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mutual fund by radhakrishna

A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests typically in investment securities (stocks, bonds, short-term money market instruments, other mutual funds, other securities, and/or commodities such as precious metals).^[1] The mutual fund will have a fund manager that trades (buys and sells) the fund's investments in accordance with the fund's investment objective. In the U.S., a fund registered with the Securities and Exchange Commission (SEC) under both SEC and Internal Revenue Service (IRS) rules must distribute nearly all of its net income and net realized gains from the sale of securities (if any) to its investors at least annually. Most funds are overseen by a board of directors or trustees (if the U.S. fund is organized as a trust as they commonly are) which is charged with ensuring the fund is managed appropriately by its investment adviser and other service organizations and vendors, all in the best interests of the fund's investors.

Since 1940 in the U.S., with the passage of the Investment Company Act of 1940 (the '40 Act) and the Investment Advisers Act of 1940, there have been three basic types of registered investment companies: open-end funds (or mutual funds), unit investment trusts (UITs); and closed-end funds. Other types of funds that have gained in popularity are exchange-traded funds (ETFs) and hedge funds, discussed below. Similar types of funds also operate in Canada, however, in the rest of the world, mutual fund is used as a generic term for various types of collective investment vehicles, such as unit trusts, open-ended investment companies (OEICs), unitized insurance funds, undertakings for collective investments in transferable securities (UCITS, pronounced "YOU-sits") and SICAVs(pronounced "SEE-cavs").

 

History

Massachusetts Investors Trust (now MFS Investment Management) was founded on March 21, 1924, and, after one year, it had 200 shareholders and $392,000 in assets. The entire industry, which included a few closed-end funds, represented less than $10 million in 1924.

The stock market crash of 1929 hindered the growth of mutual funds. In response to the stock market crash, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws require that a fund be registered with the U.S. Securities and Exchange Commission (SEC) and provide prospective investors with a prospectus that contains required disclosures about the fund, the securities themselves, and fund manager. The Investment Company Act of 1940 sets forth the guidelines with which all SEC-registered funds must comply.

With renewed confidence in the stock market, mutual funds began to blossom. By the end of the 1960s, there were approximately 270 funds with $48 billion in assets. The first retail index fund, First Index Investment Trust, was formed in 1976 and headed by John Bogle, who conceptualized many of the key tenets of the industry in his 1951 senior thesis at Princeton University.^[2] It is now called the Vanguard 500 Index Fund and is one of the world's largest mutual funds, with more than $100 billion in assets.

A key factor in mutual-fund growth was the 1975 change in the Internal Revenue Code allowing individuals to open individual retirement accounts (IRAs). Even people already enrolled in corporate pension plans could contribute a limited amount (at the time, up to $2,000 a year). Mutual funds are now popular in employer-sponsored "defined-contribution" retirement plans such as (401(k)s) and 403(b)s as well as IRAs including Roth IRAs.

As of October 2007, there are 8,015 mutual funds that belong to the Investment Company Institute (ICI), a national trade association of investment companies in the United States, with combined assets of $12.356 trillion.^[3] In early 2008, the worldwide value of all mutual funds totaled more than $26 trillion.^[4]

Usage, investment objectives

Since the Investment Company Act of 1940, a mutual fund is one of three basic types of investment companies available in the United States.^[5]

Mutual funds may invest in many kinds of securities (subject to its investment objective as set forth in the fund's prospectus, which is the legal document under SEC laws which offers the funds for sale and contains a wealth of information about the fund). The most common securities purchased are "cash" or money market instruments, stocks, bonds, other mutual fund shares and more exotic instruments such as derivatives like forwards, futures, options and swaps. Some funds' investment objectives (and or its name) define the type of investments in which the fund invests. For example, the fund's objective might state "...the fund will seek capital appreciation by investing primarily in listed equity securities (stocks) of U.S. companies with any market capitalization range." This would be "stock" fund or a "domestic/US stock" fund since it stated U.S. companies. A fund may invest primarily in the shares of a particular industry or market sector, such as technology, utilities or financial services. These are known as specialty or sector funds. Bond funds can vary according to risk (e.g., high-yield junk bonds or investment-grade corporate bonds), type of issuers (e.g., government agencies, corporations, or municipalities), or maturity of the bonds (short- or long-term). Both stock and bond funds can invest in primarily U.S. securities (domestic funds), both U.S. and foreign securities (global funds), or primarily foreign securities (international funds). Since fund names in the past may not have provided a prospective investor a good indication of the type of fund it was, the SEC issued a rule under the '40 Act which aims to better align fund names with the primary types of investments in which the fund invests, commonly called the "name rule". Thus, under this rule, a fund must invest under normal circumstances in at least 80% of the securities referenced in its name. for example, the "ABC New Jersey Tax Free Bond Fund" would generally have to invest, under normal circumstances, at least 80% of its assets in tax-exempt bonds issued by the state of New Jersey and its political subdivisions. Some fund names are not associated with specific securities so the name rule has less relevance in those situations. For example, the "ABC Freedom Fund" is such that its name does not imply a specific investment style or objective. Lastly, an index fund strives to match the performance of a particular market index, such as the S&P 500 Index. In such a fund, the fund would invest in securities and likely specific derivates such as S&P 500 stock index futures in order to most closely match the performance of that index.

