Pricing

You don’t sell through price.

You sell the price.

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The Learning Objectives

 Setting Pricing Policy

 Price-adjustment Strategies
 Price changes

©2003 South-Western
 Price

To the seller... To the consumer...

Price is revenue What is Price? Price is the cost
and profit source of something

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 What is Price?

Price may be defined as the

exchange of goods or services in
terms of money.
What you pay is the price for
what you get.

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The Importance of Price

 Price is a direct determinant of profits (or losses)

 Price indirectly affects costs (through quantity
sold)
 Price determines the type of customer and
competition the organization will attract
 Price affects the image of the brand
 A pricing error can nullify all other marketing mix
activities

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8-6
 The Importance of Price
to Marketing Managers

The price charged to customers multiplied

Revenue by the number of units sold.

Profit Revenue minus expenses

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 The Importance of Price
Marketers must select a price that is not too
high or not too low,
A price that equals the perceived value to target
consumers

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 Trends Influencing Price Setting
High rate of new product introduction

Increased availability of bargain-priced

Trends dealer and generic brands
in the
Market Price cutting as a strategy to maintain
or regain market share

More efficient and better informed

buyers
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 Factors affecting pricing

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 INTERNAL FACTORS AFFECTING PRICING

 Organisation Factors:
 Top executives deal with over-all price strategy. They determine the
basic ranges that the product falls into in terms of market segments.
 The actual mechanics of pricing are dealt with at lower levels in the
firm and focus on individual product strategies. Usually, some
combination of production and marketing specialist are involved in
choosing the price.
 Marketing Mix:
 Marketing experts view price as only one of the many important
elements of the marketing mix. A shift in any one of the elements has an
immediate effect on the other three-Production, Promotion and
Distribution.
 Product Differentiation:
 The price of the product also depends upon the characteristics of the
product. Generally, customers pay more price for the product which is
of the new style, fashion, better package etc.
 Cost of the Product:
 Cost and price of a product are closely related. The most important
factor is the cost of production.
 Objectives of the Firm:
 A firm may have various objectives and pricing contributes its share in
achieving such goals.
 Pricing policy should be established only after proper considerations of
the objectives of the firm.
 EXTERNAL FACTORS AFFECTING PRICING

 Demand:
 The market demand for a product or service obviously has a big impact
on pricing. A firm can determine the expected price in a few test-
markets by trying different prices in different market and comparing the
results with a controlled market in which price is not altered. If the
demand of the product is inelastic, high prices may be fixed. On the
other hand, if demand is elastic, the firm should not fix high prices,
rather it should fix lower prices than that of the competitors.
 Competition:
 A firm cam fix the price to or lower than that of the competitors,
provided the quality of product, in no case, be lower than that of the
competitors.
 Suppliers:
 If the price of cotton goes up, the increase is passed on by suppliers to
manufacturers. Manufacturers, in turn, pass it on to consumers.
Sometimes, however, when a manufacturer appears to be making large
profits on a particular product, suppliers will attempt to cash in on the
profits by charging more for their supplier.
 Economic Conditions:
 In recession period, the prices are reduced to a sizable extent to
maintain the level of turnover. On the other hand, the price are increased
in boom period to cover the increasing cost of production and
distribution.
 Buyers:
 The various consumers and businesses that buy a company’s products or
services may have an influence in the pricing decision. Their nature and
behaviour for the purchase of a particular product, brand or services etc.
affect pricing when their number is large.
 Government:
 Price discretion is also affected by the price-control by the government
through enactment of legislation, when it is thought proper to arrest the
inflationary trend in prices of certain products.
 Pricing Process

1. Selecting the pricing

objective

2. Determining demand

3. Estimating costs

4. Analyzing competitors’
costs, prices, and offers

5. Selecting a pricing
method

6. Selecting final price

STEP 1: SELECTING THE PRICING OBJECTIVE

 Survival.
 This is a short-term objective that is appropriate only for companies that
are plagued with overcapacity, intense competition, or changing
consumer wants. As long as prices cover variable costs and some fixed
costs, the company will be able to remain in business.
 Product-quality leadership.
 Companies that aim to be product-quality leaders will offer premium
products at premium prices. Because they offer top quality plus
innovative features that deliver wanted benefits, these firms can charge
more.
 Maximum market share.
 Firms believe that higher sales volume will lead to lower unit costs and
higher long-run profit. With this market-penetration pricing, the firms
set the lowest price, assuming the market is price sensitive.
 This is appropriate when
1. The market is highly price sensitive, so a low price stimulates
market growth;
2. Production and distribution costs fall with accumulated production
experience; and
3. A low price discourages competition.
 Maximum market skimming.
 Many companies favor setting high prices to “skim” the market.
 This objective makes sense under the following conditions:
1. A sufficient number of buyers have a high current demand;
2. The unit costs of producing a small volume are not so high that
they cancel the advantage of charging what the traffic will bear;
3. The high initial price does not attract more competitors to the
market; and
4. The high price communicates the image of a superior product.
 STEP 2: DETERMINING DEMAND

