Introdution to pricing


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  • Summary Overview Guided by the company’s objectives, marketing managers must develop a set of pricing objectives and policies. Key Issues The pricing objectives and policies should spell out: How flexible prices will be. At what level prices will be set over the product life cycle. To whom and when discounts and allowances will be given. How transportation costs will be handled. Clearly, prices reflect many dimensions, which in turn impact customer value and buyer behavior. Discussion Question: Many retailers advertise what appear to be very low prices on computers, but at second glance, the prices are not what they seem. Why? What impact does this pricing have on consumer behavior? This slide relates to material on pp. 464-465.
  • Summary Overview Price is the amount of money that is charged for “something” of value. The things for which prices are charged range from purely physical products, to products with substantial service components, to pure services. College tuitions, apartment rents, hotel room rates, country club dues, bank interest rates, airline fares, and attorneys’ fees are all examples of price. Key Issues This exhibit summarizes some possible variations of price for consumers or users: On the price side, discounts, allowances, rebates or coupons, transportation, and taxes may alter the list price. The price ultimately paid equals the value component. As shown, this component may be much more than a purely physical good, and may encompass intangible value assessments, such as the assurance of quality. Discussion Question: Can you provide an example of a product for which it is worth it to pay more because you perceive the quality of the product to be better than the competition? This slide relates to material on p. 465-466.  Indicates place where slide “builds” to include the corresponding point.  
  • Summary Overview Company-level and marketing objectives provide the guidance for setting pricing objectives. Pricing objectives should be explicitly stated because of their effect on the pricing policies adopted by the company. Pricing policies also affect other aspects of the marketing mix as marketing managers use strategy planning to support the information communicated to consumers through the product’s price. Key Issues Two types of profit-oriented objectives are common: Target return objective : sets specific guidelines for a level of profit. Prices may be linked to a percentage of sales or return on investment. Some companies just want satisfactory profits that ensure the firm’s survival and provide adequate returns to shareholders. Companies that are industry leaders, as well as public service companies, often pursue satisfactory profits because of the public scrutiny they receive. Profit maximization objective : the firm sets prices to seek as much profit as possible. This objective may be used to recoup high investment costs or it may be simply a matter of company policy. Profit maximization can be socially responsible , as it does not always lead to high prices. Prices that are initially high during market introduction can go down in the later stages of the product life cycle, thus expanding sales and profits. Discussion Question: Can you provide examples of products that entered the market at a high price and got progressively less expensive as they matured? This slide relates to material on pp. 466-468.  Indicates place where slide “builds” to include the corresponding point.    
  • Summary Overview With sales-oriented objectives , pricing supports the objective of increasing sales, without regard to their effects on profit. Key Issues Sales growth doesn’t necessarily mean big profits , because marketers may overlook the costs associated with delivering those sales. Market share growth objectives are popular . Coupled with a long-run view of the overall market growth rate and attention to costs, this approach can lead to long-term competitive advantages. In recent years, as profit margins in the personal computer industry have shrunk, Dell Computer has reduced prices to protect its market share. Discussion Question: What is the danger of pricing a product too low in an attempt to maintain market share? This slide relates to material on pp. 468-469.  Indicates place where slide “builds” to include the corresponding point.   
  • Summary Overview For firms content with the way things are, two status quo objectives are often used. They might be termed “ don’t rock the boat” objectives . Key Issues Meeting competition stabilizes market prices because no firm benefits from raising or lower prices. This objective is often used when the total market for a product is not growing. With nonprice competition , aggressive action is taken in the other three areas of the 4Ps, staying clear of price as a competitive “battleground.” Many specialty goods compete using nonprice competition aimed at the consumer who is seeking advantages other than price—such as a prestige image or high quality. Discussion Question: For some specialty products, there is an old saying, “If you have to ask how much it costs, you can’t afford it.” Can you give examples of these kinds of products? Is price emphasized in their promotion? This slide relates to material on pp. 469-470.  Indicates place where slide “builds” to include the corresponding point.   