Most mutual funds' investment portfolios are continually monitored by one or more employees within the sponsoring investment adviser or management company, typically called a portfolio managerand their assistants, who invest the funds assets in accordance with its investment objective and trade securities in relation to any net inflows or outflows of investor capital (if applicable), as well as the ongoing performance of investments appropriate for the fund. A mutual fund is advised by the investment adviser under an advisory contract which generally is subject to renewal annually.

Mutual funds are subject to a special set of regulatory, accounting, and tax rules. In the U.S., unlike most other types of business entities, they are not taxed on their income as long as they distribute 90% of it to their shareholders and the funds meet certain diversification requirements in the Internal Revenue Code. Also, the type of income they earn is often unchanged as it passes through to the shareholders. Mutual fund distributions of tax-free municipal bond income are tax-free to the shareholder. Taxable distributions can be either ordinary income or capital gains, depending on how the fund earned those distributions. Net losses are not distributed or passed through to fund investors.

Net asset value

Main article: Net asset value

The net asset value, or NAV, is the current market value of a fund's holdings, minus the fund's liabilities, that is usually expressed as a per-share amount. For most funds, the NAV is determined daily, after the close of trading on some specified financial exchange, but some funds update their NAV multiple times during the trading day. The public offering price, or POP, is the NAV plus a sales charge. Open-end funds sell shares at the POP and redeem shares at the NAV, and so process orders only after the NAV is determined. Closed-end funds (the shares of which are traded by investors) may trade at a higher or lower price than their NAV; this is known as a premium or discount, respectively. If a fund is divided into multiple classes of shares, each class will typically have its own NAV, reflecting differences in fees and expenses paid by the different classes.

Some mutual funds own securities which are not regularly traded on any formal exchange. These may be shares in very small or bankrupt companies; they may be derivatives; or they may be private investments in unregistered financial instruments (such as stock in a non-public company). In the absence of a public market for these securities, it is the responsibility of the fund manager to form an estimate of their value when computing the NAV. How much of a fund's assets may be invested in such securities is stated in the fund's prospectus.

The price per share, or NAV (net asset value), is calculated by dividing the fund's assets minus liabilities by the number of shares outstanding. This is usually calculated at the end of every trading day.

 

Average annual return

US mutual funds use SEC form N-1A to report the average annual compounded rates of return for 1-year, 5-year and 10-year periods as the "average annual total return" for each fund. The following formula is used:^[6]

P(1+T)ⁿ = ERV

Where:

P = a hypothetical initial payment of $1,000.

T = average annual total return.

n = number of years.

ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or fractional portion).

 

Turnover

Turnover is a measure of the fund's securities transactions, usually calculated over a year's time, and usually expressed as a percentage of net asset value.

This value is usually calculated as the value of all transactions (buying, selling) divided by 2 divided by the fund's total holdings; i.e., the fund counts one security sold and another one bought as one "turnover". Thus turnover measures the replacement of holdings.

In Canada, under NI 81-106 (required disclosure for investment funds) turnover ratio is calculated based on the lesser of purchases or sales divided by the average size of the portfolio (including cash).

 

Expenses and expense ratios

Mutual funds bear expenses similar to other companies. The fee structure of a mutual fund can be divided into two or three main components: management fee, non-management expense, and 12b-1/non-12b-1 fees. All expenses are expressed as a percentage of the average daily net assets of the fund.

