Lancasters Characteristics and the Standard Neo-Classical Approach to Consumer Demand - Essay Example

?Comparison Between Lancasters 'Characteristics' Approach to Consumer Demand and the Standard Neo ical Approach Introduction Economic theories help us explore the real world of business in a theoretical term. Over the years its strategies have become so influential that, today they simply redefine the reality of the business world. Observing the consumer behavior is an important part of business strategy as it influences the design of the product, the way it is marketed and priced. Identifying why, when and how a consumer chooses a particular product is important for any company. They can decide whether to continue, halt or alter the production of the particular product only if they know what aspect of the product most of the customers love or hate. Take any microeconomics book and one would be able to see a lot about consumer demand and supply, pricing strategy, branding and supply chain management in detail. These theories and strategies are (Lee & Keen, 2002, p- 7) mostly framed on various concepts which evolved throughout the time for centuries. The neoclassical economic theories are the most famous among them. They are used extensively in economics till date. Neoclassical theory basically explains the output of employment. According to it, the value of the product is determined by the time spend to create it and the labor cost involved. Consumers buy the product for their pleasure(utility). Every consumer purchases a product to make their life easier or pleasurable in one way or another (Clark, n.d.). The theory emphasizes, the people who work more, earn more and hence purchase more. Every business uses neoclassical theories mentioned in these books for creating value for their products and marketing them to a certain extent. Over the years, many strategies like the prospect theory started to evolve in the place of the neoclassical theory. Lancaster's model of consumer demand which explores the characteristics of the goods is widely applicable to the modern day businesses where no major physical entity is involved. He argues a person buys the characteristics of the product not the real product. He simply states “goods are what are thought of as goods”. According to the theory, a consumer actually pays for some characteristic of the product like the nutrient content in the milk which will be useful to them. This paper compares the Lancaster theory with the neoclassical concepts and analyzes how the former one is more suitable to the modern day businesses. Lancaster’s Concept The "New Economic Theory of Consumer Behavior" redefined the way the economists look at business. According to the theory, every product is considered as a set of characteristics that are useful to the customer (Wierenga). This model is multidimensional and helps in maximizing the profits of modern day businesses like cloud computing and software as a service where only the characteristics of the product are utilized by the customers. The Lancaster model is not as famous as the other economic theories. Only a very few scholars have tried to prove its benefits with empirical data. Ratchford has proved the model is applicable when a customer is given a choice to choose one particular product from various alternatives. Lancaster model opposes the traditional demand theory model emphasized widely by the neoclassical theory. The main advantage of this approach is it gives us a chance to explore the technological attributes of the product in a much better way (Marcin, 1992). According to the neoclassical theory, only goods concerned with the basic needs like food, shelter and entertainment are considered as commodities of high demand. They deal with customer choice with budget constraint as the main factor influencing the customer behavior. The customer will choose a product that is useful to them in maximum ways and still stays affordable. The Lancaster model on the other hand insists, the goods themselves are not purchased, but only their characteristics, which are in turn shaped by observing the customer behavior closely. The Neoclassical model or the traditional analysis cannot easily predict how an improved characteristic of a product will affect its demand. For example, the software industry was providing great products to its customers for the past three decades. But, as cloud computing started emerging, SaaS or Software as a Service started gaining huge popularity transacting nearly $68.3 billion in 2011. A simple change of a characteristic affected the demand of the traditional software industry and increased the demand of the new SaaS model by many folds in quite a short time. The Lancaster clearly stated such changes are unpreventable and "“we must throw away any information derived from observing behavior in the previous situation and begin again from scratch” way back in 1966 (Lancaster, 1966). According to the Neoclassical theory wealth is the direct result of a certain set of steps or actions taken by an individual. They do not connect the external environment factors like coercion, influence of ads etc. Change according to the theory can only occur from market changes done from the management side. This is the way most of the governments and traditional companies worked for a long time. Such theories cannot be applied fully in today's market and governance. The changes suggested by Lancaster forms the backbone of the modern day globalization market. His contribution to the consumer behavior analysis is quite notable. Most of the great corporate companies analyze the importance for new products using the Lancaster characteristics model. The theory enabled us to derive the "Shadow prices" associated with various attributes of a product. This helps us understand what drives the demand basically. Lancaster models operational use can be found in many technology oriented sectors and firms. There is a general criticism that this model is successful only when the characteristics of the product is additive or non-conflicting (Silberberg, 1990). Else it is hard to calculate or measure them as the relevant data might not be available. In simple words, the nutrient content of a food particle can be measured. But, we cannot measure the potentiality of a software fully as it is not additive. Some users might find it very easy to use while the other might feel it too technological. The best way to solve this problem is to group the relevant characteristics of the product according to the necessity of the intended market. Lancaster stated a product can be grouped in two different ways. It can be grouped based on the similar characteristics it shares with other products created for same use. But, the price and the demand for each product will vary depending upon its special character. Consider the sofware industry. Both traditional software and SaaS are created for the same purpose and have more or less same characteristics. For example cloud computing is advertised as cost effective and a process which does not require