Strategy Dynamics Briefing 20: The Bass Diffusion Model

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We have discussed how resources drive or hold back each others’ growth rates, and the idea that the level of a resource may affect its own development.

A particularly common framework arises when the saturation of a limited opportunity combines with word-of-mouth between already active customers and potential customers. This captures well how new products diffuse into a market, a process first set out by Professor Frank Bass1 hence the framework’s title.

Although initially focused on how durable products are adopted (products that last a long time before being replaced), the idea can be widened to deal with consumable products too.To launch a new product, management uses advertizing. In addition, potential customers are persuaded to buy a product by talking to or observing customers who already own it. Consider a market with the following characteristics:

  • Potential customers = 500 000 (Initial customers or owners = 0.)
  • Advertizing required to reach all potential customers = $2 million/month, with lower spending rates reaching only a fraction
  • contacts per month between potential customers and existing owners = two times per month
  • Two percent of potential customers reached by advertizing become new customers each month
  • Five percent of potential customers who come into contact with actual customers buy the product each month

The figure shows how the S-shaped growth of customers in this market develops. Initially (purple line segmentsblue segments). While the number of owners is growing fast and the potential is still large, this word-of-mouth effect wins customers increasingly fast. Eventually, however, so few potential customers remain that this rate also declines, even though there is a large number of active customers (green segments).

Bass Diffusion Model

The exact pattern of customer win rate this model exhibits over time depends on several factors—the size of the potential market, the relationship between advertizing spend and potential customers reached, the contact frequency between existing owners and potential customers, and the fractions of people contacted who buy the product. What makes this model especially useful is that, unlike other forecasting techniques, it is able to anticipate a reversal of sales. This occurs in month 19, when total new customers hits a peak of nearly 16000 per month. It is therefore possible to assess the impact of changing advertizing rates as the product’s uptake develops. It might make sense, for example, to start with heavy advertizing to get some active customers quickly, then cut back on advertizing and allow the word-of-mouth mechanism to do the work of winning new customers.

The Bass Diffusion Model is found in very many real-world situations, and can be extended to capture the richness of more complex situations. For example, the potential customer stock can be divided between early adopters – customers who are particularly keen to try new products and respond strongly both to advertizing and to observing other early adopters with the product – and late adopters or followers who only respond when products are well established. The model can also be extended to deal with more issues, such as pricing, product functionality and R&D investments.

1 Bass, F. (1969) A new product growth model for consumer durables. Management Science, 15, 215–227.

Until next time…

 

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Consumable vs. Durable products

Previous briefings have stated rather simply that customers drive sales, i.e. the level of the customer resource. However, this is only strictly accurate for continuously consumed products, for example gas or water supplies. Even for fast-moving consumable products, such as breakfast cereals or beer, a small fraction of sales each month come from the few new customers who buy the product for the first time. For more durable products, such as shoes, both first-time customers and people buying replacements contribute to sales, and for the most durable products, like cars or washing machines, sales are almost entirely driven by the win-rate of new customers, i.e. the flow-rate. The level of the customer resource may still be relevant and worth attention, for example through driving word-of-mouth capture of further new customers, but contributes no sales.

Strategic Management Dynamics book coverIt is often possible to improve the sales performance of durable products by trying to capture some of the benefits of repeat-purchase. Car makers such as Toyota and BMW, for example, have especially high rates of repeat purchase for their vehicles, so a large fraction of sales comes from the stock of loyal owners. An intriguing example concerned a real-estate agency, who made a policy of keeping in touch with first-time home-buyers to capture their business each time they upgraded to larger homes as their families grew.

This briefing summarises discussion from chapter 4 of Strategic Management Dynamics, pages 185-189

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