 

Management fees

The management fee for the fund is usually synonymous with the contractual investment advisory fee charged for the management of a fund's investments. However, as many fund companies include administrative fees in the advisory fee component, when attempting to compare the total management expenses of different funds, it is helpful to define management fee as equal to the contractual advisory fee plus the contractual administrator fee. This "levels the playing field" when comparing management fee components across multiple funds.

Contractual advisory fees may be structured as "flat-rate" fees, i.e., a single fee charged to the fund, regardless of the asset size of the fund. However, many funds have contractual fees which include breakpoints so that as the value of a fund's assets increases, the advisory fee paid decreases. Another way in which the advisory fees remain competitive is by structuring the fee so that it is based on the value of all of the assets of a group or a complex of funds rather than those of a single fund..

 

Non-management expenses

Apart from the management fee, there are certain non-management expenses which most funds must pay. Some of the more significant (in terms of amount) non-management expenses are: transfer agent expenses (this is usually the person you get on the other end of the phone line when you want to buy/sell shares of a fund), custodian expense (the fund's assets are kept in custody by a bank which charges a custody fee), legal/audit expense, fund accounting expense, registration expense (the SEC charges a registration fee when funds file registration statements with it), board of directors/trustees expense (the members of the board who oversee the fund are usually paid a fee for their time spent at meetings), and printing and postage expense (incurred when printing and delivering shareholder reports).

 

2b-1/Non-12b-1 service fees

In the United States, 12b-1 service fees/shareholder servicing fees are contractual fees which a fund may charge to cover the marketing expenses of the fund. Non-12b-1 service fees are marketing/shareholder servicing fees which do not fall under SEC rule 12b-1. While funds do not have to charge the full contractual 12b-1 fee, they often do. When investing in a front-end load or no-load fund, the 12b-1 fees for the fund are usually .250% (or 25 basis points). The 12b-1 fees for back-end and level-load share classes are usually between 50 and 75 basis points but may be as much as 100 basis points. While funds are often marketed as "no-load" funds, this does not mean they do not charge a distribution expense through a different mechanism. It is expected that a fund listed on an online brokerage site will be paying for the "shelf-space" in a different manner even if not directly through a 12b-1 fee.

Investor fees and expenses

Fees and expenses borne by the investor vary based on the arrangement made with the investor's broker. Sales loads (or contingent deferred sales loads (CDSL)) are included in the fund's total expense ratio (TER) because they pass through the statement of operations for the fund. Additionally, funds may charge early redemption fees to discourage investors from swapping money into and out of the fund quickly, which may force the fund to make bad trades to obtain the necessary liquidity. For example, Fidelity Diversified International Fund (FDIVX) charges a 10 percent fee on money removed from the fund in less than 30 days.

 

Brokerage commissions

An additional expense which does not pass through the fund's income statement (statement of operations) and cannot be controlled by the investor is brokerage commissions. Brokerage commissions are incorporated into the price of securities bought and sold and, thus, are a component of the gain or loss on investments. They are a true, real cost of investing though. The amount of commissions incurred by the fund and are reported usually 4 months after the fund's fiscal year end in the "statement of additional information" which is legally part of the prospectus, but is usually available only upon request or by going to the SEC's or fund's website. Brokerage commissions, usually charged when securities are bought and again when sold, are directly related to portfolio turnover which is a measure of trading volume/velocity (portfolio turnover refers to the number of times the fund's assets are bought and sold over the course of a year). Usually, higher rate of portfolio turnover (trading) generates higher brokerage commissions. The advisors of mutual fund companies are required to achieve "best execution" through brokerage arrangements so that the commissions charged to the fund will not be excessive as well as also attaining the best possible price upon buying or selling.

 

Types of mutual funds

 

Open-end fund, forms of organization, other funds

The term mutual fund is the common name for what is classified as an open-end investment company by the SEC. Being open-ended means that, at the end of every day, the fund continually issues new shares to investors buying into the fund and must stand ready to buy back shares from investors redeeming their shares at the then current net asset value per share.

Mutual funds must be structured as corporations or trusts, such as business trusts, and any corporation or trust will be classified by the SEC as an investment company if it issues securities and primarily invests in non-government securities. An investment company will be classified by the SEC as an open-end investment company if it does not issue undivided interests in specified securities (the defining characteristic of unit investment trusts or UITs) and if it issues redeemable securities. Registered investment companies that are not UITs or open-end investment companies are closed-end funds. Closed-end funds are like open end except they are more like a company which sells its shares a single time to the public under an initial public offering or "IPO". Subsequently, the fund's shares trade with buyers and sellers of shares in the secondary market at a market-determined price (which is likely not equal to net asset value) such as on the New York or American Stock Exchange. Except for some special transactions, the fund cannot continue to grow in size by attracting more investor capital like an open-end fund may.