more space on the disk as well as maintenance free. The core characteristics related to the IT field are underlined to maximize its utility in comparison to the traditional software. Lancaster theory rightly forecasted, there has always been a "Subversive undercurrent" which prompted the economists to include the property of the product in their theory. But, most of them simply denied the relevance influence of intrinsic properties of a product in relation to its demand. Studies conducted on Neoclassical theory comparing it with other rival theories like the Prospects theory on the marketplace, always noted this gap (List, 2004). But, most of the neoclassical economist considered the degree of difference between the goods and its attributes was worthy enough to bother or cause trouble in its demand (Terleckyj, 1976, p332). Lancaster theory suggested goods with new properties can be looked upon as substitutes for the the current or existing properties. He simply used the dishwashing detergent combined with the characteristics of the hand lotion example to insist on the fact. The same can be implied to the modern day software industry too. SaaS which started to appear with improved characteristics compared to traditional software originally served as its main competitor. Now it is feared to become a substitute for the traditional software market. Lancaster clearly predicted the brand loyalty will not play a major role in influencing the customer choice unless the brand does not provide or adapt the new characteristics of the substitute product. The customers using a specific company software like Microsoft will use it in the cloud too, if they launch their products and services much ahead of others there. Else, they will automatically choose the best available options there, no matter how good their original software was. This a trend seen exactly in the modern market today. The Lancaster theory formed in 1966 failed to explore the "Perceived characteristics" notion. A customer simply buys a product because they perceive it has a certain set of characteristics. If the product fails to meet their demand, it is labeled as a useless one immediately. Lancaster talks about the responsibility of the advertisers and packagers in giving the right information about the quality and the characteristics of the products to the customers. But, he does not mention anything directly about the 'perceived characteristics' because it is a phenomenon which evolved much later. The mind of the modern day consumer and the consumer who shopped in 1966 was more or less the same. 1970’s is actually defined as the transition period of the 20th century where everything from dressing to music changed drastically. People started to shop for the first time for fun and just because they desired an object instead of purchasing it for its utility purpose. This major change in the consumer behavior was noted rather fast by Lancaster. The reason for Lancaster framing the theory in 1966 is not very clear till date. But, his theory was simply way ahead of its times. It would have gained much more importance if it was stated after 20 years when the globalization started to rule the world. But, Lancaster was simply a genius who guessed the age old practices will not help any more in predicting the future market. He guessed right as most of the work’s in customer demand and customer perception which followed him insisted various new points to measure and analyze the customer behavior rather than stressing on the neoclassical methods and theories. But, Lancaster still remains a forgotten and less used name in the area of economics. He was not given any critical acclamation like the Nobel prize in his lifetime. But, most of the experts in economic hail him in high esteem. Conclusion Both the neoclassical theory and the Lancaster theory are relevant to some extent even today. The neo-classical theory studied the customers based on the time it was framed. Each family had ten kids then and the malls were reserved for the rich and the upper middle class who had lots of money to spend. Money was looked upon as a commodity hard earned and was spend only rarely on items indispensable to living. The utility of the item was given more importance than its beauty or brand name. The Lancaster theory was framed exactly when this trend started to change. He rightly predicted people will want everything new and will be attracted to any product with an improved value or a new characteristic no matter it is necessary to the customer or not. They buy it because the facility is available. This model was hard to understand and accept by most of the economists who had very traditional views. Hence, the Lancaster customer demand theory did not get its due respect in the days of its invention. But the modern day shopping scenario, the way business are done treating consumers as the top entity rather the the CEO of the company everything serves as a proof for Lancaster theories reliability. Lancaster theory does not contrast with the neoclassical theory in every aspect. It only adds the characteristic part as an extra entity which should be explored both in the production of the goods, its marketing and pricing. Modern day companies invest millions of dollars in studying the consumer necessities and creating products catering their needs. Everything from the modern software we use in our mobile to the new features of eh smartphone are created based on studying the customer behavior, manufacturing products meeting their expectations, advertising their core features and increasing their price based on their special characteristics which cannot be found in other products. References 1. Clark, B.J., 'Neoclassical Theory', Retrieved 19th December, 2012, from https://www.mtholyoke.edu/courses/sgabriel/neoclassical_theory.htm 2. Lancaster, J. K., 1966, 'A New Approach to Consumer Theory', The Journal of Political economy, Vol. 74, No. 2., Chicago Press, Retrieved 19th December, 2012, from http://www.dklevine.com/archive/refs41385.pdf 3. Lee, S. F. & Keen, S., 2002, 'Neoclassical Microeconomic Theory: Should Heterodox Economists Show it any Respect', Retrieved 19th December, 2012, from http://arts.uwaterloo.ca/~rneedham/needhdata/Lee/LeeandKeen.pdf 4. List, A. J., 2004, 'Neoclassical Theory versus Prospect Theory: Evidence from the Marketplace', Econometrica, Vol.72. No.2., Retrieved 19th December, 2012, from http://karlan.yale.edu/fieldexperiments/pdf/List_Neoclassical%20Theory%20Versus%20Prospect%20Theory.pdf 5. Marcin, C.T., 1992, 'A Characteristics Model Approach to Demand Analysis for Wood Composites', USDA Forest Service, Retrieved 19th December, 2012, from http://www.fpl.fs.fed.us/documnts/pdf1993/marci93a.pdf 6. Terleckyj, E. N., 1976, 'Household Production and Consumption', National Bureau of Economic Research, Retrieved 19th December, 2012, from http://www.nber.org/chapters/c3965.pdf 7. Wierenga, B., 'Empirical test of the Lancaster Chracteristics Model', Retrieved 19th December, 2012, from http://repub.eur.nl/res/pub/12536/EmpiricalTest0f_1984.pdf Read More