Functions and Frameworks is dedicated to helping business owners innovate

Monday, July 7, 2014

How Calculus Can Help You in Business

Ever wonder why we take calculus during college (with the exception of degrees heavily focusing in the arts)? I remember that most students do not really appreciate this subject due to the 'alien' concept and mind-boggling equations.

Being an engineering student myself, I was a bit confused as to how this subject can help me once I get a full time job. Like any other student, I also asked sarcastically the question - Why do I need calculus? It's not like I'll go to the market and ask for the differential price of a product. Nobody really uses it in real life.  

But as years gone by, and I matured in my chosen field of profession - I realised that Calculus was more than a math subject I need to pass in college. I remember my CEO calling me one time showing me a bell curve graph showing the fluctuation of our EBITDA numbers as we increase or decrease our OPEX. I know, I know... big words! Simply put, my CEO was asking me to find out what metric should we tweak in order to meet that sweet spot to optimise our production cost and at the same time hit our profitability target.

This experience is one of the countless events that forced me to go back to my old textbooks and find a way to answer these crucial questions. And it brought me back to Calculus and the concept of derivatives, limits and functions.

In order to appreciate Calculus and its many applications for business, let me hone this discussion in the topic of derivatives and differentiation. To make it simpler, let me provide a non-standard definition of these two concepts in the context of business administration and management.

A DERIVATIVE is something (a number, a metric, a KPI, etc) which is based  on another source. It is the number or the event that you would like to know given a certain set of information or facts to predict a certain outcome. It is determined only if another variable is present. And the process of finding this Derivative is called DIFFERENTIATION. 

To make sense of this topic, let me give you two cases that I've used  this concepts in reality

CASE 1: Budget Rooms for Rent

Situation: One of the business owners I've helped is an owner of a small apartment for rent for backpackers. He owns 250 rooms across the city and marketing it heavily via the internet and travel agencies. If they rent X apartments then his monthly profit, in dollars, is given by the following equation:

P(x) = 3200x - 80,000 - 8x

3,200x is the price per room per stay.
-80,000 is the fixed monthly cost to operate the business.
- 8x2 is the recorded rate of the variable cost during operations.

Case Problem: How many rooms should they rent in order to maximise profit?

Some people would think immediately that renting all rooms will be the best case scenario reaping maximum profits. But factoring in cost of operations (both fixed and variable cost), it would be interesting to know if renting out all rooms will definitely be the best possible course monthly for this business owner.


We know that the maximum profit is between 0<x<250 range of rented rooms. What we need to do next is to find the derivative of the profit as declared above to get the Critical Points to which we will get the maximum profit. Again, as defined, derivative is something that you would like to know based on other facts (in this case the PROFIT). And we need to differentiate it to get the derivative.

(I assume you know basic differentiation)

P'(x) = 3200-16X
If P'(x) = 0
0 = 3200-16X
X = 200

200 is one of the critical points. Hence the range is between 0<200<250

Substituting these three numbers, we get the following profit per month:

P(0) = -80,000
P(200) = 240,000
P(250) = 220,000

As you can see, renting all 250 rooms produced less profits versus 200 rooms if we factor in operational cost. Hence, the business owner was advice to aim to rent out 200 rooms at regular price in any given month and utilise the remaining 50 for any promotions they would like to do to further increase their earnings.

CASE 2: Cupcakes for Sale!

Situation: Every December, one of my friends sells cupcakes to earn extra during the holiday season. One of her biggest challenge is that after the end of the month, she feels that her total effort in producing the cupcakes versus the money she earns from it is not generating her significant income. She doesn't know what price tiering she would do because her cost increases if she produces more cupcakes.

So, after observing and recording data, we found out that her production cost per day has this function:

C(x) = 2500 - 10x - 0.01x - 0.0002x3
2500 is her total cost
-10X is her savings since she can produce 10 more cupcakes using the same amount of ingredients
- 0.01xis her savings on electricity
- 0.0002xis her savings on delivery per batch to clients

Case Problem: She wanted to know what would be the rate of change of her cost if she produces 200, 300 and 400 cupcakes in a day in order for her to create an optimal pricing scheme.


Same process in the first case, look for the derivative and apply the critical points 200, 300 and 400.

C'(x) = -10 - 0.02x + 0.0006x

C'(200) = $10
C'(300) = $38
C'(400) = $78

As you can see, producing the 201st cupcake will add $10 to her cost, 301st cupcake will cost $38 and the 401st cupcake will be $78.

From this information, she knows that her cost increases every time she increased her production. This made it possible for her to create tiering in her price schemes to cover the increasing cost associated with production.

So there you have it, simple ways you can use derivatives in your business. It has more applications which we can cover in other blog post. If used properly, you can definitely outwit your competition.

11:51 PM Posted by Nicco Joselito Lopez-Tan (陳里道) 0

Tuesday, June 24, 2014

Reconstructing Market Boundaries - How to Develop a New Market

Whenever I discuss marketing as a subject with a few friends or lecture about marketing principles, I always get questions about the pressure of emerging media. Specifically digital concepts and how it affects their existing strategies. Then there is this debate if digital marketing is another form of "market penetration" or "market development" strategy.