  • Summary Overview Price policies usually lead to administered prices --consciously set prices. This practice is difficult with indirect distribution, but administered prices help achieve pricing objectives . One key decision is about price flexibility policies . Key Issues One-price policy : the same for everyone . It is common with frequently purchased, inexpensive items. It can be more convenient, entail lower transaction costs, and maintain goodwill with customers. Flexible-price policy : offering different prices for different customers . Pricing databases make flexible pricing easier , less costly, and less time consuming, because they contain information about different customers. Salespeople can also adjust prices to take into account the competition, the firm’s relationship with a customer, and the customer’s bargaining ability. However, too much price-cutting may erode profits . A flexible-price policy may prompt resentment by customers who do not get the lowest price. Channel conflict may also result, or an unauthorized “gray” channel may evolve if customers buy in large quantities, say, to get a price break, and then resell what they don’t need. Discussion Question: Airlines and auto dealers often use flexible pricing. Is this practice fair to all consumers? Why or why not? This slide relates to material on pp. 470-472.  Indicates place where slide “builds” to include the corresponding point.  
  • Introdution to pricing

    1. 1. Pricing 1
    2. 2. Why is Pricing Important?• Pricing deals with how much you are going to charge your customers for your product or service.• Price is the primary profit determinant.• Organisations must have clear long-term strategies for pricing. 2
    3. 3. The Role of Pricing• To create an “image” for a product or service: – Rolex watches, Rolls Royce cars, etc. Price is used partially to create the aura of value. – Sometimes too low a price can back-fire and damage image (4 T-shirts for Rs 666 – just how good can they be??). 3
    4. 4. The Role of Pricing• To generate revenues and income: – Pricing tied to sophisticated demand • Rolex watches or BMW cars – Prices lowered to near-break even to raise cash for operations or other opportunities. • Deccan Airlines Rs 99 offers – Prices raised temporarily to take advantages of market opportunities (demand) and to increase income • Flowers on Mother’s Day 4
    5. 5. The Role of Pricing• To give customers incentives or disincentives to use a product or a service: – Zero percent financing for cars (incentive) – Higher taxes on cigarettes (price driven dis- incentive) 5
    6. 6. The Role of Pricing• To capture market share or squeeze out a rival: – Coke and Pepsi routinely use pricing to capture share units in local markets. – Full Airlines squeezed out Low cost carriers by matching prices. 6
    7. 7. •Making All Things Unequal•Marketing is making all things unequal and thiscan be made by price and or value.•Some times value is developed by therelationships that make it easy to choose yourproduct over all others. 7
    8. 8. Flexibility• Three of the four P’s in marketing are usually not very flexible: – Products/Services often take years to bring to market. – Distribution channels are often costly and take time to set up. – Promotion – Can be quick but usually takes months to create and use. 8
    9. 9. Flexibility• Pricing is perhaps the most “flexible” – Jet Air “ Price Saver” – Price created on Thursday for the coming weekend. – Negotiation for the purchase of a car. 9
    10. 10. Methodology Some industries use very sophisticated databases and research models to test pricing options and to track the(1) impact of price changes(2) the need to change prices.(3)Others (small, retail) often go by instinct, market knowledge. 10
    11. 11. “Strategic” Pricing• Pricing is a key part of the marketing mix.• The “strategy” of pricing options (competitive position, goals of pricing decisions) are key parts of the overall marketing approach.• In other words, pricing is a deliberate decision with specific goals in mind (not limited to profit) to a long-ago set base. 11
    12. 12. Profit MaximizationEconomic Theory – The quantity demanded is a function of the price that is charged – Generally, the higher the price, the lower the quantity demandedPricing – Management should set the price that provides the greatest amount of profit 12
    13. 13. Determining the Profit-Maximizing Price and QuantityRupeesper unit Profit is maximized where marginal cost equals marginal revenue, resulting in price p* and quantity q*. p* Demand Marginal cost Marginal Quantity made revenue and sold q* per month 13
    14. 14. Determining the Profit-Maximizing Price and Quantity Total costP Total revenue Total profit at the profit-maximizing quantity and price, q* and p*. Quantity made and sold q* per month 14
    15. 15. Strategic Planning for Price 15© 2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin
    16. 16. Price Perspectives: Price Equals Something of Value 16© 2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin
    17. 17. Objectives Should Guide Strategy Planning for Price 17© 2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin
    18. 18. Objectives Should Guide Strategy Planning for Price 18© 2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin
    19. 19. Objectives Should Guide Strategy Planning for Price 19© 2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin
    20. 20. Most Firms Set Specific Pricing Policies to Reach Objectives Flexible-Price Flexible-Price One-Price Policy One-Price Policy Policy Policy • The same for • Different everyone customers, • Frequently different prices purchased items OR • Databases make it • Convenient easier • Low cost • Salespeople can adjust prices • Maintains goodwill • Too much cutting can hurt profits 20© 2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin
    21. 21. Responsibility• Finance plays a role in the setting of prices in most industry, but often is NOT the key decision maker. – Factory managers for industrial products – Store managers for consumer goods – Even hotel front desk clerks under the right circumstances! 21
    22. 22. Legalities (General)• Collusion/Price-Fixing.• Pricing below cost/predatory pricing• Manufacturer-set pricing 22
    23. 23. PricingWhen setting a price, we need to take account of 3 critical points:• Market Value – What is your product worth to your customers• Cost structure – What it costs you to provide the product or service• Competition – The price your competitors charge 23
    24. 24. Market Value• Successful businesses maximise their profit by matching their pricing with the value customers put on their products or services• The Cost is the total outlay required to create the product or service• The Value is what the customer thinks the product or service is worth 24
    25. 25. Market ValueFor a plumber to fix a burst pipe, it may cost:• Rs.10 for travel costs• Rs.5 for materials• Rs.20 for one hour’s labour• However, the value to the customer who has water pouring down the stairway is far greater than the Rs.35 cost. A plumber may, therefore, charge Rs.50+ to fix a burst pipe, more so for an out of hours service• Product pricing is often built around the “cost plus” price model, while service pricing is generally created on a perceived value basis.• Both methods, however, do still require a full understanding of costs and the competition 25
    26. 26. Cost Structure• Your cost structure provides a basis for what you need to charge...however it will not necessarily show what you can or should charge.• As long as the price you sell your product or service at is higher than the variable cost then each sale will make a contribution towards covering fixed costs and making profits. 26
    27. 27. Competition• Due to deregulation companies face competition in some form. There is a need to benchmark potential pricing.• Generally done by: • Getting someone to phone or visit your rivals and ask for a price quote. • Look at their published annual accounts to analyse their cost base. • It is much easier to get prices if it is a e- commerce company. 27
    28. 28. Competition• The analysis framework. Too low and you throw away profit, too high you lose customers.• Evaluate competitors price along with other factors such as: • Where they deliver the product or service • How they deliver it • The quality of their service provision 28
    29. 29. PricingPricing Models:• Cost Plus Pricing• Marginal Costing and Contribution Pricing• Value Based Pricing• A mixture of pricing strategies for differing situations 29
    30. 30. Who determines the price? Once competition enters the market, the price of a product becomes squeezed between the cost of the product and the lowest price of a competitor.Organizations that choose to compete by offering innovative products and services have a more difficult pricing decision because there is no existing price for the new product or service. 30/30
    31. 31. Influences on Price• Customer demand• Competitors’ behavior/prices/actions• Costs• Regulatory environment – legal, political and image related 31/30
    32. 32. Pricing approaches1. C o s t p l u s 32/30
    33. 33. Cost Plus Pricing• This is the most common method and is based on two elements: • The mark-up you must add to your costs to make the desired profit • The mark-up used by competitors• The mark-up is how much you add to your costs to arrive at your selling price. It is usually expressed as a % of the cost, e.g. Cost plus 50%.• Different products and businesses apply hugely different mark-ups, e.g. • Branded clothing: Cost plus 135% • Jewellery: Cost plus 350% 33
    34. 34. Cost-Plus Pricing• If the final price looks uncompetitive then review the size of the mark-up. Never remove the mark-up altogether to make the price competitive, instead look at reducing costs.• Cost-plus pricing does however have pitfalls: • It ignores the image and market position you are looking for • It assumes you will achieve a sales target to make break even or better 34
    35. 35. Cost-Plus Pricing ExampleThe costs involved in making a product are:Direct Materials Rs.3 per unitDirect Labour Rs.11 per unitDirect Expenses Rs.2 per unitIndirect Expenses Rs.4 per unitTotal cost Rs. 20 per unit 35
