Consumer choice modeling … how people decide to buy

Excerpted from Strategy+Business, “Tracking the Elusive Consumer”, by John Jullens and Gregor Harter, Novermber 11, 2008

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Consumer choice modeling … offers a better understanding of consumer preferences:
  • What does the consumer want?
  • Why do individuals prefer one product or service over another?
  • How, precisely, do most consumers make their purchasing decisions?

Recent work on the art and science of consumer behavior has refined, updated, and strengthened an analytical tool known as consumer choice modeling, initially developed in the 1960s by Daniel McFadden, a winner of the 2000 Nobel Prize in economics.

Simply put, this model examines the personal reasons for individual choices and provides techniques researchers can use to measure and predict those choices. By exploring why individuals make specific trade-offs among various product options, consumer choice modeling can determine the features that people in different economic and demographic strata are looking for and how much they are willing to pay.

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Originally, this technique suffered from a lack of sophistication. A typical implementation involved asking respondents to react to lengthy paper-and-pencil surveys offering a series of preconfigured and static product or service possibilities. Although some insight about consumer preferences was typically evinced, it was often shallow, limited by researchers’ inability to dynamically change the direction of the questioning on the basis of the responses.

However, advances in experimental designs and information technology now allow researchers to better approximate the shopping experience when asking questions by adjusting product choices in reaction to a person’s answers. By analyzing the responses from a representative sample of consumers (or potential future customers), researchers can produce econometric models that depict the relative weighting of specific product features and price points.

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Early in 2007, Booz & Co.applied consumer choice modeling to identify and measure the drivers of demand for mobile phones. One example::  Apple’s iPhone.

Long before the iPhone’s launch,  the Booz  model correctly predicted that it would be the most attractive overall offering to consumers despite its high price tag. 

Booz  surveyed more than 1,800 consumers by simulating the actual mobile phone purchasing process and asking people to compare their existing package with alternatives.

For example, owners of low-cost Sharp handsets running on pay-as-you-go carriers such as Virgin Mobile or Boost Mobile were offered a U$100-plus Samsung phone with Nextel service and a $250-plus LG phone with Verizon’s network. Respondents were asked, “If these two packages were your only alternatives, which one would you choose: Samsung/Nextel, LG/ Verizon, or neither?” and “If Samsung/Nextel were your only option, would you purchase it or continue to use your current package?”

The majority of the low-end and midlevel consumers were highly commodity driven. Other than by offering an attractive handset price, it is almost impossible to convince an individual to change his or her current mobile phone package. In fact, further analyses revealed that one-third of U.S. consumers are unwilling to change their wireless package, no matter how much the handset price is lowered.

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Of all phone users, owners of low-end handsets made by the Nokia  value their phone package the least. Consequently, these consumers are the most willing to switch to another carrier and handset — an opportunity for competitors to attack Nokia’s base by producing a low-cost package with a function or two that outpaces the relatively plain Nokia product.

The consumer choice model also revealed that owners of handsets made by Sony Ericsson , which tend to be highly designed, full-featured products, care much more than Nokia users about functionality, usage range, and purchase location (they prefer to buy their packages at stores that offer personal attention, rather than at Costco or Circuit City, for example). And although these customers, too, are price conscious, they’re willing to pay a premium to have their preferences met. A service provider could use these findings to target Sony Ericsson owners with a slightly less expensive offering that in all other ways matches their current package.

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Consumer choice modeling also has the ability to predict the impact of future products and services on the market. Booz  simulated the characteristics of “the ideal high-end phone” as consumers viewed it. From this, the survey gleaned that three primary factors — feature, design, and brand — are of paramount value to consumers considering a higher-priced model. These factors, of course, were exactly what Apple focused on in developing its blockbuster iPhone, launched in July 2007.

Significantly, as the model predicted, Apple stumbled when it came to price, which the survey showed matters at all levels of cell phone purchases.

At a price point of $599 for an eight-gigabyte phone, the research forecasted that Apple would have difficulty reaching a significant portion of the high-end market. But the same research suggested that performance would improve quickly as soon as Apple cut prices. In fact, that is precisely what happened: In September 2007, Apple discounted the phone by $200, and sales rose well over 1,000 percent in the succeeding quarter from sales in the prior three-month period. And in June 2008, CEO Steve Jobs announced a much faster eight-gigabyte iPhone — using AT&T’s state-of-the-art 3G network — for only $199, a move that further aligned Apple’s pricing with that of its peers and that will almost certainly improve the product’s market share.

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Consumer choice modeling yields valuable insights for demand-driven strategy development by providing customer value segmentation maps, measuring market share impact of new product–service combinations, and assessing overall brand equity. Perhaps most important, choice modeling can reveal sa­lient differences between managers’ beliefs about customers’ needs and preferences and customers’ actual needs and preferences. For managers seeking reliable feedback on how customers view their products and services, consumer choice modeling provides a rigorous way to turn customer-driven feedback into profitable and sustainable tactics for retaining or capturing market share.

Edit by DAF

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