 

 

Exchange-traded funds

Main article: Exchange-traded fund

A relatively recent innovation, the exchange-traded fund or ETF, is often structured as an open-end investment company. ETFs combine characteristics of both mutual funds and closed-end funds. ETFs are traded throughout the day on a stock exchange, just like closed-end funds, but at prices generally approximating the ETF's net asset value. Most ETFs are index funds and track stock market indexes. Shares are issued or redeemed by institutional investors in large blocks (typically of 50,000). Most investors buy and sell shares through brokers in market transactions. Because the institutional investors normally purchase and redeem in in kind transactions, ETFs are more efficient than traditional mutual funds (which are continuously issuing and redeeming securities and, to effect such transactions, continually buying and selling securities and maintaining liquidity positions) and therefore tend to have lower expenses.

Exchange-traded funds are also valuable for foreign investors who are often able to buy and sell securities traded on a stock market, but who, for regulatory reasons, are limited in their ability to participate in traditional U.S. mutual funds.

 

 

Equity funds

Equity funds, which consist mainly of stock investments, are the most common type of mutual fund. Equity funds hold 50 percent of all amounts invested in mutual funds in the United States.^[7] Often equity funds focus investments on particular strategies and certain types of issuers.

 

 

Market Cap(italization)

Fund managers and other investment professionals have varying definitions of mid-cap, and large-cap ranges. The following ranges are used by Russell Indexes:^[8]

§  Russell Microcap Index – micro-cap ($54.8 – 539.5 million)

§  Russell 2000 Index – small-cap ($182.6 million – 1.8 billion)

§  Russell Midcap Index – mid-cap ($1.8 – 13.7 billion)

§  Russell 1000 Index – large-cap ($1.8 – 386.9 billion)

 

Growth vs. value

Another distinction is made between growth funds, which invest in stocks of companies that have the potential for large capital gains, and value funds, which concentrate on stocks that are undervalued. Value stocks have historically produced higher returns; however, financial theory states this is compensation for their greater risk. Growth funds tend not to pay regular dividends. Income funds tend to be more conservative investments, with a focus on stocks that pay dividends. A balanced fund may use a combination of strategies, typically including some level of investment in bonds, to stay more conservative when it comes to risk, yet aim for some growth.^{[citation needed]}

 

Index funds versus active management

Main articles: Index fund and active management

An index fund maintains investments in companies that are part of major stock (or bond) indexes, such as the S&P 500, while an actively managed fund attempts to outperform a relevant index through superior stock-picking techniques. The assets of an index fund are managed to closely approximate the performance of a particular published index. Since the composition of an index changes infrequently, an index fund manager makes fewer trades, on average, than does an active fund manager. For this reason, index funds generally have lower trading expenses than actively managed funds, and typically incur fewer short-term capital gains which must be passed on to shareholders. Additionally, index funds do not incur expenses to pay for selection of individual stocks (proprietary selection techniques, research, etc.) and deciding when to buy, hold or sell individual holdings. Instead, a fairly simple computer model can identify whatever changes are needed to bring the fund back into agreement with its target index.

Certain empirical evidence seems to illustrate that mutual funds do not beat the market and actively managed mutual funds under-perform other broad-based portfolios with similar characteristics. One study found that nearly 1,500 U.S. mutual funds under-performed the market in approximately half of the years between 1962 and 1992.^[9] An analysis of the equity funds returns of the 15 biggest asset management companies worldwide from 2004 to 2009 showed that about 80% of the funds have returned below their respective benchmarks.^{[citation needed]} Moreover, funds that performed well in the past are not able to beat the market again in the future (shown by Jensen, 1968; Grinblatt and Sheridan Titman, 1989)..^[10]

 

Bond funds

Bond funds account for 18% of mutual fund assets.^[7] Types of bond funds include term funds, which have a fixed set of time (short-, medium-, or long-term) before they mature. Municipal bond funds generally have lower returns, but have tax advantages and lower risk. High-yield bond funds invest in corporate bonds, including high-yield or junk bonds. With the potential for high yield, these bonds also come with greater risk.