 Each price will lead to a different level of demand and, therefore, will
have a different impact on a company’s marketing objectives. The
relationship between alternative prices and the resulting current demand
is captured in a demand curve. Normally, demand and price are
inversely related: The higher the price, the lower the demand.
 Price Sensitivity
 The first step in estimating demand is to understand what affects price
sensitivity. Nagle says there is less price sensitivity when:
 The product is more distinctive,
 Buyers are less aware of substitutes,
 Buyers cannot easily compare the quality of substitutes,
 The expenditure is a lower part of buyer’s total income,
 The expenditure is small compared to the total cost of the end product,
 Part of the cost is borne by another party,
 The product is used in conjunction with assets previously bought,
 The product is assumed to have more quality, prestige, or exclusiveness, and
 Buyers cannot store the product.
 Estimating Demand Curves
 Companies can use one of three basic methods to estimate their demand
curves.
 The first involves statistically analyzing past prices, quantities sold, and other
factors to estimate their relationships.
 The second approach is to conduct price experiments,.
 The third approach is to ask buyers to state how many units they would buy at
different proposed prices. One problem with this method is that buyers might
understate their purchase intentions at higher prices to discourage the
company from setting higher prices.
 STEP 3: ESTIMATING COSTS

 While 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.
 Total costs consist of the sum of the fixed and variable costs for any
given level of production.
 Average cost is the cost per unit at that level of production; it is equal to
total costs divided by production.
 Management wants to charge a price that will at least cover the total
production costs at a given level of production.
 To price intelligently, management needs to know how its costs vary
with different levels of production.
 A firm’s cost per unit is high if only a few units are produced every day,
but as production increases, fixed costs are spread over a higher level of
production results in each unit, bringing the average cost down.
 By calculating costs for different-sized plants, a company can identify
the optimal plant size and production level to achieve economies of
scale and bring down the average cost.
 What is the 'Learning Curve'
 A learning curve is a concept that graphically depicts the relationship
between cost and output over a defined period of time, normally to
represent the repetitive task of an employee or worker.
 Differentiated Marketing Offers
 Today’s companies try to adapt their offers and terms to different
buyers. Thus, a manufacturer will negotiate different terms with
different retail chains, meaning the costs and profits will differ with
each chain. To estimate the real profitability of dealing with different
retailers, the manufacturer needs to use activity-based cost (ABC)
accounting instead of standard cost accounting.
 ABC accounting tries to identify the real costs associated with serving
different customers. Companies that fail to measure their costs correctly
are not measuring their profit correctly, and they are likely to
misallocate their marketing effort.
 Target Costing
 Many Japanese firms use a method called target costing.
 First, they use market research to establish a new product’s desired
functions, then they determine the price at which the product will sell
given its appeal and competitors’ prices. They deduct the desired profit
margin from this price, and this leaves the target cost they must achieve.
 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 into account its competitors’ costs,
prices, and possible price reactions.
 If the firm’s offer is similar to a major competitor’s offer, then the firm
will have to price close to the competitor or lose sales.
 If the firm’s offer is inferior, it will not be able to charge more than the
competitor charges.
 If the firm’s offer is superior, it can charge more than does the
competitor—remembering, however, that competitors might change
their prices in response at any time.
 Step 5: Selecting a Pricing Method
 Costs set a floor to the price.
 Demand sets ceiling for price.
 Companies must therefore select a pricing method that includes one or more
of these considerations.
 We will examine six price-setting methods: markup pricing, target-return
pricing, perceived-value pricing, value pricing, going-rate pricing, and
sealed-bid pricing.
 Markup Pricing (Cost Plus Pricing)
 The most elementary pricing method is to add a standard markup to the
product’s cost.
 Construction companies do this when they submit job bids by estimating the
total project cost and adding a standard markup for profit.
 Similarly, lawyers and Carpenters typically price by adding a standard
markup on their time and costs.
 Suppose a toaster manufacturer has the following costs and sales
expectations:
 Variable cost per unit $10
 Fixed cost $ 300,000
 Expected unit sales 50,000
 The manufacturer’s unit cost is given by:
 Unit cost = variable cost + fixed costs
unit sales
= $ 10 + 300,000
50,000
= $ 16
 If the manufacturer wants to earn a 20 percent markup on sales, its
markup price is given by:
 Markup price = unit cost = $16 = $ 20
(1 desired return on sales) 1 -- 0.2
 Does the use of standard markups make logical sense? Generally, no.
 Any pricing method that ignores current demand, perceived value, and
competition is not likely to lead to the optimal price.
 Companies that introduce a new product often price it high, hoping to
recover their costs as rapidly as possible. But a high-markup strategy
could be fatal if a competitor is pricing low.
 This happened to Philips, the Dutch electronics manufacturer, in pricing
its videodisc players. Philips wanted to make a profit on each videodisc
