Economics and Marketing: What it Means for BusinessThere’s long-standing tension between economics and marketing — despite the fact that marketing is an offshoot of economics. Marketing is really the blending of economics and psychology (with a little sociology thrown in). And, it’s the addition of psychology that irritates economists.

The major difference between economics and marketing is that economists believe consumers are rational and seek products providing the greatest utility. Marketers accept that consumers (including business consumers) are sometimes (often) irrational — else why would middle-aged men like red corvettes — and utility includes social status, ego stroking, group affinity and lots more borrowed from psychology and sociology.

Even finance is mired in the debate over rationality and utility. Financial formulas include elements such as interest rates, betas, and other rational investment variables. However, a new school of thought, called behavioral finance, mirrors marketing in many respects by including non-rational investment criteria such as the “coolness” factor of Apple.

Of course, ignoring economics is dangerous, but fitting economics and marketing into your business strategy creates success.

Economics and Marketing: A case-study

For some businesses that operate using economic principles, the blending of economics and marketing requires a serious shift in thinking.

A good example of this occurred during the 1970′s gas crisis. During the crisis, the price of gas increased dramatically (a 300% spike in crude in just 3 months in 1973), while production fell short of demand. While some blame the energy crisis on corporate greed from a handful of energy companies, such as BP, Shell, etc., others blame production decisions made by these companies based on econometric models.

Meanwhile, over at Shell, scenario modelling replaced models based purely on economics. Shell built scenarios by including economic factors and idiosyncratic (marketing-type) insights about human behavior — they even included a former magazine editor into Eastern mysticism. 1 scenario pretty accurately predicted the events leading to the OPEC embargo, which precipitated the energy crisis. Of course, adopting this scenario was challenging, but allowed Shell to weather the energy storm better than its competitors.

Now, such scenario planning is commonplace — about 65% of firms used it in 2011. According the Harvard Business Review, that’s because scenario planning provides:

(1) an enhanced capacity to perceive change,

(2) an enhanced capacity to interpret and respond to change,

(3) influence on other actors, and

(4) an enhanced capacity for organizational learning.

The value of scenario planning lies in its break from the status quo embedded in economics to consider non-rational factors impacting the future.

Economics and marketing: Consumer confidence

Another great example of how economics and marketing fit together is consumer confidence. Consumer confidence, published by The Conference Board based on random sample questionnaires reflects consumers’ beliefs in the strength of the economy. Consumer confidence was seriously shaken in 2008 as the US housing market collapsed, taking Wall Street and many businesses with it.

Consumers delayed spending due to worries about their retirement savings, home value, and likelihood of continued employment. Because consumers account for MORE THAN 70% of all spending in developed countries, their crisis of confidence seriously impacted all aspects of the economy.

From an economic standpoint, were consumers in serious danger that warranted drastic spending cuts? Probably not. At it’s height, unemployment reached over 10%, but that means 90% of us were gainfully employed. Many nations would envy such high employment numbers. Sure, many were upside down on their mortgages (especially younger folks), but, unless you planned to sell your home, that didn’t matter much.

Yet, consumers withheld their dollars … in case. Economics be damned; they were afraid.

Consumer confidence dropped further with each news report of how bad things were. Consumer confidence stayed down because the media fueled their fears with idiosyncratic reports of this individual who lost their home or job. Bad things sell, good things don’t, so reports of improving economic conditions got buried on the 5th page or relegated to late night talk shows.

Declining consumer confidence created a self-fulfilling prophesy — consumers believed the economy was bad, so they stopped spending, which MADE the economy bad. And the bad economy hung around too long. Even today, when unemployment is close to what economists call “full employment” and the stock market is reaching all-time highs, consumer confidence isn’t great. Over-corrections in mortgage lending help fuel this and keep thousands from buying a home — historically the path to wealth in the US.

Blending economics and marketing in your strategy

Drawing on these lessons to build your business strategy based on a blend of economics and marketing makes rational sense. Building purely economic models based on supply and demand that assume consumers are rational buyers hurts your business, especially in the long-run where econometric models fail when conditions change. However, ignoring economic realities and relying solely on marketing strategies also suffers.

Blending economics and marketing in a holistic fashion means a higher return for your business.

Innovation

Innovation is a good example where blending economics and marketing makes sense. Traditional innovation planning involves creating economic forecasts for sales of a product that doesn’t exist yet. There’s little room for intelligent exploration in what “might be” preferring what “can be”.

That’s part of the genius of Apple Computers and accounts for much of its success. Imagining what consumers want, rather than what could be created drove Jobs and Apple into radical, disruptive transformations. If instead of relying on their guts, Apple asked consumers to describe what was needed or whether they’d buy something based on spec, Apple would now be defunct.

Solving for a consumer problem (assuming the economics exist for profitability in terms of numbers of consumers with that problem) will always out perform economics-driven innovation. And, innovative products must exist without the pressure to show immediate profitability. Look at 3D printers — it took years before the promise of these printers sparked the imagination of enough consumers to make them profitable.

Strategic planning

Building scenarios based on blends of econometric modelling and marketing — consumer behavior, culture, influence — makes for better forecasting than either alone. Scenarios should aim for probabalistic models rather than predictive models. Sure, predictive models provide more concrete estimates, but those estimates may be WILDLY wrong — either 100% right or 100% wrong. Extending your trend line to future times becomes increasingly less accurate as the time horizon grows.

Pricing

Pricing is another area where using economics alone might fail your business. Commonly, businesses price products to recover their investment or to match competitors. But, are such rational pricing models effective?

Meanwhile, companies blending economics and marketing see higher profitability. Including factors such as segmentation, psychological pricing, and load management all contribute to improved financial performance.