MANAGERIAL ECONOMICS-102

streamfood chains copied its formula. M&Ss share

of the British grocery market is under 3% and falling,

CASE STUDY 1: FACTORS AFFECTING DEMAND

Does M&S have a future?

The countrys most famous retailer Marks &
Spencers big store in Londons Kensington High
Street has just had a re-fit. Instead of the usual drab
M&S interior, it is now Californian shopping mall
meets modernist chrome and creamy marble floors.
Roomy walkways and designer displays have
replaced dreary row after row of clothes racks. By the
end of the year M&S will have 26 such stores around
Britain the first visible sign that the company is
making a serious effort to pull out of the nose-dive it
has been in for the past two years. Things have
become so bad that M&S, until recently a national
icon, is in danger of becoming a national joke.
.As the attacks grow in intensity, so do the doubts
about M&Ss ability to protect its core value: a
reputation for better quality that justified a slight
price premium at least in basic items.
It is a long time since any self-respecting teenager
went willingly into an M&S store to buy clothes.
Now even parents have learned to say no. Shoppers
in their thirties and forties used to dress like their
parents. Now many of them want to dress like their
kids. M&Ss makeover comes not a moment too
soon. Compared with the jazzy store layouts of rivals
such as Gap or Hennes & Mauritz, M&S shops look
like a hangover from a bygone era. The makeover
aims to bring it into the present.
People tended to join M&S straight from college
and work their way slowly up the ranks. Few senior
appointments were made from outside the
company. This meant that the company rested on its
laurels, harking back to innovations such as
machine-washable pullovers and chilled food.
Worse, M&S missed out on the retailing revolution
that began in the mid-1980s, when the likes of Gap
and Next shook up the industry with attractive
displays and marketing gimmicks. Their supply
chains were overhauled to provide what customers
were actually buying a surprisingly radical idea at
the time.
M&S, by contrast, continued with an outdated
business model. It clung to its Buy British policy
andit based its buying decisions too rigidly on its own
buyers guesses about what ranges of clothes would
sell, rather than reacting quickly to results from the
tills. Meanwhile, its competitors were putting
together global purchasing networks that were not
only more responsive, but were not locked into high
costs linked to the strength of sterling.
In clothing, moreover, M&S faces problems that
cannot be solved simply by improving its fashion
judgments. Research indicates that overall demand
for clothing has at best stabilised and may be set to
decline. This is because changing demographics
mean that an ever-higher share of consumer spending
is being done by the affluent over 45s. They are less
inclined than youngsters to spend a high proportion
of their disposable income on clothes.
The results of M&Ss rigid management approach
were not confined to clothes. The company got an
enormous boost 30 years ago when it spotted a gap
in the food market, and started selling fancy
convenience foods. Its success in this area capitalised
on the fact that, compared with clothes, food
generates high revenues per square metre of floor
space. While food takes up 15% of the floor space in
M&Ss stores it accounts for around 40% of sales.
But the company gradually lost its advantage asmain

compared with around 18% for its biggest

supermarket rival, Tesco.
M&S has been unable to respond to this competitive
challenge. In fact, rather than leading the way, it has
been copying rivals features by introducing in-house
bakeries, delicatessens and meat counters. Food sales
have been sluggish, and operating margins have
fallen as a result of the extra space and staff needed
for these services. Operating profits from food fell
from 247m in 1997 to 137m in 1999, while sales
stayed flat. Perhaps the most egregious example of
the companys insularity was the way it held out for
more than 20 years against the use of credit cards,
launching its own store card instead.
. When, in April this year, M&S eventually bowed to
the inevitable and began accepting credit cards, it
stumbled yet again. It had to give away around 3% of
its revenues from card transactions to the card
companies, but failed to generate a big enough
increase in sales to offset this. Worse, it had to slash
the interest rate on its own card, undermining the
core of its own finance business.
And this at a time when the credit-card business was
already becoming more competitive, with new
entrants offering rates as low as 5%.
If shrunk to its profitable core, M&S may become
an attractive target for another big retailer. At the
moment, however, while its food division may be
attractive to the likes of Tesco, the clothing side
represents a daunting challenge. Why take the risk
now, when the brand may be damaged beyond
repair?
Questions
1 Identify the main factors affecting the demand for
M&S products.
2 Analyse the weaknesses and threats on the
demand side of M&S, relating these to controllable
and uncontrollable factors.
tudy 5.1: Microsoft increasing or diminishing
returns?

accurately, as well as the considerable

investment by the software producer in
developing the package.

