The document discusses various principles of pricing, including:
1) Pricing is the assignment of value for a good or service that customers must pay to acquire it. Price captures some of the value created and is an important marketing lever.
2) Non-monetary costs like time, convenience and psychological factors influence customer perceptions of value and must be considered in pricing.
3) Developing pricing strategies requires understanding demand, costs, competitors and evaluating the business environment. Common strategies include cost-based, demand-based, yield management and competition-based approaches.
3. $1,000 Your job is to buy the “ best ” Oriental rug. One rug is priced at $800 while another is priced at $1000. Which one is the best? How did you make that decision? $800
4. What should we charge? What can we charge? Marketing Mix Product Place Promotion Price
5. Why care about price? 1% improvement in… operating profit improvement of… Price Variable Cost Volume Fixed Cost 11.1% 7.8% 3.3% 2.3% The Biggest Lever the Marketer Has …
6.
7. Price & Value $Price is not just a dollar figure$ What are the non-monetary costs associated with acquiring a product/service? * TIME * CONVENIENCE * PSYCHOLOGICAL * SENSORY
8. Case in point.... A gym membership costs $50 per month. What are the non-monetary “ costs ” associated with the membership? * TIME * CONVENIENCE * PSYCHOLOGICAL * SENSORY
9. Pricing Services is… Convenience/Time Actual Price Time/Convenience Time/Convenience Psychological/sensory Really Hard Dentist Cost for Filling Distance to Dentist Wait Period for an Appointment Time in Waiting Room Anesthesia A $50 15 miles 3 Weeks 1.5 hour None B $75 15 miles 1 Week .5 hour Novocain C $125 3 miles 1 Week 1 hour Novocain D $200 3 miles 1 Week No wait Nitrous Oxide and Novocain Variability
The chapter begins by asking the question, “ What is price? ” At first glance, students may think the question has an obvious answer—the number printed on the price sticker. However, as students explore this chapter, they will discover that price is a whole lot more. Price is a function of demand, costs, revenue, and the environment. Pricing can be monetary or non-monetary. Pricing decisions lead to specific pricing strategies and tactics, discussed in the chapter. Students also learn about the psychological aspect of pricing, as well as legal, and ethical aspects of pricing. The chapter begins by asking the question, “ What is price? ” At first glance, students may think the question has an obvious answer—the number printed on the price sticker. However, as students explore this chapter, they will discover that price is a whole lot more. Price is a function of demand, costs, revenue, and the environment. Pricing can be monetary or non-monetary. Pricing decisions lead to specific pricing strategies and tactics, discussed in the chapter. Students also learn about the psychological aspect of pricing.
“ Yes, But what Does It Cost? ” The question of what to charge for a product is a central part of marketing decision making.
What is Price? Price is the assignment of value, or the amount the consumer must exchange to receive the offering or product. Payment may be in the form of money, goods, services, favors, votes, or anything else that has Value to the other party. Other non-monetary costs often are important to marketers. It is also important to consider an opportunity cost, or the value of something that is given up to obtain something else.
Step 1: Develop Pricing Objectives The first crucial step in price planning is to develop pricing objectives. These must support the broader objectives of the firm, such as maximizing shareholder value, as well as its overall marketing objectives, such as increasing market share Profit Objectives Often a firm ’ s overall objectives relate to a certain level of profit it hopes to realize. This is usually the case in B2B marketing. When pricing strategies are determined by profit objectives, the focus is on a target level of profit growth or a desired net profit margin. A profit objective is important to firms that believe profit is what motivates shareholders and bankers to invest in a company. Sales or Market Share Objectives However, lowering prices is not always necessary to increase market share. If a company ’ s product has a competitive advantage, keeping the price at the same level as other firms may satisfy sales objectives. Competitive Effect Objectives Sometimes strategists design the pricing plan to dilute the competition ’ s marketing efforts. In these cases, a firm may deliberately try to preempt or reduce the impact of a rival ’ s pricing changes Customer Satisfaction Objectives Many quality-focused firms believe that profits result from making customer satisfaction the primary objective. These firms believe that by focusing solely on short-term profits, a company loses sight of keeping customers for the long term. Image Enhancement Objectives Consumers often use price to make inferences about the quality of a product. In fact, marketers know that price is often an important means of communicating not only quality but also image to prospective customers. The image enhancement function of pricing is particularly important with prestige products (or luxury products), which have a high price and appeal to status-conscious consumers.
