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Article Excerpt
In channel structures characterized by a powerful retailer (e.g., Wal-Mart, Home Depot), the dominant retailer's acceptance of a manufacturer's new product often determines the success of the new offering. Focusing on a manufacturer in such a market, we develop an approach to positioning and pricing a new product that directly incorporates the retailer's acceptance criteria into the development process. Our method also accounts for the retailer's product assortment and the competing manufacturers' potential reactions in wholesale prices. Our method merges individual-level conjoint models of preference with game-theoretic models of retailer and manufacturer behavior that are specific to the institutional setting of the focal manufacturer. The application of our approach in the context of a new power tool development project undertaken by this manufacturer also highlights the potential of our approach to other analogous institutional settings.
Key words: new product forecasting; product positioning; distribution channel; conjoint model; game theory; big-box retailers; retailer acceptance; Wal-Mart; Home Depot
History: This paper was received September 20, 2004, and was with the authors 12 months for 3 revisions; processed by John Hauser.
1. Introduction
The new product development process has generally focused on the consumer and ways to incorporate their preferences in developing new products, using methodologies such as conjoint analysis. However, focusing on the consumer alone can be insufficient, given that big-box retailers such as Wal-Mart, Home Depot, and Toys R Us have become dominant in many product markets (Schiller et al. 1992, McCormack 1997). Consumers prefer these big-box retailers because of their low prices, attractive assortments, and close proximity (Cappo 2003). For many product categories, they have become the first place most consumers shop when considering a purchase. With the power concentrated among these retailers, the refusal of such a retailer to carry a new product can effectively block its national distribution (Feigner 1989).
With this emerging clout, these dominant retailers have become gatekeepers for the numerous new products and line extensions introduced by the manufacturers. While consumers may prefer more variety, limited shelf space motivates dominant retailers such as Home Depot and Wal-Mart to employ category management in their new product acceptance decisions (Bounds 2005). Recognizing retailers' control of market access, manufacturers have been looking for a practical solution to address the problem of channel acceptance early on in the new product development process (Lucas 1996). Academic marketing researchers have also highlighted the importance of this issue. For example, Corstjens and Corstjens (1995) suggest that "consumer companies might improve their new product success rates if they put more effort in creating retailer value as well as consumer differential advantage." Rao (1997, p. 268) and McLaughlin and Rao (1991) highlight that channel acceptance of new products is a topic that deserves investigation. Urban and Hauser (1993) emphasize that the manufacturers should be prepared to include the retailer's preferences in their decisions to introduce new products, given the increasing power of retailers.
In this paper, we respond to this need for a practical model that incorporates the retailer's acceptance decision into the manufacturer's new product choice. We present a method to incorporate the retailer's acceptance in the new product introduction of a large consumer durable goods manufacturer, and we provide a prototypical application to one product category. Within the institutional context in which the manufacturer operates, we merge consumer preference data obtained in a conjoint experiment with game-theoretic models to estimate how the retailer and the competing manufacturers will react to the specific new product concepts, and whether the retailer would find a given concept acceptable. While existing models of predicting new product success tend to predict only consumer acceptance without considering channel behavior, we explicitly model category management decisions by the retailer so that the retailer's preference is accounted for in the new product introduction decisions, in addition to the needs of the end users. We also model the expected reactions of the incumbent manufacturers to the launch of a new product. To make the approach applicable to solving an actual problem, the model we develop must be geared to the institutional setting in which the manufacturer operates. Because the general methodology should have significant appeal for analogous contexts, we also discuss ways in which our framework can be modified to apply to different contexts.
We have organized the paper as follows. In [section] 2, we discuss the institutional setting that defines the scope of the study and framework. We also discuss analogous settings where our framework will be useful. In [section] 3, we present the theoretical rationale for our framework in the context of the institutional setting. We also present the methodological details of our approach. Section 4 describes the empirical application. In [section] 5, we discuss several model extensions that go beyond the scope of our institutional setting. We conclude in [section] 6 with a discussion on the contributions and limitations of our approach, and avenues for future research.