Some marketers view digital marketing as a penetration strategy entering an existing market with existing products. They believe that  they are marketing to the same group of people (using digital marketing concepts) with existing product positioning will reap higher results.

While this might be true to some brands or products, what I have observed so far after countless experiments in a live e-commerce platform is far from just penetrating a market.

What I have observed in several digital campaigns being integrated in an entire existing strategy replicates the primary elements of a market development approach strategy. So you might ask what are those elements. Simply put, what I have observed shows the very primary elements of market development - new market, existing products.

Some argues that my definition of "new market" does not apply to the digital realm. Their argument is rooted on the fact that these are same markets but only equipped with gadgets that are able to transact and receive marketing messages.

But as I explore this new media and acquire data-tested results, I firmly believe that market development strategies would work far more better than penetration strategies. My hypothesis for this claim is based on my definition of a "new market" which is:

New Market in the digital space is  based on digital behavior rather than the general demographic profile.

This way, I can increase further our earnings through a more detailed targeting criteria with higher potential of customer conversion.

So the next question is, how do I develop a new market? There's no simple way of doing this but I have used a few frameworks out there that helped me developed profitable market segments. Here are some suggestions that you can test out on your own and see if it works!

The first time I heard this phrase was during my master's program where one of my professors said that "strategy" is being the best in your category. It doesn't mean you have to settle for 2nd best but the takeaway for this part is to know what space you are competing and being the best in that category.

In order to recreate your market boundaries, you have to start at a product category that is already acceptable. For example: luxury cars, hand soap, instant noodles, etc. These are existing acceptable categories. Before competing directly with accepted categories, understand first how your product will stand out from the rest based on an existing buyer group.

Before enhancing your target market, focus first on the existing buyer groups of the product category you are trying to win.  You can select from the following: it can be the purchaser (i.e. moms buying hotdogs), the user (i.e. kids who loves hotdogs) or the influencer (i.e. best friends of the mom who needs a suggestion for quick bites for her kids).

This is where research comes in. After deciding which buyer group you will focus on, create a list of direct competitors and define their scope of products and services offered. Some questions that will help you identify these elements:

  1. Are there other variants of these products?
  2. What is their product positioning? Who are they targeting and how are they communicating it?
  3. What value added service do they offer?
  4. How often they create promotions?
  5. Is there something intangible that customers considers valuable from the product?
  6. How long is the sales cycle?
  7. How many people buys it from the shelf? Frequency and Recency?

You can even make a matrix of the 4 P's to complete this section. List down the product info in one column, list down the place that it is distributed (include if it has shipping involved), list down how many promotions they did, and what type (i.e. discount, buy one get one, gift with purchase, etc), list down the prices in different channels of distribution.

Once you've identified all the elements in the previous step. It's now time to generate you key takeaways as to how the entire industry looks like and accept its functional and emotional orientation.

Here's an example: Product category: Luxury Cars
Functional truth - these cars are the same with other economical cars because it can take one person from point A to point B. However, the luxury car category boasts of sophisticated design, slightly expensive materials, customized  interiors, state-of-the-art electronics, 24 hours concierge/hotline, free cleaning for one month, and other features like imported leather seats.

Emotional truth - two people will buy this. People who are financially capable and demands them to put on an image of luxury and finesse. These people would most likely be CEOs and business owners. The other is a group of people who aspires to be one of the people described above. That they will do anything to come up with the money to buy the luxury car. But these two groups feels the same emotional orientation, they want to feel special and be acknowledged as a high spender radiating an image of sophistication, class and financial stability.

To reconstruct market boundaries and developed a whole new market, you can use the following strategy canvas developed by W. Chan Kim and Renee Mauborgne in their book - Blue Ocean Strategy. I find this tool very effective in developing a new market.

What you do is to have a functional vs emotional grid outlining the key functions of the product category in the X-axis. Outline all the functions as listed in the previous steps. On your Y-axis, have two  criteria - High Value or Low value. This will serve as the emotional meter. You will mark this based on the offering. Mark it high if its being offered and low if its not.

Here's an example following the Luxury Car product:

You can see immediately which functions you have and you don't have as benchmarked against your direct competitors. 

After mapping out your competitor's functional and emotional positioning, you then layer your own on top of it. From there you will use the RRC framework:

Reduce - decrease or completely eliminate from your product features or offerings
Raise - increase the value of the functions you want to highlight to develop a new market
Create - functions and features you know you can fulfill for the customer that adds value

Taking the example above, you decided to reduce a few features that are not important to the current user base. You raise the features that are important. and create new features that are not yet available to your competitors. Hence, you decided to do the following:

From this graph alone, you can already see your key differentiators and how you can make your competitors irrelevant by focusing on functions that has high emotional value to your target market. 

After setting on what you will reduce, raise and create in your strategy canvas, this will then help you fill in the rest of your marketing strategy in terms of promotion, communication, distribution and positioning.

Following that will help you target the market you want to attract and therefore help you define the characteristics of this new market.

