Developing Pricing Strategies and Programs
After reading this chapter, students should:
7. Know how consumers process and evaluate prices
8. Know how a company should set prices initially for products or services
9. Know how a company should adapt prices to meet varying circumstances and opportunities
10. Know when a company should initiate a price change
11. Know how a company should respond to a competitor’s price change
DETAILED CHAPTER OUTLINE
Price is the one element of the marketing mix that produces revenue; the other elements produce costs. Prices are perhaps the easiest element of the marketing program to adjust; product features, channels, and even promotion take more time. Price also communicates to the market the company’s intended value positioning of its product or brand. A well-designed and marketed product can command a price premium.
Pricing decisions are clearly complex and difficult. Holistic marketers must take into account many factors in making pricing decision—the company, customers, competition, and marketing environment. Pricing decisions must be consistent with the firm’s marketing strategy and its target markets and brand positioning.
Price is not just a number on a tag or an item. Price comes in many forms and performs many functions.
F) Throughout most of history prices were set by negotiation between buyers and sellers.
G) Setting one price for all buyers is a relatively modern idea.
H) Traditionally, price has operated as the major determinant of buyer choice.
I) Price remains one of the most important elements determining market share and profitability.
A Changing Pricing Environment
Today, many firms are bucking the low-price trend and have been successful in trading consumers up to more expensive products and services by combining unique product formulations with engaging marketing campaigns. Today the Internet is partially reversing the fixed pricing trend.
How Companies Price
Companies do their pricing in a variety of ways.
2) In small companies, prices are often set by the boss
3) In large companies, pricing is handled by division and product-line managers
4) In large companies, top management sets general pricing objectives, policies, and
5) Effectively designing and implementing pricing strategies requires a thorough understanding of consumer pricing psychology and a systematic approach to setting, adapting, and changing prices.
11) Consumer Psychology and Pricing
Marketers recognize that consumers often actively process price information, interpreting prices in terms of their knowledge from prior purchasing experiences, formal communications, and point-of-purchase or online resources.
Purchase decisions are based on how consumers perceive prices.
What they consider the current actual price—not the marketer’s stated price.
Consumers may have a lower price threshold below which prices may signal inferior or unacceptable quality.
Upper price threshold above which prices are prohibitive and seen as not worth the money
13) Reference Prices
15) When examining products, consumers often employ reference prices.
In considering an observed price, consumers often compare it to an internal reference price (pricing from memory).
An external frame of reference (posted “regular retail price”).
All types of reference prices are possible.
9) When consumers evoke one or more of these frames of reference, their perceived price can vary from the stated price.
A) Many consumers use price as an indicator of quality
B) Some companies adopt exclusivity and scarcity to justify premium prices
B) Many sellers believe that prices should end in an odd number.
C) Research has shown that consumers tend to process prices in a “left-to-right” manner rather than by rounding.
D) Pricing cues like “sale” signs and prices that end in a 9 are less effective the more they are employed.
17) SETTING THE PRICE
A firm must set a price for the first time when it develops a new product, when it introduces its regular product into a new distribution channel or geographic area, and when it enters bids on new contract work.
The firm must decide where to position its product on quality and price.
Most marketers have 3–5 price points or tiers.
The firm has to consider many factors in setting its pricing policy.
i. Six-step procedure
x. Selecting the pricing objective
xi. Determining demand
xii. Estimating costs
xiii. Analyzing competitors’ costs, prices, and offers
xiv. Selecting a pricing method
xv. Selecting the final price
20) Step 1: Selecting the Pricing Objective
The company first decides where it wants to position its market offering. The clearer a firm’s objectives, the easier it is to set price. The five major objectives are: survival, maximum current profit, maximum market share, maximum market skimming, and product-quality leadership.
Companies pursue survival as their major objective when they are plagued with overcapacity, intense competition, or changing consumer wants.
i. Survival is a short-run objective.
Maximum Current Profit
Many companies try to set a price that will maximize current profits. They estimate the demand and costs associated with alternative prices and choose the price that produces maximum current profit, cash flow, or rate of return on investment.