player. Meanwhile, Japanese competitors priced low and succeeded in
building their market share rapidly, which in turn pushed down their
costs substantially.
 Markup pricing remains popular for a number of reasons.
 First, sellers can determine costs much more easily than they can
estimate demand. By tying the price to cost, sellers simplify the pricing
task.
 Second, when all firms in the industry use this pricing method, prices
tend to be similar, which minimizes price competition.
 Third, many people feel that cost-plus pricing is fairer to both buyers
and sellers: Sellers do not take advantage of buyers when demand
becomes acute, and sellers earn a fair return on investment.
 Target-Return Pricing
 In target-return pricing, the firm determines the price that would yield
its target rate of return on investment (ROI).
 Target pricing is used by many firms, including General Motors, which prices
its automobiles to achieve a 15–20 percent ROI.
 Suppose the toaster manufacturer in the previous example has invested
$1 million and wants to earn a 20 percent return on its invested capital.
The target-return price is given by the following formula:
 Target-return price = unit cost * desired return *invested capital
unit sales
= $16 * .20 *$1,000,000
50,000
= $20
 The manufacturer will realize this 20 percent ROI provided its The
manufacturer will realize this 20 percent ROI provided its costs and
estimated sales turn out to be accurate.
 But what if sales do not reach 50,000 units? The manufacturer can prepare a
break-even chart to learn what would happen at other sales levels
 Note that fixed costs remain the same regardless of sales volume, while
variable costs, which are not shown in the figure, rise with volume.
 Perceived-Value Pricing
 An increasing number of companies base price on customers’ perceived
value. They see the buyers’ perceptions of value, not the seller’s cost, as
the key to pricing. Then they use the other marketing-mix elements,
such as advertising, to build up perceived value in buyers’ minds.
 The key to perceived-value pricing is to determine the market’s
perception of the offer’s value accurately.
 Sellers with an inflated view of their offer’s value will overprice their
product, while sellers with an underestimated view will charge less than they
could.
 Value Pricing
 Value pricing is a method in which the company charges a fairly low
price for a high quality offering. Value pricing says that the price should
represent a high-value offer to consumers.
 Value pricing is not a matter of simply setting lower prices on one’s
products compared to those of competitors. It is a matter of
reengineering the company’s operations to become a low-cost producer
without sacrificing quality, and lowering prices significantly to attract a
large number of value-conscious customers.
 Going-Rate Pricing
 In going-rate pricing, the firm bases its price largely on competitors’
prices.
 The firm might charge the same, more, or less than its major
competitor(s) charges.
 In oligopolistic industries that sell a commodity such as steel, paper, or
fertilizer, firms normally charge the same price.
 The smaller firms “follow the leader,” changing their prices when the market
leader’s prices change rather than when their own demand or costs change.
 When costs are difficult to measure or competitive response is uncertain,
firms feel that the going price represents a good solution.
 Sealed-Bid Pricing
 Competitive-oriented pricing is common when firms submit sealed bids
for jobs. In bidding, each firm bases its price on expectations of how
competitors will price rather than on a rigid relationship to the firm’s
own costs or demand.
 Sealed-bid pricing involves two opposite pulls. The firm wants to win
the contract—which means submitting the lowest price—yet it cannot
set its price below cost.
 STEP 6: SELECTING THE FINAL PRICE

 The previous pricing methods narrow the range from which the
company selects its final price. In selecting that price, the company must
consider additional factors: psychological pricing, the influence of other
marketing-mix elements on price, company pricing policies, and the
impact of price on other parties.
 Psychological Pricing
 Many consumers use price as an indicator of quality. Image pricing is
especially effective when information about true quality is unavailable,
price acts as a signal of quality.
 When looking at a particular product, buyers carry in their minds a
reference price formed by noticing current prices, past prices, or the
buying context.
 Sellers often manipulate these reference prices. For example, a seller can
situate its product among expensive products to imply that it belongs in the
same class.
 Often sellers set prices that end in an odd number, believing that
customers who see a television priced at 299 instead of 300 will
perceive the price as being in the 200 range rather than the 300 range.
 The Influence of Other Marketing-Mix Elements
 The final price must take into account the brand’s quality and
advertising relative to competition.
 When Farris and Reibstein examined the relationships among relative
price, relative quality, and relative advertising for 227 consumer
businesses, they found that
 Brands with average relative quality but high relative advertising budgets
were able to charge premium prices. They also found that brands with high
relative quality and high relative advertising obtained the highest prices,
while brands with low quality and advertising charged the lowest prices.
 Consumers apparently were willing to pay higher prices for known products
than for unknown products.
 Company Pricing Policies
 The price must be consistent with company pricing policies. To
accomplish this, many firms set up a pricing department to develop
policies and establish or approve decisions. The aim is to ensure that the
salespeople quote prices that are reasonable to customers and profitable
to the company.
 PRICE DISCOUNTS AND ALLOWANCES