5:45 PM Posted by Nicco Joselito Lopez-Tan (陳里道) 0

Tuesday, April 15, 2014

Applying the Alternative Response Hierarchy Models to Predict E-Commerce Success in Southeast Asia

The strong economic growth in Southeast Asia has led to a continuous improvement in Internet infrastructure making it the next hotspot for e-commerce ventures. The abundance of young, tech-savvy consumers is an appealing aspect of the Southeast Asian market. Roughly half of the region’s 600 million people are under 30 and increasingly moving to cities, which helps explain why the region has some of the highest levels of digital engagement in the world. And high Facebook and Twitter usage provides e-commerce companies with a fertile channel for connecting with potential customers.

However, the rapid increase in digital engagement did not produce a relative growth in Internet shopping. The total e-commerce transactions the past decade is still relatively small compared to more advanced economies. The level of trust in using the Internet for shopping is still weak because Southeast Asian consumers have yet to develop the maturity in buying products or services online. Comparing advanced economies to Southeast Asia, trust in Internet shopping is high. The high trust index is driven by four antecedents of which can be used to predict future buying behavior in Southeast Asian markets.

Lee and Turban (2001) proposed a theoretical model for investigating the four main antecedent influences on consumer trust in Internet shopping, a major form of business-to-consumer e-commerce: trustworthiness of the Internet merchant, trustworthiness of the Internet as a shopping medium, infrastructural (contextual) factors (e.g. security, third-party certification), and other factors (e.g. company size, demographic variables).

They suggested that the antecedent variables are moderated by the individual consumer’s degree of trust propensity, which reflects personality traits, culture, and experience. Based on the research model, a comprehensive set of hypotheses is formulated and a methodology for testing them is outlined.

Some of the hypotheses are tested empirically to demonstrate the applicability of the theoretical model. The findings indicate that merchant integrity is a major positive determinant of consumer trust in Internet shopping, and that its effect is moderated by the individual consumer’s trust propensity.

As seen in recent studies, Southeast Asia is the next big market for Internet shopping platforms. The slow but increasing growth of e-commerce transactions in the past is an indicator of adoption and increasing consumer trust. However, as more online stores opens, consumers are presented with several websites that are similar in nature but provides different experiences from discovery to purchasing an offer. This experience is a predictor for future online transactions – whether to continue buying online or abandon Internet shopping and revert to the physical retail stores.
In most studies, experience in the online context is synonymous to the entire digital sales funnel. It is the entire user experience from discovering the offer through online ads, increasing their knowledge by familiarizing themselves with the website, until the consumer reaches the end of the sales cycle and decides to buy the offer. Most marketers also use this linear formula to improve their digital marketing campaigns and expect incremental sales growth by replicating the offline retail experience in an online setting. What most marketers forget is that online buying behavior does not follow the traditional consumer response processes.

Product tangibility is what’s lacking in the Internet shopping process hence forces the consumer to respond to the experience differently compared to the traditional retail experience. And if the consumer behaves differently, a different approach is needed to further investigate what are the key drivers for buying online.

Michael Ray (1974) has developed a model of information processing that identifies three alternative orderings of the three stages on perceived product differentiation and product involvement. These alternative response hierarchies are the standard learning, low-involvement, and dissonance/attribution models (Figure 1)

Figure 1

Ray’s study show that not all consumers follow the same purchase patterns and their response process varies based on their level of involvement. A change in consumer attitude, in this case the act of purchasing an item, changes depending on what type of product or services is being bought and under what circumstances. Adding the Internet as a medium complicates this process and highly influences the consumer attitude. Ergo, applying the alternative response process in understanding Internet shopping can easily predict e-commerce success. E-commerce succes is defined as total sales revenue and repeat spending on the online store.

The DeLone and McLean IS (Information System) Success Model is an existing success-measurement framework that has found wide application since its publication in 1992. It is a comprehensive framework for measuring the performance of information systems. With the emergence of new business models and e-commerce platforms, an updated version of the model can be applied to e-commerce success measurement (Figure 2).

Figure 2

The new and updated model is based on the empirical and theoretical contributions of researchers who have tested and discussed the original model. They suggested that the updated model is composed of six dimensions - System Quality, Information Quality, Service Quality, Use, User Satisfaction, and Net Benefits. Based on these independent researchers, they stressed the importance of measuring the possible interactions among the success dimensions in order to isolate the effects of independent variables on one or more of them.

Viewing the DeLone & McLean IS Success Model from both a process perspective and a variance perspective can be useful in identifying and understanding these interactions. Drawing from the information system and marketing literature over recent years, the six dimensions of the updated DeLone and McLean model comprise a parsimonious framework for organizing the various e-commerce success metrics identified in the literature.

Applying the alternative response hierarchies to predict e-commerce success will give insights to the key drivers for a successful online business. Understanding how a consumer develop their attitude towards Internet shopping in Southeast Asia will provide future researchers insights into how to tap this growing economy.
4:36 PM Posted by Nicco Joselito Lopez-Tan (陳里道) 0