2. The Institutional Setting
The focal manufacturer in our study is a large multinational consumer durable goods manufacturer competing with several other large multinational firms with similar but differentiated products in the U.S. market characterized by a dominant retailer. The focal product category, a handheld power tool, is targeted towards metal and construction workers who buy their own tools, with the dominant retailer controlling much of the access to the market. Manufacturers have a strong incentive for acceptance of their products in this channel due to the large volumes handled by the dominant retailer. The second-largest retailer in this product category is considerably smaller, carrying only two store brands. While there may exist some strategic influences from this competing retailer, it is reasonable to assume that they are negligible. We provide a sensitivity test of this assumption later in [section] 5.
Our discussions with our industrial partner indicated that manufacturers in this category post a wholesale price for their products to the retailer. If the retailer decides to carry the product, the retailer sets the retail price. The acceptance or rejection of these new products is done during line reviews held by the retailer. These involve the review of a large number of products offered by the manufacturer to the retailer. The time devoted to any specific product is minimal, and ordinarily there is no negotiation between the manufacturer and retailer on wholesale prices. (1) Hence, we make the corresponding assumption in our strategic model. The line reviews allow the dominant retailer to benefit from the intense competition in new product entries. Therefore, the retailer avoids making any commitment on new product acceptance or dictating the desired product positioning and pricing to the manufacturers.
An important characteristic of the manufacturer-retailer setting is the uniform pricing structure. Various channel coordination mechanisms (such as two-part pricing, slotting allowances, and quantity discounts) are absent in our setting. (2) One possible reason for this is that the competition between manufacturers in the product market keeps them from reaching the collusive agreements needed to enforce the coordination mechanisms (Shaffer 1991). Another reason is that the focal product belongs to a mature category in which both the manufacturers and the retailer have good knowledge about the end users' preferences and demand, thus obviating the need to use slotting allowances or two-part pricing to communicate private information regarding product demand. (3) This pricing practice is likely in many other mature categories, so this institutional setting can have many analogies in which our approach can be useful.
Given that the product market is mature, the new products introduced in the focal category tend to be "continuous innovations" rather than "paradigm shifts." Consumers have good knowledge of the product category, and thus their inputs regarding product features and preferences can be quite useful for new product development. New products are introduced by a manufacturer every four to five years, and nonprice attributes of the incumbent products are typically not altered in the short term.
In summary, the product market is characterized by competing manufacturers and a decentralized dominant channel partner, with uniform pricing structure. Manufacturers determine product design and set wholesale prices, while the retailer is interested in maximizing category profit in making the product acceptance decisions, using a line review process. It is within this context that we propose our framework to help the focal manufacturer to identify the optimal product design that satisfies the needs of both the end users and the dominant retailer, while maximizing the manufacturer's profitability.
3. Application Framework
3.1. Development of Application Framework for the Institutional Setting
Our analysis consists of two stages. In the first stage, we estimate individual-level consumer preferences, wholesale prices, and marginal costs of the incumbent competitive products before the entry of the new product. Given the focus of our approach on accurate market forecasting, we use a choice-based hierarchical Bayesian conjoint model to obtain individual-level consumer preferences. (4) We collect data from the group of consumers who consider the dominant retailer as their primary store choice. We include "outside goods" in the consumer choice model, which implicitly allows for purchases at some competing retailers. As stated earlier, the relatively small presence of the main competing retailer in this category makes it unlikely that this retailer plays a major strategic role for this product. (5) In the first stage of our analysis, we also employ a model of manufacturer-retailer interaction to determine retail and wholesale costs, margins, and profits given our demand estimates. This model is based on an assumption that manufacturers maximize profits for their own product, and that the dominant retailer maximizes category profits. (6)
In the second stage, using the estimates obtained in Stage 1, we develop market scenarios to predict the channel acceptance decision for each design alternative. The market scenario is developed based upon the interactions among the retailer, the competing manufacturers, and the manufacturer of the new product in adjusting retail and wholesale prices to maximize their own profits after new product entry. As indicated earlier, the adjustment of the nonprice attributes occurs only every four or five years as part of a new product introduction in the market we study. Consequently, we model competitive reactions to new product introductions by changes in wholesale price only, which is consistent with the extant literature in product positioning and pricing (Carpenter 1989, Hauser 1988, Horsky and Nelson 1992, Moorthy 1988). (7)
We denote the market forecast of each possible product position as one market scenario. In each scenario, we solve for the Nash equilibrium retail and wholesale prices after the introduction of each design alternative. This follows from...
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