27) Maximum Market Share
29) Some companies want to maximize their market share. They believe that a higher sales volume will lead to lower unit costs and higher long-run profit.
6) This practice is called market-penetration pricing.
7) The following conditions favor setting a low price:
h. The market is highly price-sensitive, and a low price stimulates market growth.
i. Production and distribution costs fall with accumulated production experience.
j. A low price discourages actual and potential competition.
30) Maximum Market Skimming
Companies unveiling a new technology favor setting high prices to maximize market skimming.
A) This is also called market-skimming pricing, where prices start high and are slowly lowered over time.
14) Market skimming makes sense under the following conditions:
o. A sufficient number of buyers have a high current demand.
p. The unit costs of producing a small volume are not so high that they cancel the advantage of charging what the traffic will bear.
q. The high initial price does not attract more competitors to the market.
r. The high price communicates the image of a superior product.
32) Product-Quality Leadership
A company might aim to be the product- quality leader in the market.
B) Many brands strive to be “affordable luxuries”—products or services characterized by high levels of perceived quality, taste, and status with a price just high enough not to be out of consumer’s reach.
35) Other Objectives
Nonprofit and public organizations may have other pricing objectives. Whatever the specific objective, businesses that use price as a strategic tool will profit more than those who simply let costs or the market determine their pricing.
38) Step 2: Determining Demand
Each price will lead to a different level of demand and therefore have a different impact on a company’s marketing objectives.
G) The relation between alternative prices and the resulting current demand is captured in a demand curve.
I) Price Sensitivity
The demand curve shows the market’s probable purchase quantity at alternative prices. The first step in estimating demand is to understand what affects price sensitivity.
9) Generally speaking, customers are most price-sensitive to products that cost a lot or are bought frequently.
10) Customers are less price-sensitive to low-cost items or items they buy infrequently.
11) They are also less price-sensitive when price is only a small part of the total cost of obtaining, operating, and servicing the product over its lifetime (total cost of ownership—TCO).
12) Companies prefer customers who are less price-sensitive.
L) Estimating Demand Curves
Most companies attempt to measure their demand curves using several different methods.
F) Surveys can explore how many units consumers would buy at different proposed prices.
G) Price experiments can vary the prices of different products to see how the change affects sales.
H) Statistical analysis of past prices, quantities sold, and other factors can reveal their relationships. These can be:
1) Longitudinal or
Price Elasticity of Demand
Marketers need to know how responsive or elastic, demand would be to a change in price.
If demand hardly changes with a small change in price, we say the demand is inelastic.
If demand changes considerably, demand is elastic.
Demand is likely to be less elastic under the following conditions:
G) There are few or no substitutes or competitors.
H) Buyers do not readily notice a higher price.
I) Buyers are slow to change their buying habits.
J) Buyers think the higher prices are justified.
D) If demand is elastic, sellers will consider lowering the price.
1) A lower price will produce more total revenue as long as the costs of producing and selling more units do not increase disproportionately
E) Price elasticity depends on the magnitude and direction of the contemplated price change.
It may be negligible with a small price change.
Substantial with a large price change
It may differ for a price cut versus a price increase.
There may be a price indifference band within which price changes have little or no effect
G) Long-run price elasticity may differ from short-run elasticity.
Step 3: Estimating Costs
Demand sets a ceiling on the price the company can charge for its product. Costs set the floor.
Types of Costs and Levels of Production
A company’s costs take two forms, fixed and variable.
(v) Fixed costs (also known as overhead) are costs that do not vary with production or sales revenue.
(vi) Variable costs vary directly with the level of production.
(vii) Total costs consist of the sum of the fixed and variable costs for any given level of production.
(viii) Average cost is the cost per unit at that level of production
E) Management wants to charge a price that will at least cover the total production costs at a given level of production.
F) To price intelligently, management needs to know how its costs vary with different levels of production.
