change, then an MMM either needs to be recalibrated or is simply unable to predict the future with the requisite reliability.

SYSTEM DYNAMICS is used to model “levels and flows”, such as the flow of consumers through the purchase funnel (i.e., awareness to consideration, consideration to purchase intent, purchase intent to purchase, etc.) Like MMM, System Dynamics models develop a top-down relationship between variables (for example, between category awareness and brand awareness, between brand consideration and purchase intent, etc.). The challenge in using System Dynamics models is that the modeler has to describe equations for each of these flows—what influences the flow and where all parts of the “flow” go. It is not very intuitive to think of customers flowing, and such a model does little better than MMM in helping a marketer to understand why

better than MMM in helping a marketer to understand why consumers behave the way they do.

consumers behave the way they do. For example, System Dynamics might tell you the quantitative impact of a change in brand awareness activities on purchase intent, but it doesn’t explain how that comes about in the consumer choice process nor, how that process is influenced by your actions nor, how that influence will change with competitive changes. Because System Dynamics models use a top-down approach, the modeler must have a knowledge of all of the relationships ahead of time. If a relationship in the marketplace is missing in the model, the model can totally miss a key result. Similar to marketing mix models using statistical regression analysis, System Dynamics models have difficulty in modeling dynamic markets. They assume that the future is like the past. In short, System Dynamics models don’t tell you anything you don’t already know, and the form in which they operate is not directly aligned with reality.

Market Modeling The New Business Gesso* Those companies that are first in their categories to

Market Modeling

The New Business Gesso*

Those companies that are first in their categories to invest in modeling will not only develop a competitive advantage but will develop a barrier for others entering the market.

CONJOINT ANALYSIS AND DISCRETE CHOICE MODELING are effective at modeling consumer choice. They have become very helpful in weighing the value in the marketplace of different product features and attributes in order to determine the level of preference consumers might have for a new product, versus a set of known competitive products.

Conjoint Analysis Models are typically limited to product feature preferences and often miss the impact of advertising and brand. Discrete Choice Models correct this deficiency and can support modeling for new product launches in the context of advertising and brand awareness. However, discrete choice models do not account for the overall market context and, because they are static, cannot replicate the impact that the changing market environment has on consumer choice as competitive marketing plans unfold.

TEST MARKETING is effective at obtaining true consumer feedback to new products and marketing programs. Unfortunately, test markets can often be derailed by competitive actions. With test marketing, once the test has begun, flexibility is very limited. The test can only evaluate a few factors and if any change is required after the test begins it is almost impossible to make those changes.

Compared to other modeling and testing, test marketing can be very expensive. Not only is the cost of the test market itself very high, but also the opportunity cost of ‘letting the cat out of the bag’ can be even higher. With a live test market you have just announced to the competition “what you are up to.” Lastly, test marketing is challenged with the limited patience a test panel might have for answering detailed survey questions and evaluating different products and marketing tactics.

Agent-Based Modeling:

The Modeling Process

Agent-based modeling was developed to help marketers answer complex,

business questions about their markets. Sample questions might include:

n What would be the impact of a communications campaign informing

consumers that yes-they-can use a credit card for purchases under $10.00?

n If we lower our price and increase awareness, what impact will this have

on acquisition and retention?

n

What would be the best way to merge two brands after an acquisition?

n

What is the impact of campaigns on our overall profitability?

Because ABM models the way consumers process marketing inputs, many marketing changes can be simultaneously modeled yielding a highly accurate consumer response. For example, what should our response be if two of our competitors merge and during the transition they increase ad

spend and lower their pricing? An agent-based modeling project begins with the refinement of this

spend and lower their pricing?

An agent-based modeling project begins with the refinement of this business question. Once this is done, data gathering begins. Data requirements include typical time series data of your (and your competition’s) 4-Ps and Exogenous factors. Agent-based models then take in consumer-oriented data, which can be sourced in many different ways. Once the data is present, ‘Calibrations’ are run to fit the model to the market. Calibration is done in a similar way to statistical models except that the ‘fit’s are significantly better for two reasons. First, all of your data is used. This includes your data about you, your competition, your channel and your consumer. The second reason that agent-based models produce more accurate and robust calibrations is that there are fewer variables to calibrate than for statistical regression models. The model “rules” of consumer behavior have fewer unknowns than the plethora of possible interactions between each marketing mix element for each competitor.

Once calibration is complete, the model is ready to live and breathe your market. You can immediately begin simulating different scenarios. As different scenarios are run they can be stack-ranked and/or optimized to determine which scenarios deliver the best results across the space of likely competitive strategies & responses. The ability to provide accurate simulations of the real world is one of the most powerful features of the model.

Unfortunately, the world doesn’t stand still: Unexpected things happen; new regulations are passed; competitors change strategy, suppliers become interrupted and word-of- mouth can lift or harm your brand. What is the impact and how should you best respond? With ABM, the model doesn’t need to be rebuilt. Because it is a living and breathing model, these questions can be quickly answered. No other modeling technique can provide these types of answers in these types of environments.

The Future of Modeling

For most companies modeling is becoming a strategic imperative. It is a tactical capability within marketing driving strategic advantage in the marketplace. Modeling is coming

strategic advantage in the marketplace. Modeling is coming of age in helping companies to gain and

of age in helping companies to gain and maintain strategic advantage. Those companies that are first in their categories to invest in modeling will not only develop a competitive advantage but will develop an entry barrier for others entering the market. New entrants without modeling entering a market against a modeling company will have difficulty making a beachhead. They will lose at every turn. Only at great cost will the new entrant be able to be successful.

At the top end, agent-based modeling will be used more and more for more and more brands, categories and geographies. The business questions that can be answered will become more numerous and more critical. ABM is the future of modeling. What will you use to sculpt your marketplace.

Market Modeling The New Business Gesso*  Notes:

Market Modeling

The New Business Gesso*

Notes:

Market Modeling The New Business Gesso* www.decisionpower.com PRICE $95.00 Prove and Improve your Marketing Performance

Market Modeling

The New Business Gesso*

Market Modeling The New Business Gesso* www.decisionpower.com PRICE $95.00 Prove and Improve your Marketing Performance
Market Modeling The New Business Gesso* www.decisionpower.com PRICE $95.00 Prove and Improve your Marketing Performance

www.decisionpower.com

PRICE $95.00

The New Business Gesso* www.decisionpower.com PRICE $95.00 Prove and Improve your Marketing Performance Authorized
The New Business Gesso* www.decisionpower.com PRICE $95.00 Prove and Improve your Marketing Performance Authorized

Prove and Improve your Marketing Performance

Authorized MarketSim Consultants

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DemandROMI and “Prove and Improve your Marketing Performance” are trademarks of DemandROMI. All others are the properties of their respective owners. Additional editorial content provided by Ken Karakotsios, CEO, DecisionPower. © Copyright, 2005, DemandROMI All rights reserved. For information, please visist www.demandromi.com or www.returnonmarketing.net.