 

Money market funds

Money market funds hold 26% of mutual fund assets in the United States.^[11] Money market funds generally entail the least risk, as well as lower rates of return. Unlike certificates of deposit (CDs), open-end money fund shares are generally liquid and redeemable at "any time" (that is, normal business hours during which redemption requests are taken - generally not after 4 PM ET). Money funds in the US are required to advise investors that a money fund is not a bank deposit, not insured and may lose value. Most money fund strive to maintain an NAV of $1.00 per share though that is not guaranteed; if a fund "breaks the buck", its shares could be redeemed for less than $1.00 per share. While this is rare, it has happened in the U.S., due in part to the mortgage crisis affecting related securities.

 

Funds of funds

Funds of funds (FoF) are mutual funds which invest in other mutual funds (i.e., they are funds composed of other funds). The funds at the underlying level are often funds which an investor can invest in individually, though they may be 'institutional' class shares that may not be within reach of an individual shareholder). A fund of funds will typically charge a much lower management fee than that of a fund investing in direct securities because it is considered a fee charged for asset allocation services which is presumably less demanding than active direct securities research and management. The fees charged at the underlying fund level are a real cost or drag on performance but do not pass through the FoF's income statement (statement of operations), but are usually disclosed in the fund's annual report, prospectus, or statement of additional information. FoF's will often have a higher overall/combined expense ratio than that of a regular fund. The FoF should be evaluated on the combination of the fund-level expenses and underlying fund expenses, as these both reduce the return to the investor.

Most FoFs invest in affiliated funds (i.e., mutual funds managed by the same advisor), although some invest in unaffilated funds (those managed by other advisors) or both. The cost associated with investing in an unaffiliated underlying fund may be higher than investing in an affiliated underlying because of the investment management research involved in investing in fund advised by a different advisor. Recently, FoFs have been classified into those that are actively managed (in which the investment advisor reallocates frequently among the underlying funds in order to adjust to changing market conditions) and those that are passively managed (the investment advisor allocates assets on the basis of on an allocation model which is rebalanced on a regular basis).

The design of FoFs is structured in such a way as to provide a ready mix of mutual funds for investors who are unable to or unwilling to determine their own asset allocation model. Fund companies such as TIAA-CREF, American Century Investments, Vanguard, and Fidelity have also entered this market to provide investors with these options and take the "guess work" out of selecting funds. The allocation mixes usually vary by the time the investor would like to retire: 2020, 2030, 2050, etc. The more distant the target retirement date, the more aggressive the asset mix.

Hedge funds

Main article: Hedge fund

Hedge funds in the United States are pooled investment funds with loose, if any, SEC regulation, unlike mutual funds. Some hedge fund managers are required to register with SEC as investment advisers under the Investment Advisers Act of 1940.^[12] The Act does not require an adviser to follow or avoid any particular investment strategies, nor does it require or prohibit specific investments. Hedge funds typically charge a management fee of 1% or more, plus a “performance fee” of 20% of the hedge fund's profit. There may be a "lock-up" period, during which an investor cannot cash in shares. A variation of the hedge strategy is the 130-30 fund for individual investors.

Mutual funds vs. other investments

Mutual funds offer several advantages over investing in individual stocks. For example, the transaction costs are divided among all the mutual fund shareholders, which allows for cost-effective diversification. Investors may also benefit by having a third party (professional fund managers) apply expertise and dedicate time to manage and research investment options, although there is dispute over whether professional fund managers can, on average, outperform simple index funds that mimic public indexes. Yet, the Wall Street Journal reported that separately managed accounts (SMA or SMAs) performed better than mutual funds in 22 of 25 categories from 2006 to 2008. This included beating mutual funds performance in 2008, a tough year in which the global stock market lost US$21 trillion in value.^[13][14] In the story, Morningstar, Inc said SMAs outperformed mutual funds in 25 of 36 stock and bond market categories. Whether actively managed or passively indexed, mutual funds are not immune to risks. They share the same risks associated with the investments made. If the fund invests primarily in stocks, it is usually subject to the same ups and downs and risks as thestock market.