 Cash Discounts:
 A cash discount is a price reduction to buyers who pay their bills
promptly.
 A typical example is “2/10, net 30,” which means that payment is due
within 30 days and that the buyer can deduct 2 percent by paying the
bill within 10 days. Such discounts are customary in many industries.

 Quantity Discounts:
 A quantity discount is a price reduction to those buyers who buy large
volumes. Quantity discounts must be offered equally to all customers.
They can be offered on a noncumulative basis (on each order placed) or
a cumulative basis (on the number of units ordered over a given period).
 Seasonal Discounts:
 A seasonal discount is a price reduction to buyers who buy merchandise
or services out of season. Hotels, motels, and airlines will offer seasonal
discounts in slow selling periods.
 Functional Discounts:
 Functional discounts (also called trade discounts) are offered by a
manufacturer to trade-channel members if they will perform certain
functions, such as selling, storing, and record keeping. Manufacturers
may offer different functional discounts to different trade channels but
must offer the same functional discounts within each channel.
 Allowances:
 Allowances are extra payments designed to gain reseller participation in
special programs.
 Trade-in allowances are price reductions granted for turning in an old
item when buying a new one. Trade-in allowances are most common in
durable goods categories.
 Promotional allowances are payments or price reductions to reward
dealers for participating in advertising and sales support programs.
 DISCRIMINATORY PRICING

 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.
 In first-degree price discrimination, the seller charges a separate price
to each customer depending on the intensity of his or her demand.
 In second-degree price discrimination, the seller charges less to buyers
who buy a larger volume.
 In third-degree price discrimination, the seller charges different
amounts to different classes of buyers, as in the following cases:
 Airlines charge different fares to passengers on the same flight, depending
on the seating class, the time of day (morning or night coach); the day of the
week (workday or weekend); the season, the persons’ company, past
business or status (youth, military, senior citizen) and so on.
 Most consumers are probably not even aware of the degree to which they
are the targets of discriminatory pricing.
 Some forms of price discrimination (in which sellers offer different price
terms to different people within the same trade group) are illegal. However,
price discrimination is legal if the seller can prove that its costs are different
when selling different volumes or different qualities of the same product to
different retailers. Predatory pricing-selling below cost with the intention of
destroying competition–is unlawful.)
 Customer-segment price: Different customer groups are charged
different prices for the same product or service. For example,
museums often charge a lower admission fee to students and senior
citizens.
 Product-form pricing: Different versions of the product are priced
different but not proportionately to their respective costs.
 Image pricing: Some companies price the same product at two different
levels based on image differences. A perfume manufacturer can put the
perfume in one bottle, give it a mane and image and price it at 1000. It
can put the same perfume in another bottle with a different name and
image and price it at 3000.
 Channel pricing: Coca-Cola carries a different price depending on
whether it is purchased in a fast-food restaurant or a vending machine.
 Location pricing: The same product is priced differently at different
locations even though the cost of offering at each location is the same. A
theater varies its seat prices according to audience performance for
different locations.
 Time pricing: Prices are varied by season, day or hour. Public utilities
very energy rates to commercial user by time of day and weekend
versus weekend. Restaurant charge less to “early bird” customers.
Hotels charge less on weekend. Hotel and airlines use yield pricing by
which they offer lower rates on unsold inventory just before it expires.
 Coca-Cola considered raising its vending machine soda prices on hot
day using wireless technology and lowering the price on cold days.
However, customers so disliked the idea that Coke abandoned it.
 For price discrimination to work, certain conditions must exist.
 First the market must be segmentable and the segments must show
different intensities of demand.
 Second, members in the lower-price segment must not be able to resell
the product to the higher-price segment.
 Third, competitors must not be able to undersell the firm in the higher-
price segment.
 Forth, the cost of segmenting and policies the market must not exceed
the extra revenue derived from price discrimination.
 Fifth, the practice must not breed customer resentment and ill will.
 Sixth, the particular form of price discrimination must not be illegal.