CASE STUDY 2 : MICROSOFT

INCREASING OR DIMINISHING RETURNS?
In some industries, securing the adoption of an
industry standard that is favourable to ones own
product is an enormous advantage. It can
involve marketing efforts that grow more
productive the larger the products market share.
Microsofts Windows is an excellent example.
The more customers adopt Windows, the more
applications are introduced by independent
software developers, and the more applications
that are introduced the greater the chance for
further adoptions. With other products the
market can quickly exhibit diminishing returns
to promotional expenditure, as it becomes
saturated. However, with the adoption of new
industry standards, or a new technology,
increasing returns can persist.
Microsoft is therefore willing to spend huge
amounts on promotion and marketing to gain
this advantage and dominate the industry. Many
would claim that this is a restrictive practice,
and that this has justified the recent anti-trust
suit against the company.
There is another side to the situation regarding
returns that should be considered.
Microsoft introduced Office 2000, a program
that includes Word, Excel, PowerPoint and
Access, to general retail customers in December
1999. It represented a considerable advance over
the previous package, Office 97, by allowing
much more interaction with the Internet. It also
allows easier collaborative work for firms using
an intranet. Thus many larger firms have been
willing to buy upgrades and pay the price of
around $230.
However, there is limited scope for users to take
advantage of these improvements. Office 97 was
already so full of features that most customers
could not begin to exhaust its possibilities. It has
been estimated that with Word 97 even
adventurous users were unlikely to use more
than a quarter of all its capabilities. In this
respect Microsoft is a victim of the law of
diminishing returns.Smaller businesses and
home users may not be too impressed with the
further capabilities of Office 2000.
Given the enormous costs of developing
upgrades to the package, the question is where
does Microsoft go from here. It is speculated
that the next version, Office 2003, may
incorporate a speech-recognition program,
making keyboard and mouse redundant. At the
moment such programs require a considerable
investment in time and effort from the user to
train the computer to interpret their commands
2

Questions
1 Is it possible for a firm to experience both
increasing and diminishing returns at the same
time?
2 What other firms, in other industries, might be
in similar situations to Microsoft, and inwhat
respects?
3 What is the nature of the fixed factor that is
causing the law of diminishing returns in
Microsofts case?
4 Are there any ways in which Microsoft can
reduce the undesirable effects of the law of
diminishing returns?

Some towns and cities are well served by health

clubs in both the premium and economy
segments of the market. When there is genuine
market competition, price elasticity of demand
should be higher.
ELASTICITY OF DEMAND - CASE STUDY 3:
HEALTH CLUBS

Elasticity of Demand for Health Clubs

The health club market provides an interesting
case study in using the concepts of price
elasticity of demand and income elasticity of
demand
Price Elasticity of Demand

Income Elasticity of Demand

Income elasticity measures the responsiveness
of demand to a change in consumers' real
income. Although some fitness fanatics may
regard their membership as a necessity (giving a
low but positive value for income elasticity), for
many consumers, an individual or family
membership is often seen as a luxury item in
their annual budget.
Normal luxury products have a highly positive
income elasticity of demand. When the economy
is strong, and incomes and employment are
rising, we expect to see strong growth in market
demand for health and fitness activities. This
encompasses health clubs together with other
activities (including sports-based holidays).
In an economic slowdown, discretionary
spending on health clubs may fall-although in
the short term, thousands of members are
committed to an annual fee.

Price elasticity of demand measures the

responsiveness of demand to a change in the
own price of a good or service. When demand is
inelastic (e.g. demand curve D1 in the diagram
above), consumer demand is relatively
insensitive to changes in price.
Elasticity tends to be low when the product is
viewed by the consumer as a necessity, or when
it takes up a small percentage of total income.
Elasticity is low when there are few close
substitutes and when the consumer has
developed a strong sense of brand loyalty. A
relatively elastic demand curve is shown by D2
in the same diagram.
What of the price elasticity of demand for health
club memberships?
Regular gym users regard their health club visits
as an important feature of their weekly exercise
regime. They are unlikely to cancel a
membership if fees rise from time to time. The
majority of gym members pay their
subscriptions using direct debit. They may take
some time to realise that their monthly charge
has changed. And, for most consumers, having
made the decision to commit themselves to a
membership of between Rs 2500 Rs 5000 per
month, a small rise in fees is unlikely to lead to a
cancelled membership.

4. REQUIREMENTS OF A GOOD FORECAST

A good forecast should satisfy the following criteria:

Time frame: The first factor that can

influence the choice of forecasting is the time frame
of the forecasting situation. Forecasts are generally
for points in time that may be a number of days,
weeks, months, quarters, or years in the future. This
length of time is called the time frame or time
horizon. The length of the time frame is usually
categorized as Immediate, Short term, Medium or
Long term. In general, the length of the time frame
will influence the choice of the forecasting technique.
Typically a longer time frame makes accurate
forecasting more difficult with qualitative forecasting
techniques becoming more useful as the time frame
lengthens.