 

Share classes

Mutual funds may offer different types of shares, known as classes. For a given fund, each class will invest in the same portfolio of securities and will have the same investment objectives and policies. But each class will have different shareholder services and/or distribution arrangements with different fees and expenses. As a result, each class will likely have different performance results.^[15]

As an example, a fund may have three classes of shares that are sold to the general public – Class A, Class B, and Class C – and a class that is sold only to institutional investors – Class I.

§  Class A shares often have a front-end sales load (a type of fee that investors pay when they purchase fund shares).

§  Class B shares often have no front-end sales load, instead having a contingent deferred sales load, or CDSL (a type of fee paid when fund shares are sold, and that typically decreases to zero over time) and a 12b-1 fee. Class B shares also may convert automatically to a class of shares with a lower 12b-1 fee (usually Class A) if held long enough.

§  Class C shares might have a 12b-1 fee and a front-end sales load or CDSL, but these would be lower than a Class A’s front-end sales load or a Class B’s CDSL. Class C shares usually do not convert to another class. ^[16]

§  Class I would be sold only to institutional investors and might have different fees and expenses. These generally have very high minimum investment requirements. In some cases, by aggregating regular investments made by many individuals, a retirement plan (such as a 401(k) plan) may qualify to purchase "institutional" shares (and gain the benefit of their typically lower expense ratios) even though no members of the plan would qualify individually.^[17]

 

Load and expenses

Main article: Mutual fund fees and expenses

A front-end load or sales charge is a commission paid to a broker by a mutual fund when shares are purchased, taken as a percentage of funds invested. The value of the investment is reduced by the amount of the load. Some funds have a deferred sales charge or back-end load. In this type of fund an investor pays no sales charge when purchasing shares, but will pay a commission out of the proceeds when shares are redeemed depending on how long they are held. Another derivative structure is a level-load fund, in which no sales charge is paid when buying the fund, but a back-end load may be charged if the shares purchased are sold within a year.

Load funds are sold through financial intermediaries such as brokers, financial planners, and other types of registered representatives who charge a commission for their services. Shares of front-end load funds are frequently eligible for breakpoints (i.e., a reduction in the commission paid) based on a number of variables. These include other accounts in the same fund family held by the investor or various family members, or committing to buy more of the fund within a set period of time in return for a lower commission "today".

It is possible to buy many mutual funds without paying a sales charge. These are called no-load funds. In addition to being available from the fund company itself, no-load funds may be sold by some discount brokers for a flat transaction fee or even no fee at all. (This does not necessarily mean that the broker is not compensated for the transaction; in such cases, the fund may pay brokers' commissions out of "distribution and marketing" expenses rather than a specific sales charge. The buyer is therefore paying the fee indirectly through the fund's expenses deducted from profits.)

No-load funds include both index funds and actively managed funds. The largest mutual fund families selling no-load index funds are Vanguard and Fidelity, though there are a number of smaller mutual fund families with no-load funds as well. Expense ratios in some no-load index funds are less than 0.2% per year versus the typical actively managed fund's expense ratio of about 1.5% per year. Load funds usually have even higher expense ratios when the load is considered. The expense ratio is the anticipated annual cost to the investor of holding shares of the fund. For example, on a $100,000 investment, an expense ratio of 0.2% means $200 of annual expense, while a 1.5% expense ratio would result in $1,500 of annual expense. These expenses are before any sales commissions paid to purchase the mutual fund.

Many fee-only financial advisors strongly suggest no-load funds such as index funds. If the advisor is not of the fee-only type but is instead compensated by commissions, the advisor may have aconflict of interest in selling high-commission load funds.

Industrial marketing by radhakrishna

Industrial marketing is the marketing of goods and services from one business to another. Industrial goods are those which are used in Industry for producing a Different end product from one or more raw materials. The word "industrial" means machinery run by power to produce goods and services. But "industrial marketing" is not confined to these types of business activities. Broadly, marketing could be split into consumer marketing (B2C "Business to Consumer") and industrial marketing (B2B "Business to Business").

B2B Business to Business (or "Industrial")

Typical examples of a B2B selling process are...

§  An organization is seeking to build a new warehouse building. After carefully documenting their requirements, it obtains three proposals from suitable construction firms and after a long process of evaluation and negotiation it places an order with the organization that it believes has offered the best value for money.

§  An organization has significant need for legal services and obtains submissions from two law firms. Analysis of the proposals and subsequent discussions determines that there is no price advantage to placing all of the work with one firm and the decision is made to split the work between the two firms based on an evaluation of each firm's capabilities.