G) To estimate the real profitability of dealing with different retailers, the manufacturer needs to use activity-based accounting (ABC).
e. ABC accounting tries to identify the real costs associated with serving each customer.
f. The key to effectively employing ABC is to define and judge “activities” properly.
7) Accumulated Production
The decline in the average cost with accumulated production experience is called the experience curve or learning curve.
A) Experience-curve pricing carries major risks.
Aggressive pricing might give the product a cheap image.
The strategy assumes that competitors are weak followers.
B) Most experience-curve pricing has focused on manufacturing costs, but all costs, including marketing costs, can be improved on
Costs change with production scale and experience. They can also change as a result of a concentrated effort to reduce them through target costing.
i. The objective is to bring the final cost projections into the target cost range.
Step 4: Analyzing Competitors’ Costs, Prices, and Offers
Within the range of possible prices determined by market demand and company costs, the firm must take competitors’ costs, prices, and possible price reactions into account.
)A The firm should first consider the nearest competitor’s price.
)B The introduction of any price or the change of any existing price can provoke a response from customers, competitors, distributors, suppliers, and even the government.
)C How can a firm anticipate a competitor’s reactions?
)3 One way is to assume the competitor reacts in the standard way to a price being set or changed.
Step 5: Selecting a Pricing Method
Given the customers’ demand schedule, the cost function, and competitors’ prices, the company is now ready to select a price.
C) Costs set the floor to the price.
D) Competitors’ prices and the price of substitutes provide an orienting point.
E) Customers’ assessment of unique features establish the price ceiling.
F) There are six price-setting methods:
vii. Markup pricing
viii. Target-return pricing
ix. Perceived-value pricing
x. Value pricing
xi. Going-rate pricing
xii. Auction-type pricing
A) The most elementary pricing method is to add a standard markup to the product’s cost
B) Does the use of standard markups make logical sense?
1) Generally, no. Any pricing method that ignores current demand, perceived value, and competition is not likely to lead to the optimal price.
C) Markup pricing remains popular.
Sellers can determine costs much more easily than they can estimate demand.
By tying the price to cost, sellers simplify the pricing task.
Where all firms in the industry use this pricing method, prices tend to be similar.
Many people feel that cost-plus pricing is fairer to both buyers and sellers.
)A In target-return pricing, the firm determines the price that would yield its target rate of return on investments (ROI).
)B Target-return pricing tends to ignore price elasticity and competitors’ prices.
Perceived Value Pricing
An increasing number of companies base their price on the customer’s perceived value. They must deliver the value promised by their value proposition, and the customer must perceive this value.
K) Perceived value is made up of several characteristics:
1) Buyer’s image of the product performance
2) Channel deliverables
3) The warranty quality
4) Customer support
5) Supplier’s reputation
The key to perceived-value pricing is to deliver more value than the competitor and to demonstrate this to prospective buyers.
In recent years, several companies have adopted value pricing: they win loyal customers by charging a fairly low price for a high-quality offering.
)A Value pricing is not a matter of simply setting lower prices.
)B It is a matter of reengineering the company’s operations to become a low-cost producer without sacrificing quality.
)C Lowering pricings significantly helps to attract a large number of value-conscious customers.
)D An important type of value pricing is everyday low pricing (EDLP) that takes place at the retail level.
)E A retailer who holds to an EDLP pricing policy charges a constant low price with little or no price promotions and special sales.
)F In high-low pricing, the retailer charges higher prices on an everyday basis but then runs frequent promotions in which prices are temporarily lowered below the EDLP level.
)G The two different pricing strategies have been shown to affect consumer price judgments
)3 Deep discounts (EDLP) can lead to lower perceived prices by consumers over time than frequent shallow discounts (high-low) even if the actual averages are the same.
I) Some retailers have even based their entire marketing strategy around what could be called extreme everyday low pricing.
In going-rate pricing, the firm bases its price largely on competitor’s prices.
A) The firm might charge the same, more, or less than major competitor (s).
B) Going-rate pricing is quite popular where costs are difficult to measure or competitive response is uncertain.
F) Auction-type pricing is growing more popular, especially with the growth of the Internet.