    36. 36. Cost-Plus Pricing ExampleIf we want a mark up of 30% on each unit, then:Full Cost = Direct Materials Rs. 3 Direct Labour Rs.11 Direct Expenses Rs. 2 Indirect Expenses Rs. 4Full Cost= Rs.20Mark Up= 30% of Rs.20 Rs. 6Selling Price= Rs.26 36
    37. 37. Marginal Costing and Contribution Pricing• The Marginal Cost approach takes a different view from the Cost Plus pricing method• Instead of starting from the cost of the product or service, you start from the price that you can charge, and the amount of sales you can make at that price• This technique will allow you to see whether you can cover costs and make a profit at a certain price 37
    38. 38. Marginal Costing and Contribution Pricing • This approach to costs and pricing takes cost behaviour as the basis for allocating costs • The categories of costs considered for this method are the variable and fixed costs • This method also introduces the concept of contribution – the amount remaining after deducting the variable costs from the selling price • This goes towards covering the fixed costs and any remainder goes to profit 38
    39. 39. Marginal Costing and Contribution PricingExampleSales Price of a Product: Rs.7.50 per itemVariable Costs: Rs.4.50 per itemFixed Costs: Rs.2.90 per item 39
    40. 40. Marginal Costing and Contribution PricingExampleContribution = Sales less Variable Costs = Rs.7.50 – Rs.4.50Contribution = Rs.3.00 per itemFixed Cost = Rs.2.90 per itemProfit = Rs.0.10So, selling 100 items, a profit of Rs.10 would be generated. 40
    41. 41. Value Based Pricing• States that the price should reflect the value of a product as customers perceive it (the “willingness-to-pay”)• Value-based pricing is an effort to extract this perceived value from the market• This involves quantifying perceived value and increasing it whenever possible—i.e., when the customer’s willingness to pay for the increased value exceeds the cost of delivering it 41
    42. 42. Value Based PricingThis perceived-value pricing takes a number of forms: • Convenience: A convenient, local service will normally be able to charge more • Brand: Many customers will pay more for a well marketed brand • Competition: The less competition there is then the less choice the customer has • Supply & Demand: More customer demand than there is supply will lead to the ability to charge higher prices• Overcharging could alienate customers and could draw in competitors 42
    43. 43. Cost-based vs. Value-based• Cost-based • Value-based – most common – optimal profits pricing method – requires research – easiest pricing – complicated to method administer – considered fair – can be considered – difficult to allocate unfair fixed costs – sub-optimal profits 43
    44. 44. MarginsMargins indicate the % profit a business makes after applying a mark-up• If an enterprise, for example, costs its product or service at Rs.100 and marks it up by 50% to sell it for Rs150 then• its profit margin is 33.3% (Rs.50), i.e. the value of the mark-up (Rs.50), divided by the selling price (Rs.150) x 100• Margins are good barometers of how important particular products or services are to the profitability of your business. 44
    45. 45. Opportunity cost• Opportunity cost is the most fundamental cost concept. – The opportunity cost of doing or getting something is:• what you could have done or gotten instead 45
    46. 46. PriceThe price of a chocolate bar is the amount of moneythat I have to give up to buy.In paying the price, The customer is sacrificing whatelse these coins could have bought. 46
    47. 47. Opportunity cost is what you forgo. Example: Your opportunity cost for taking this class includes:• Whatever else you could have bought with your tuition and fee money Plus• the work, family participation, and recreation that you are not doing because you are here. 47
    48. 48. Opportunity cost is not resources used• Strictly speaking, the cost of something is not the resources used up to get it.• Instead, the cost is what else you could have done with those resources.• Resources have value only because you can use them to make goods and services that have value. 48
    49. 49. Using prices for costs• Opportunity cost can be hard to use in practice.• Rupee costs (prices) are easier to determine And easier to add up. 49
    50. 50. But one should not lose sight of opportunity cost.For example:• saving medical institutional costs by discharging patients early• adds opportunity costs for family members drafted into being home caregivers 50
    51. 51. Opportunity cost = price?Prices can reflect societys opportunity cost• Means that the ratio of prices of any two goods or services is the opportunity cost of the one in terms of the other.• If the market system works properly then the price ratio of any two goods or services tells you how many of good X you give up to get each unit of good Y.• For this to work properly, you have to have strong competition and savvy consumers. Competition will then force the sellers to be efficient, and provide goods and services at prices in line with costs. 51