§  A sales representative makes an appointment with a small organization that employs 22 people. He demonstrates a photocopier/fax/printer to the office administrator. After discussing the proposal with the business owner it is decided to sign a contract to obtain the machine on a fully maintained rental and consumables basis with an upgrade after 2 years.

The main features of the B2B selling process are...

§  Marketing is one-to-one in nature. It is relatively easy for the seller to identify a prospective customers and to build a face-to-face relationship.

§  Highly professional and Trained people in Buying processes are involved.In many cases two or three decision makers have to be considered in purchasing industrial products.

§  High value considered purchase.

§  Purchase decision is typically made by a group of people ("buying team") not one person.

§  Often the buying/selling process is complex and includes many stages (for example; request for expression of interest, request for tender, selection process, awarding of tender, contract negotiations, and signing of final contract).

§  Selling activities involve long processes of prospecting, qualifying, wooing, making representations, preparing tenders, developing strategies and contract negotiations.

See also B2B definition.

B2C Business to Consumer (or "Consumer")

Examples of the B2C selling/buying process are...

§  A family are at home on a Sunday night and are watching television. An advertisement appears that advertises home delivered pizza. The family decides to order a pizza.

§  Walking down a supermarket aisle, a single man aged in his early 30's sees a hair care product that claims to reduce dandruff. He picks the product and adds it to his shopping cart.

§  A pensioner visits her local shopping mall. She purchases a number of items including her favourite brand of tea. She has bought the same brand of tea for the last 18 years.

The main features of the B2C selling process are...

§  Marketing is one-to-many in nature. It is not practical for sellers to individually identify the prospective customers nor meet them face-to-face.

§  Lower value of purchase.

§  Decision making is quite often impulsive (spur of the moment) in nature.

§  Greater reliance on distribution (getting into retail outlets).

§  More effort put into mass marketing (One to many).

§  More reliance on branding.

§  Higher use of main media (television, radio, print media) advertising to build the brand and to achieve top of mind awareness.

See also B2C definition.

Blurring between the definitions

As in all things, the definitions are not clear cut. For example, an organisation that sells electronic components may seek to distribute its products through marketing channels (see channel (marketing)), and be selling relatively low value products. However, the final purchaser is still a business. Equally there are big ticket items purchased by non-business consumers (houses and motor vehicles being the obvious examples). However, even though these definitions are blurred, sales and marketing activities aimed at B2B are distinctly different from B2C (as outlined above).

Competitive tendering

Industrial marketing often involves competitive tendering (see tender, tendering). This is a process where a purchasing organization undertakes to procure goods and services from suitable suppliers. Due to the high value of some purchases (for example buying a new computer system, manufacturing machinery, or outsourcing a maintenance contract) and the complexity of such purchases, the purchasing organization will seek to obtain a number of bids from competing suppliers and choose the best offering. An entire profession (strategic procurement) that includes tertiary training and qualifications has been built around the process of making important purchases. The key requirement in any competitive tender is to ensure that...

§  The business case for the purchase has been completed and approved.

§  The purchasing organization's objectives for the purchase are clearly defined.

§  The procurement process is agreed upon and it conforms with fiscal guidelines and organisational policies.

§  The selection criteria have been established.

§  A budget has been estimated and the financial resources are available.

§  A buying team (or committee) has been assembled.

§  A specification has been written.

§  A preliminary scan of the market place has determined that enough potential suppliers are available to make the process viable (this can sometimes be achieved using an expression of interestprocess).

§  It has been clearly established that a competitive tendering process is the best method for meeting the objectives of this purchasing project. If (for example) it was known that there was only one organisation capable of supplying; best to get on with talking to them and negotiating a contract.

Because of the significant value of many purchases, issues of probity arise. Organisations seek to ensure that awarding a contract is based on "best fit" to the agreed criteria, and not bribery, corruption, or incompetence.

Bidding process

Suppliers who are seeking to win a competitive tender go through a bidding process. At its most primitive, this would consist of evaluating the specification (issued by the purchasing organization), designing a suitable proposal, and working out a price. This is a "primitive" approach because...

§  There is an old saying in industrial marketing; "if the first time you have heard about a tender is when you are invited to submit, then you have already lost it."

§  While flippant, the previous point illustrates a basic requirement for being successful in competitive tendering; it is important to develop a strong relationship with a prospective customer organization well before they have started the formal part of their procurement process.