G) There are three types of auction-type pricing:
B) English auctions (ascending bids)
C) Dutch auctions (descending bids)
D) Sealed-bid auctions
Step 6: Selecting the Final Price
Pricing methods narrow the range from which the company must select its final price. In selecting the price, the company must consider additional factors, including the impact of other marketing activities, company pricing policies, gain-and-risk sharing pricing, and the impact of price on other parties.
Impact of Other Marketing Activities
The final price must take into account the brand’s quality and advertising relative to the competition.
F) Farris and Reibstein‘s findings suggest that price is not as important as quality and other benefits in the market offering.
Company Pricing Policies
The price must be consistent with company pricing policies.
8) Many companies set up a pricing department to develop policies and establish or approve pricing decisions.
i. The aim is to ensure that salespeople quote prices that are reasonable to customers.
j. Profitable to the company
Gain-and-Risk Sharing Pricing
Buyers may resist accepting a seller’s proposal because of a high-perceived level of risk.
xi. The seller has the option of offering to absorb part or all of the risk if he does not deliver the full promised value.
Impact of Price on Other Parties
Management must also consider the reactions of other parties to the contemplated price:
7) How will distributors and dealers feel about it?
8) Will the sales force be willing to sell at that price?
9) How will competitors react?
10) Will suppliers raise their prices when they see the company’s price?
11) Will the government intervene and prevent this price from being charged?
F) Marketers need to know the laws regulating pricing in the United States.
ADAPTING THE PRICE
Companies usually do not set a single price, but rather a pricing structure that reflects variations in:
N) Geographical demand and costs
O) Market-segment requirements
P) Purchase timing
Q) Order levels
R) Delivery frequency
T) Service contracts
U) Other factors
I) As a result of discounts, allowances, and promotional support, a company rarely realizes the same profit from each unit of a product it sells.
Geographical Pricing (Cash, Countertrade, Barter)
A) Geographical pricing involves the company in deciding how to price its products to different customers in different locations and countries.
K) Should the company charge higher prices to distant customers to cover the higher shipping costs or a lower price to win additional business?
L) How should exchange rates and the strength of different currencies be accounted for?
M) Another issue is how to get paid.
n. Many buyers want to offer other items in payment, a practice known as countertrade.
B) Countertrade may account for 15 to 25 percent of the world’s trade and takes several forms:
xvi. Compensation deal
xvii. Buyback arrangement
Price Discounts and Allowances
Most companies will adjust list prices and give discounts and allowances for early payment, volume purchases, and off-season buying.
J) Discount pricing has become the modus operandi of a surprising number of companies offering both products and services.
K) Some product categories tend to self-destruct by always being on sale.
L) Discounting can be a useful tool if the company can gain concessions in return.
M) Sales management needs to monitor the proportion of customers who are receiving discounts.
N) Higher levels of management should conduct a net price analysis to arrive at the “real price” of their offering.
Companies can use several pricing techniques to stimulate early purchase:
8) Loss-leader pricing
9) Special-event pricing
10) Cash rebates
11) Low-interest financing
12) Longer payment terms
13) Warranties and service contracts
14) Psychological discounting
H) Promotional-pricing strategies are often a zero-sum game
Companies often adjust their basic price to accommodate differences in customers, products, locations, and so on.
Price discrimination occurs when a company sells a product or service at two or more prices that do not reflect a proportional difference in costs.
)A In first-degree price discrimination, the seller charges a separate price to each customer depending on the intensity of his or her demand.
)B In second-degree price discrimination, the seller charges less to buyers who buy a larger volume.
)C In third-degree price discrimination, the seller charges different amounts to different classes of buyers:
)1 Customer-segment pricing
)2 Product-form pricing
)3 Image pricing
)4 Channel pricing
)5 Location pricing
)6 Time pricing
.a Yield pricing, and yield management systems are used to offer discounts based upon some criteria.
.b The phenomenon of offering different pricing schedules to different consumers is exploding.
.c Research shows that constant price variations work best in situations where there is no bond between buyer and seller.