Step 1: Develop Pricing Objectives The first crucial step in price planning is to develop pricing objectives. These must support the broader objectives of the firm, such as maximizing shareholder value, as well as its overall marketing objectives, such as increasing market share Profit Objectives Often a firm ’ s overall objectives relate to a certain level of profit it hopes to realize. This is usually the case in B2B marketing. When pricing strategies are determined by profit objectives, the focus is on a target level of profit growth or a desired net profit margin. A profit objective is important to firms that believe profit is what motivates shareholders and bankers to invest in a company. Sales or Market Share Objectives However, lowering prices is not always necessary to increase market share. If a company ’ s product has a competitive advantage, keeping the price at the same level as other firms may satisfy sales objectives. Competitive Effect Objectives Sometimes strategists design the pricing plan to dilute the competition ’ s marketing efforts. In these cases, a firm may deliberately try to preempt or reduce the impact of a rival ’ s pricing changes Customer Satisfaction Objectives Many quality-focused firms believe that profits result from making customer satisfaction the primary objective. These firms believe that by focusing solely on short-term profits, a company loses sight of keeping customers for the long term. Image Enhancement Objectives Consumers often use price to make inferences about the quality of a product. In fact, marketers know that price is often an important means of communicating not only quality but also image to prospective customers. The image enhancement function of pricing is particularly important with prestige products (or luxury products), which have a high price and appeal to status-conscious consumers.
Step 2: Estimate Demand The second step in price planning is to estimate demand. Demand refers to customers ’ desires for a product: How much of a product are they willing to buy as the price of the product goes up or down? Demand Curves Economists use a graph of a demand curve to illustrate the effect of price on the quantity demanded of a product. The demand curve, which can be a curved or straight line, shows the quantity of a product that customers will buy in a market during a period at various prices if all other factors remain the same. The demand curve for most goods slopes downward and to the right. As the price of the product goes up the number of units that customers are willing to buy goes down. If prices decrease, customers will buy more. This is the <emphasis> law of demand . For example, if the price of bananas goes up, customers will probably buy fewer of them. In fact, there are situations in which (otherwise sane) people desire a product more as it increases in price. For prestige products such as luxury cars or jewelry, a price hike may actually result in an in the quantity consumers demand because they see the product as more valuable. In such cases, the demand curve slopes upward. The higher-price/higher-demand relationship has its limits. If the firm increases the price too much, to making the product unaffordable for all but a few buyers, demand will begin to decrease.
3.1.2 Shifts in Demand The demand curves we have shown assume that all factors other than price stay the same. However, what if they do not? What if the company improves the product? What happens when there is a glitzy new advertising campaign that turns a product into a “ must-have ” for many people? What if stealthy paparazzi i catch Brad Pitt using the product at home? Any of these things could cause an upward shift of the demand curve. An upward shift in the demand curve means that at any given price, demand is greater than before the shift occurs. Demand curves may also shift downward. Estimate Demand Marketers predict total demand first by identifying the number of buyers or potential buyers for their product and then multiplying that estimate times the average amount each member of the target market is likely to purchase. Once the marketer estimates total demand, the next step is to predict what the company ’ s market share is likely to be. The company ’ s estimated demand is then its share of the whole market. Such projections need to take into consideration other factors that might affect demand, such as new competitors entering the market, the state of the economy, and changing customer tastes.