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Non-tender purchasing

Not all industrial sales involve competitive tendering. Tender processes are time consuming and expensive, particularly when executed with the aim of ensuring probity. Government agencies are particularly likely to utilise elaborate competitive tendering processes due to the expectation that they should be seen at all times to be responsibly and accountably spending public monies. Private companies are able to avoid the complexity of a fully transparent tender process but are still able to run the procurement process with some rigour.Beneficial

Developing a sales strategy/solution selling/technical selling

The "art" of technical selling (solution selling) follows a three stage process...

§  Stage 1: Sell the appointment: Never sell over the telephone. The aim of the first contact with a prospective purchaser is to sell the appointment. The reason is simple; industrial sales are complex, any attempt to sell over the phone will trivialise your product or service and run the risk of not fully understanding the customer's need.

§  Stage 2: Understand their needs: The best method of selling is to minimise the information about your goods or services until you have fully understood your customer's requirements.

§  Stage 3: Develop and propose a solution. The solution is (of course) developed from your (or the firm that you represent's) product or service offerings.

The important point about solution selling is that it is essential not to sell the solution before you understand the customer's requirements; otherwise you are highly likely to unwittingly sell them on how ill-suited your solution is to meeting their requirements. To illustrate; imagine a couple seeking the services of an architect start their first meeting with the inevitable "we want to build a house." If the architect leapt in at that point and proceeded to show them his favourite design influence "the Mediterranean look" only to discover that they hate "Mediterranean" and wanted something "a bit more Frank Lloyd Wright" he will have gone most of the way toward alienating the sale. You can see that if he had "kept his powder dry" for a bit longer and first discovered what they were looking for, he could have better understood which way to skew his pitch. He was equally capable of designing in a Frank Lloyd Wright style.

The marketing function is able to support this solution sell through tactics like account-based marketing – understanding the requirements of a specific target organization and building a marketing program around these. As research shows, sales success is heavily weighted towards suppliers who can understand their audience before selling to them (in UK research, 77 per cent of senior decision-makers believe that the marketing approaches made by new suppliers are poorly targeted and make it easy to justify staying with their current supplier).^[1]

Sales force management has a critical function in industrial selling, where it assumes a greater role than other parts of the marketing mix. Typical industrial organisations are highly dependent on the ability of its sales people to build relationships with customers. During periods of high demand (economic boom) the sales force often become mere order takers and struggle to respond to customer requests for quotations and information. However, when economic downturn hits it becomes critical to direct the sales force out selling.

From cannon fodder to preferred tenderer

The term "cannon fodder" derives from the World Wars and refers to the massing of undertrained and recently recruited troops sent to the fronts to face the enemy. It was noted that such troops invariably had a short survival rate but provided the tactical advantage of distracting the enemy while professional soldiers mounted a flanking manoeuvre and came around from the side or from behind the enemy. In adopting the term to Industrial Marketing it means those bids being submitted that have no chance of winning but are involved to make up the numbers (you can't have only one bid in a "competitive" tender process; that wouldn't satisfy the requirements of probity) (for example in government tenders, or for private enterprise the requirement to "truly test the market" and to "keep them honest"). The reader might be wondering why anybody would go to all of the work of submitting a tender when they had no chance of winning; for the same reason that troops were sent in to battle to die; they thought they had a real chance.

[The key features of a successful industrial sales organisation

In industrial marketing the personal selling is still very effective because many products must be customized to suit the requirements of the individual customer. Indicators such as the sales tunnel give information on the expected sales in the near future, the hit rate indicates whether the sales organization is busy with promising sales leads or it is spending too much effort on projects that are eventually lost to the competition or that are abandoned by the prospect.

The internet and B2B marketing

The "dotcom" boom and bust of the late 90's saw significant attempts to develop a new retailing business model; on-line shopping. Many entrepreneurs (and their investors) discovered that merely having a website (no matter how innovative) was insufficient to generate sales; the amount of conventional main media advertising required to promote the sites burnt cash at a faster rate than they could generate through on-line sales. They also presumed that consumers would eschew the irksome shopping experience (driving, parking, poor service etc.) for the wonder and convenience of shopping on-line. Some did; but not in sufficient numbers. There were many unforeseen problems and apart from some notable exceptions (Amazon.com and others) the B2C online model was a spectacular failure. However, the same cannot be said of B2B selling where some quite impressive results have been achieved.