Figure 4.10 Exercise: The Bass Diffusion Model of market development

1. STRATEGIC MANAGEMENT DYNAMICS Kim Warren Figure 4.10 Exercise: The Bass Diffusion Model of market development Exploring how a population of potential customers is developed by the combined effects of advertising and word-of-mouth. This exercise supports part of Figure 4.10 in chapter 4 of the textbook ‘Strategic Management Dynamics’ by Kim Warren, from J Wiley & Sons, 2008. www.wiley.com/go/smd. See www.strategydynamics.com/smdresources for the related course.

2. NOTE: • This slide show has no audio – the call-outs explain each point. • Use the Pause button and slider in your viewer to suit your reading speed and move to different points in the presentation.

3. The model … • The model to which these instructions refer - ‘Fig 4.10 Bass Diffusion Model.msf’ – can be found at www.strategydynamics.com/smdresources/chapter4.asp. • The model requires the mystrategy™ software – a Reader version can be downloaded from www.strategydynamics.com/msi • The model can be run with the Reader version, but results cannot be saved • Instructions on fully licensing the software can be found in its Help menu • Getting started: • Install mystrategy • Open the model • Read the following pages before working with the model • ™ ‘mystrategy’ is a registered trade mark of Global Strategy Dynamics Ltd.

4. This figure [4.10 from chapter 4] shows how customers in a market develop through what is known as “S-shaped growth”, because the chart of active customers looks like an elongated “S.” Initially, advertising is the only factor driving the customer win rate. As potential customers are used up, advertising is not able to sustain a high win-rate, but potential customers are also made aware of the product by contact with active customers. While the active customer base is growing fast and the potential is still large, this word-of-mouth effect wins customers increasingly fast. Eventually,, so few potential customers remain that this rate also declines. The word-of-mouth win rate also starts to decline, along with the advertising-driven win rate, and market growth slows and stops. How a population of potential customers is developed by the combined effects of advertising and word-of-mouth This is the number of people who own or buy the product. This is the number of people who might want the product, but do not yet own or buy it. For a durable product each month’s sales reflect the flow-rate of total new customers per month. For a consumable product, active customers drive continuing sales also. [Sales are not reported in this Figure] See pages 185-189 of Strategic Management Dynamics for detailed explanation.

5. Running the model … Charts display the number of potential and active customers, the customer win-rate, and total sales each month. Charts display the number of potential and active customers, the customer win-rate, and total sales each month. Charts display the sources of new customers, the number of potential and active customers, and total customer win-rate. In this section at left, change the rate of advertising spend and customers’ behaviour. Click ‘’ to run all 36 months at once or ‘| ’ to step through one year on each click. You must stop the model ‘’ before you can make any changes. Current values for each variable are also displayed whenever the model is paused. This chart displays the monthly profit, reflecting the product’s sales and a range of other assumptions.

6. Managing the number of customers won and lost … This variable and its small time-chart controls the rate of advertising spend each month over the 36 months of the product launch. This variable sets the fraction of customers seeing your advertising who start buying the product. [set this only a the start of the simulation] This variable sets the fraction of contacts between active and potential customers that results in the winning of a new customer. [set this only a the start of the simulation] See next pages for how to change the values of these variables.

7. Changing the monthly advertising spend … 2. Select the Graph tab [do not enter any values in the Equations tab, or the graph’s values will be ignored] 1. Double-click the variable ‘ADVERTISING SPEND $000 per month’ ... the ‘Element Set-Up’ window will appear. Do not change the vertical axis – the model is configured to work within the range shown. 3. Enter values in the cells for the monthly advertising spend during each 6-month period. Optionally, you can vary advertising more frequently – click the ‘Time Interval’ button. 5. Click ‘OK’ to confirm your changes 4. … alternatively, drag the mouse across the chart area – the values in the cells at left will change to reflect this red line

8. Changing either the fraction of potential customers responding to advertising, or the fraction of contacts between active and potential customers that result in a new customer being won. 1. Double-click the constant ‘Fraction responding to advertising per month’ ... the ‘Element Set-Up’ window will appear. 2. Select the Equation tab 3. Enter a new value in the Equation: box for the fraction of people seeing your advertising that become customers. Although this value can be changed whenever the model is paused, it reflects a behaviour that may not change much during a product launch. So, set the value before running the simulation, and leave it unchanged while it runs the 36 months. 4. Click ‘OK’ to confirm your changes Follow the same procedure to change the fraction of contacts between potential and active customers that result in a new customer being won..

9. Comparing different scenarios There are two copies of the underlying model. One version runs the base-case values, the other version runs with the values you choose for advertising spend. In this case, advertising spend was raised during the first three 6-month periods, then later reduced. Black lines show base-case values. Green lines show the results of running with changes you make to advertising spend. This chart and the numbers displayed alongside it show how the customer win-rate is made up of [a] people won by advertising, and [b] others won by word-of-mouth. No base-case values are displayed on this chart. Note that the current value of each variable for your scenario is also displayed.

10. Estimate the answers to the following questions before running the simulation to confirm the result. [It is not possible to calculate the answers exactly]. The planning sheet and the screen-shot of the base-case scenario on the next pages will be helpful for some of questions. What constant rate of advertising spend produces the highest rate of profit by month 36? What is the earliest month the product becomes profitable if you spend a constant amount on advertising over the 3 years of [a] $100,000, [b] $200,000, [c] $300,000, and so on? What final rate of profit is achieved in each case? You are given a total advertising budget over the 3 years of $20 million. How should that budget best be split over the 36 months to achieve [a] the earliest profit, and [b] the highest final profit? You have been brought in after 12 months of a disappointing product launch, in which previous management spent just $200,000 per month. [Set advertising for the first two 6-month periods to 200]. You have been asked to make the product generate $0.5million per month throughout the third year. How much advertising budget should you ask for in year 2, in order to hit this target? Suggested investigations …

11. Planning sheet for advertising spend plans

12. Base-case scenario – sketch estimated outcomes for your alternative advertising strategies on this sheet.