Price Elasticity of Demand Marketers also need to know how their customers are likely to react to a price change. In particular, it is critical to understand whether a change in price will have a large or a small impact on demand. Price elasticity of demand is a measure of the sensitivity of customers to changes in price. The word elasticity indicates that changes in price usually cause demand to stretch or retract like a rubber band. Some customers are very sensitive to changes in price, and a change in price results in a substantial change in the quantity demanded. In such instances, we have a case of elastic demand. In other situations, we describe a change in price that has little or no effect on the quantity that consumers are willing to buy as inelastic demand. When demand is elastic, changes in price and in total revenues work in opposite directions. If the price is increased, revenues decrease. If the price is decreased, total revenues increase. In some instances, demand is inelastic so that a change in price results in little or no change in demand. When demand is inelastic, price and revenue changes are in the same direction; that is, increases in price result in increases in total revenue, while decreases in price result in decreases in total revenue. Elasticity of demand for a product often differs for different price levels and with different percentages of change. As a rule, businesses can determine the actual price elasticity only after they have tested a pricing decision and calculated the resulting demand. To estimate what demand is likely to be at different prices for new or existing products, marketers often do research. Other factors can affect price elasticity and sales. Consider the availability of substitute goods or services. If a product has a close substitute, its demand will be elastic; that is, a change in price will result in a change in demand, as consumers move to buy the substitute product. Marketers of products with close substitutes are less likely to compete on price because they recognize that doing so could result in less profit as consumers switch from one brand to another. Changes in prices of other products also affect the demand for an item, a phenomenon we label cross-elasticity of demand When products are substitutes for each other, an increase in the price of one will increase the demand for the other. For example, if the price of bananas goes up, consumers may instead buy more strawberries, blueberries, or apples. However, when products are complements < hat is, when one product is essential to the use of a second—an increase in the price of one decreases the demand for the second.
Step 3: Determine Costs Estimating demand helps marketers determine possible prices to charge for a product. It tells them how much of the product they think they will be able to sell at different prices. Knowing this brings them to the third step in determining a product ’ s price: making sure the price will cover costs. Before marketers can determine price, they must understand the relationship of cost, demand, and revenue for their product.
Variable and Fixed Costs First, a firm incurs variable costs —the per-unit costs of production that will fluctuate depending on how many units or individual products a firm produces. Variable costs can go down with higher levels of production but do not always do so. Fixed costs are costs that do not vary with the number of units produced—the costs that remain the same whether the firm produces 1,000 bookcases this month or only 10. Fixed costs include rent or the cost of owning and maintaining the factory, utilities to heat or cool the factory, and the costs of equipment such as hammers, saws, and paint sprayers used in the production of the product. Average fixed cost is the fixed cost per unit produced, that is, the total fixed costs divided by the number of units produced. Although total fixed costs remain the same no matter how many units are produced, the average fixed cost will decrease as the number of units produced increases. As we produce more and more units, average fixed costs go down, and so does the price we must charge to cover fixed costs. In the long term, total fixed costs may change. Combining variable costs and fixed costs yields total costs for a given level of production. As a company produces more and more of a product, both average fixed costs and average variable costs may decrease. Average total costs may decrease, too, up to a point. As output continues to increase, average variable costs may start to increase. These variable costs ultimately rise faster than average fixed costs decline, resulting in an increase to average total cost. As total cost fluctuates with differing levels of production, the price that producers have to charge to cover those costs changes accordingly. Therefore, marketers need to calculate the minimum price necessary to cover all costs—the break-even price . Break-Even Analysis Break-even analysis is a technique marketers use to examine the relationship between cost and price and to determine what sales volume must be reached at a given price before the company will completely cover its total cost and past which it will begin making a profit. Simply put, the break-even point is the point at with the company does not lose any money and does not make any profit. A break-even analysis allows marketers to identify how many units of a product they will have to sell at a given price to be profitable. To determine the break-even point, the firm first needs to calculate the contribution per unit , or the difference between the prices the firm charges for a product (the revenue per unit) and the variable costs. This figure is the amount the firm has after paying for the goods that contribute to meeting the fixed costs of production. Often a firm will set a profit goal, which is the dollar profit figure it desires to earn. The break-even point may be calculated with that dollar goal included in the figures. Sometimes the target return or profit goal is expressed as a percentage of sales . For example, a firm may say that it wants to make a profit of at least 10 percent on sales. In such cases, this profit is added to the variable cost in calculating the break-even point. Break-even analysis does not provide an easy answer for pricing decisions. It provides answers about how many units the firm must sell to break even and to make a profit, but without knowing whether demand will equal the quantity at that price, companies can make big mistakes. It is, therefore, useful for marketers to estimate the demand for their product and then perform a marginal analysis.
Markups and Margins: Pricing Through the Channel So far, we have talked about costs simply from the manufacturer ’ s perspective. However, in reality, most products are not sold directly to the consumers or business buyers of the product. Instead, a manufacturer sells to a wholesaler, distributor, or jobber who in turn sells to a retailer who finally sells the product to the ultimate consumer. Setting prices means considering all of these steps.