.d Companies are using variable prices as a reward for good behavior
.e Some forms of price discrimination are illegal.
.f Price discrimination is legal if the seller can prove that its costs are different when selling different volumes or different quantities of the same product to retailers.
.g Predatory pricing—selling below cost with the intent of destroying competition - is unlawful.
.h For price discrimination to work, certain conditions must exist:
.a The market must be segmentable and the segments must show different intensities of demands.
.b Members in the lower-price segment must not be able to resell the product to the higher-price segment.
.c Competitors must not be able to undersell the firm in the higher-price segment.
.d The cost of segmenting and policing the market must not exceed the extra revenue derived from price discrimination.
.e The practice must not breed customer resentment and ill will.
6) The particular form of price discrimination must not be illegal.
INITIATING AND RESPONDING TO PRICE CHANGES
Companies often face situations when they may need to cut or raise prices.
Initiating Price Cuts: Several circumstances might lead a firm to cut prices:
ii. Excess plant capacity
iii. Companies may initiate a price cut in a drive to dominate the market through lower costs.
iv. Either the company starts with lower costs or initiates price cuts in hope of gaining market share and lower costs.
v. A price-cutting strategy involves possible traps:
8. Low-quality trap
9. Fragile-market-share trap
10. Shallow-pockets trap
Initiating Price Increases: A successful price increase can raise profits considerably.
A major circumstance provoking price increases is cost inflation.
1) Rising costs unmatched by productivity gains squeeze profit margins and lead companies to regular rounds of price increases.
B) Companies often raise their prices by more than the cost increase in anticipation of further inflation or governmental price controls, in a practice called anticipatory pricing.
C) Another factor leading to price increase is over-demand.
1) The price can be increased in the following ways:
8) Delayed quotation pricing
9) Escalator clauses
11) Reduction of discounts
D) A company needs to decide whether to raise its price sharply on a one-time basis or to raise it by small amounts several times.
1) Consumers, generally, prefer small price increases on a regular basis to sudden, sharp increases.
E) In passing on price increases to consumers, the company must avoid looking like a price gouger. Customer memories are long, and they can turn against companies they perceive as price gougers.
H) Several techniques help consumers avoid sticker shock and a hostile reaction when prices rise:
H) Sense of fairness must surround any price increase.
I) Customers must be given advance notice so that they can do forward buying or shop around.
J) Sharp price increases need to be explained in understandable terms.
K) Making low-visibility price moves first is also a good technique:
l. Eliminating discounts
m. Increasing minimum order sizes
n. Curtailing production of low-margin products
o. Creating new economy brands
Responding to Competitor’s Price Changes
How should a firm respond to a price cut initiated by a competitor? The best response varies with the situation.
L) One way is to assume that the competitor reacts in a set way to price changes.
M) The other is to assume that the competitor treats each price change as a fresh challenge and reacts according to self-interests at that time.
C) In markets characterized by high product homogeneity, the firm should search for ways to enhance its augmented product.
1) If not it will have to meet the price reduction.
D) In non-homogeneous product markets, the firm has more latitude. It needs to consider the following:
11) Why did the competitor change the price?
12) Does the competitor plan to make the price change temporary or permanent?
13) What will happen to the company’s market share and profits if it does not respond?
14) Are other companies going to respond?
15) What are the competitor’s and other firm’s responses likely to be to each possible reaction?
E) Market leaders frequently face aggressive price cutting by smaller firms trying to build market share.
F) The brand leader can respond in several ways:
7) Maintain price
8) Maintain price and add value
9) Reduce price
10) Increase price and improve quality
11) Launch a low-price fighter line
G) The company has to consider the products:
Stage in the life cycle
Its importance in the company’s portfolio
The competitor’s intentions and resources
The market’s price and quality sensitivity
The behavior costs of with volume.
The company’s alternative opportunities
H) An extended analysis of alternatives may not be feasible when the attack occurs.
I) It would make better sense to anticipate possible competitors’ price changes and to prepare contingent responses.