Pattern of the data: The pattern of the data

must also be considered when choosing a forecasting
model. The components present i.e. trend, cycle,
seasonal or some combination of these will help
determine the forecasting model that will be used.
Thus it is extremely important to identify the existing
data pattern.

Cost/Economy of forecasting: Though the

firm is interested in accurate forecasts, the benefits of
accurate results must be weighed against the cost of
the method. While choosing a forecasting technique,
several costs are relevant. First, the cost of
developing the model must be considered. Second the
cost of storing the necessary data must be considered.
Some forecasting methods require the storage of a
relatively small amount of data, while other methods
require the storage of large amounts of data. Last, the
cost of the actual operation of the forecasting
technique is obviously very important. Some
forecasting methods are operationally simple, while
others are very complex. The degree of complexity
can have a definite influence on the total cost of
forecasting.

Accuracy desired: Accuracy in forecasting is

very important. The previous method must be
checked for want of accuracy by observing that the
predictions made in the past are accurate or not. The
accuracy of past forecasting can be checked against
present performance and of present forecasts against
future performance. In some situations a forecast that
is in error by as much as 20% may be acceptable. In
other situations a forecast that is in error by 1% might
be disastrous. The accuracy that can be obtained
using any particular forecasting method is always an
important consideration.

Availability of data: Immediate availability

of data is an important requirement and the method
employed should be able to produce good results
quickly. The technique which takes much time to

produce useful information is of no use. Historical

data on the variable of interest are used when
quantitative forecasting methods are employed. The
availability of this information is a factor that may
determine the forecasting method to be used. Since
various forecasting methods require different
amounts of historical data, the quantity of data
available is important. Beyond this, the accuracy and
the timeliness of the data that are available must be
examined, since the use of inaccurate or outdated
historical data will obviously yield inaccurate
predictions

Plausibility/Ease of operation and

understanding: The ease with the forecasting method
is operated and understood is important. Management
must be able to understand and have confidence in
the technique used. It has to understand clearly how
the estimate was made. Mathematical and statistical
techniques should be avoided if the management
cannot understand what the forecaster does.
Managers are held responsible for the decisions they
make and if they are to be expected to base their
decisions on predictions, they must be able to
understand the techniques used to obtain these
predictions. A manager simply will not have
confidence in the predictions obtained from a
forecasting technique he or she does not understand,
and if the manager does not have confidence in these
predictions, they will not be used in the decisionmaking process. Thus, the managers understanding of
the forecasting system is of crucial importance.

Durability: The forecast should be durable

and should not be changed frequently. The durability
of the forecasts depends on the simplicity and ease of
comprehension as well as on continuous link between
the past and the present and between present and the
future.

Flexibility: The technique used in

forecasting must be able to accommodate and absorb
frequent changes occurring in the economy.

board of directors that the price of each kit

should be reduced by Rs 4 which will
increase sales by 2000 kits per month and
this requires additional fixed cost of Rs 4000
CASE STUDY 5:
BREAK EVEN ANALYSIS
Mentor Plcs Writing Materials

per month.
a) With reference to Mentor plc distinguish
between fixed cost and variable cost.

Mentor

Inc

produces

creative

writing

materials kit for school kids. Each kit

b)

Calculate the following[ Show relevant

workings]:

includes artistic pen sets, drawing pencil sets

i.

contribution per kit

ii.

the monthly output of kits

& fragrant erasers. Kits are sold by retail

shops across India. The kits are sold to

required to break even.

retailers for a premium price of Rs 44. In

iii.

their marketing, Mentor Inc justifies the

iv.

quality of the materials used. The Mentor

of safety at

the monthly level of profit at

present sales level.

brand is highly regarded by their target

c) Construct a break even graph

and

identify the following:

Cost details are:

Production cost Rs 20 per kit.

i.

break even output

Sales representative commission Rs

ii.

margin of safety at present

level of sales

3 per kit.

Transportation

and

iii.

miscellaneous

expenses Rs 1 per kit.

Fixed costs per month Rs 40,000.

The factory capacity is 5000 kits per month

and at present 4000 kits are sold per month.
The marketing manager has proposed to the

margin

present level of sales.

relatively high price by emphasizing the

market of 12 to 18 year old school kids.

the

monthly level of profit at

present sales level

d) Evaluate

the

marketing

managers

proposal to reduce price of each kit by

Rs 4