Step 4: Evaluate The Pricing Environment Marketers look at factors in the firm ’ s external environment when they make pricing decisions. The fourth step in developing pricing strategies is to examine and evaluate the pricing environment. Only then can marketers set a price that not only covers costs but also provides a competitive advantage—a price that meets the needs of customers better than the competition The Economy Broad economic trends tend to direct pricing strategies. The business cycle, inflation, economic growth, and consumer confidence all help to determine whether one pricing strategy or another will succeed. During recessions , consumers grow more price sensitive. Many firms find it necessary to cut prices to levels at which costs are covered but the company does not make a profit to keep factories in operation. Inflation may give marketers cause to either increase or decrease prices. First, inflation gets customers used to price increases. They may remain insensitive to price increases, even when inflation goes away, allowing marketers to make real price increases. In periods of recession, inflation may cause marketers to lower prices and temporarily sacrifice profits in order to maintain sales levels. The Competition Marketers try to anticipate how the competition will respond to their pricing actions. It is not always a good idea to fight the competition with lower prices. Pricing wars can change consumers ’ perceptions of what is a “ fair ” price, leaving them unwilling to buy at previous price levels. Generally, firms that do business in an oligopoly (in which the market has few sellers and many buyers) are more likely to adopt status quo pricing objectives in which the pricing of all competitors is similar. Avoiding price competition allows all players in the industry to remain profitable. Firms in a purely competitive market have little opportunity to raise or lower prices. Price is directly influenced by supply and demand. Government Regulation Governments in the U.S. and other countries develop two different types of regulations, which have an effect on pricing. First, a large number of regulations increase the costs of production. Regulations for health care, environmental protection, occupational safety, and highway safety, just to mention a few, cause the costs of producing many products to increase. Other regulations of specific industries such as those imposed by the Food and Drug Administration (FD) on the production of food and pharmaceuticals increase the costs of developing and producing those products. In addition, some regulations directly address prices. Consumer Trends Consumer trends also can strongly influence prices. Culture and demographics determine how consumers think and behave and so these factors have a large impact on all marketing decisions. The International Environment The marketing environment often varies widely from country to country. This can have important consequences in developing pricing strategies.
PRICING THE PRODUCT: ESTABLISHING STRATEGIES AND TACTICS In modern business, there seldom is any one-and-only, now-and-forever, and best pricing strategy. Like playing a game of chess, making pricing moves and countermoves requires thinking two and three moves ahead. Step 5: Choose a Pricing Strategy The next step in price planning is to choose a pricing strategy. Pricing Strategies Based on Cost Marketing planners often choose cost-based strategies because they are simple to calculate and relatively risk free. They promise that the price will at least cover the costs the company incurs in producing and marketing the product. Cost-based pricing methods have drawbacks, however. They do not consider such factors as the nature of the target market, demand, competition, the product life cycle, and the product ’ s image. The calculations for setting the price may be simple and straightforward but accurate cost estimating may prove difficult. The most common cost-based approach to pricing a product is cost-plus pricing in which the marketer totals all the costs for the product and then adds an amount (or marks up the cost of the item) to arrive at the selling price. Many marketers use cost-plus pricing because of its simplicity—users need only estimate the unit cost and add the markup. To calculate cost-plus pricing, marketers usually calculate either a markup on cost or a markup on selling price. Pricing Strategies Based on Demand Demand-based pricing means that the firm bases the selling price on an estimate of volume or quantity that it can sell in different markets at different prices. Firms must determine how much product they can sell in each market and at what price. Today, firms find that they can be more successful if they match price with demand using a target costing process. They first determine the price at which customers would be willing to buy the product and then works backward to design the product in such a way that it can produce and sell the product at a profit. With target costing, firms first use marketing research to identify the quality and functionality needed to satisfy attractive market segments and what price they are willing to pay before the product is designed . The next step is to determine what margin retailers and dealers require as well as the profit margin the company requires. Based on this information, managers can calculate the target cost—the maximum it will cost the firm to manufacture the product. If the firm can meet customer quality and functionality requirements and control costs to meet the required price, it will manufacture the product. Yield management pricing, another type of demand-based pricing, is a pricing strategy used by airlines, hotels, and cruise lines. Firms charge different prices to different customers in order to manage capacity while maximizing revenue. This strategy works because different customers have different sensitivities to price. The goal of yield management pricing is to accurately predict the proportion of customers who fall into each category and