    52. 52. Inefficiency• To know that the resources that could be used to make more of the drug are instead being used to make something less valuable?• Because the price of a resource depends on what it can be used for.• If there are some resources that are not being used in the most valuable way, that is the definition of inefficiency and loss of opportunity. 52
    53. 53. Hospital day price example• Prices for hospital days late in a patient’s stay are higher than opportunity cost.• This leads to substituting other forms of care. 53
    54. 54. Functional-Based Management Model Cost View ResourcesOperational View Efficiency Analysis Functions Performance Analysis Products 54
    55. 55. Activity-Based Management Model Cost View ResourcesProcess View Driver Analysis Activities Performance Analysis Why? What? How Well? Products and Customers 55
    56. 56. Comparison of FBM and ABM Accounting Systems Functional-Based Activity-Based1. Unit-based drivers 1. Unit- and nonunit-based drivers2. Allocation-intensive 2. Tracing-intensive3. Focus on managing cost 3. Focus on managing activities4. Sparse activity information 4. Detailed activity information5. Maximization of individual unit 5. Systemwide performanceperformance maximization6. Use of financial measures of 6. Use of both financial andperformance nonfinancial measures of performance 56
    57. 57. Customer perception of product•Price is the amount of money you pay to buy theequipment.•Cost is the amount of money you pay to operate theequipment over the lifetime.•This is called the Total Cost of Ownership. There are fivekey points that affect the Total Cost of Ownership (TCO). 57
    58. 58. The five key points that affect the Total Cost of Ownership (TCO)Labor CostIf your laundry runs 10 loads per day, a washerwith 3⁄4” water valves versus 1⁄2” water valves could saveyou 30 minutes of operating time.Lower priced machines generally have lower extractionspeeds. To get the lowest TCO, you should invest in higherextraction speeds to remove more water from linens.This allows the linen to dry faster. If extraction efficiency ismeasured by G-force, a 300 G-force washer will removesignificantly more water than a 90 G-force washer.The dry time difference in a 60 lb load of terry towels can bealmost ten minutes! How much labor can you save in youroperation by cutting ten minutes on every load of towels? 58
    59. 59. Cost of Power•Utilities are a controllable cost that is often overlooked whenconsidering which laundry equipment to buy.•Using the above scenario, you might save more than Rs.1500per year by reducing the time in your save in your utility bill bycutting ten minutes of drying time on every load of towels?Value for Your Money•Look at the total weight of the machine. Weight generallyindicates if the frame or bearings are built to a higher standardand are more likely to give you extended years of service.•This may even lower maintenance costs over the life of theproduct. Stainless steel panels versus painted panels are worth 59spending a little extra money for.
    60. 60. Past PerformanceIt is the best indicator of future performance! What do youknow about the machine you are considering?Do you know anyone that has used this brand of machine for5+ years?What do you know about the company you are buying from?How will they perform service for you in the future?Service supportHow many service technicians do they have? How many hoursdoes it take to respond to your future service needs?It is worth paying a little more for good service support for theequipment. 60
    61. 61. Warranty?The industry warranty period varies from one year to threeyears. Having the longest and most comprehensivewarranty should lower your TCO.Is there a labor warranty? You may even consider anextended labor warranty.So when buying laundry equipment customer looks for theproducts that will lower Total Cost of Ownership (TCO)!The marketer must make sure you determine the underlying difference between price and cost. 61
    62. 62. Defining business and value• The horse carriage makers mistakenly thought they were in the horse carriage business (product) rather than the transportation market (benefit).• The best way to succeed is not to focus on the product, but the benefit youre providing your customers:• It is important to bear in mind that people value benefits and not necessarily forms.• The key benefit that journalists and news organizations have provided has been relevant, timely, accurate information that helps people make decisions, take action, and form opinions. 62
    63. 63. Pricing StrategiesAccording to McKinsey, “80 to 90 percentof all poorly chosen prices are too low…Companies habitually charge less than theycould for new offerings. It’s a terriblehabit.” Glenn Voss 63
    64. 64. Target costing vs traditional cost based pricinga. traditional cost based pricing is designed to appeal to anycustomers, but target costing target specific customers.b. traditional cost based pricing consider the market that isavailable for the product at the end of the process, whereastarget costing considers the market at the beginning of theprocess.c. product costs are irrelevant under target costing, but arevery important under traditional cost based pricing. 64