allocate the percentage of the airline or hotel ’ s capacity accordingly so that no product goes unsold. Pricing Strategies Based on the Competition Sometimes a firm ’ s pricing strategy involves pricing its wares near, at, above, or below the competition. A price leadership strategy, which usually is the rule in an industry dominated by few firms and called an oligopoly, may be in the best interest of all firms because it minimizes price competition. Price leadership strategies are popular because they provide an acceptable and legal way for firms to agree on prices without ever talking with each other. Pricing Strategies Based on Customers ’ Needs When firms develop pricing strategies that cater to customers, they are less concerned with short-term results than with keeping customers for the long term. Firms that practice value pricing or everyday low pricing (EDLP), develop a pricing strategy that promises ultimate value to consumers. What this means is that, in the customer ’ s eyes, the price is justified by what they receive. When firms base price strategies solely or mainly on cost, they are operating under the old production orientation and not a customer orientation. Value-based pricing begins with customer, then considers the competition, and then determines the best pricing strategy. New Product Pricing When a product is new to the market or when there is no established industry price norm, marketers may use a skimming price strategy, a penetration pricing strategy, or trial pricing when they first introduce the item to the market. Setting a skimming price means that the firm charges a high, premium price for its new product with the intention of reducing it in future response to market pressure. If a product is highly desirable and it offers unique benefits, demand is price inelastic during the introductory stage of the product life cycle, allowing a company to recover research-and-development and promotion costs. When rival products enter the market, the price is lowered in order for the firm to remain competitive. Firms focusing on profit objectives in developing their pricing strategies often set skimming prices for new products. A skimming price is more likely to succeed if the product provides some important benefits to the target market that make customers feel they must have it no matter what the cost. For a skimming price to be successful there should also be little chance that competition can get into the market quickly. In addition, the market should consist of several customer segments with different levels of price sensitivity. Penetration pricing is the opposite of skimming pricing. In this situation, the company prices a new product very low to sell more in a short time and gain market share early on. One reason marketers use penetration pricing is to discourage competitors from entering the market. The firm first out with a new product has an important advantage. Experience shows that a pioneering brand often is able to maintain dominant market share for long periods. Penetration pricing may act as a barrier-to-entry for competitors if the prices the market will bear are so low that the company will not be able to recover development and manufacturing costs. Trial pricing means that a new product carries a low price for a limited time to generate a high level of customer interest. Unlike penetration pricing, in which the company maintains the low price, in this case it increases the trial price after the introductory period. The idea is to win customer acceptance first and make profits later.
Pricing for Multiple Products A firm may sell several products that consumers typically buy at one time. Price bundling means selling two or more goods or services as a single package for one price—a price that is often less than the total price of the items if bought individually. Captive pricing is a pricing tactic a firm uses when it has two products that work only when used together. The firm sells one item at a very low price and then makes its profit on the second high-margin item.
Psychological Pricing Strategies Setting a price is part science, part art. Marketers must understand psychological aspects of pricing when they decide what to charge for their products or services. 6.2.1 Odd-Even Pricing Marketers have assumed that there is a psychological response to odd prices that differ from the responses to even prices. Habit may also play a role. Research on the difference in perceptions of odd versus even prices indeed supports the argument that prices ending in 99 rather than 00 lead to increased sales. Some prices are set at even numbers because of necessity. Lottery tickets and admission to sporting events are two examples. Many luxury items such as jewelry, golf course fees, and resort accommodations use even dollar prices to set them apart. When prices are given with dollar signs or even the word dollar, customers spend less. 6.2.2 Price Lining Marketers often apply their understanding of the psychological aspects of pricing in a practice they call price lining , whereby items in a product line sell at different prices, or price points . If you want to buy a new digital camera, you will find that most manufacturers have one “ stripped-down ” model for $100 or less. A better-quality but still moderately priced model likely will be around $200, while a professional quality camera with multiple lenses might set you back $1,000 or more. Price lining provides the different ranges necessary to satisfy each segment of the market. For marketers this technique is a way to maximize profits. A firm charges each customer the highest price the he is willing to pay. 6.2.3 Prestige Pricing Sometimes luxury goods marketers use a prestige pricing strategy that turns the typical assumption about price-demand relationships on its head: Contrary to the “ rational ” assumption that we value a product or service more as the price goes down, in these cases, believe it or not, people tend to buy more as the price goes up
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