Pricing Concepts


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  • Notes: Marketing has the broadest perspective on pricing because it is the function that looks at both internal cost issues and external pressure demands. Price means one thing to the consumer and another to the seller. To the consumer, the price is the cost of something; to the seller, price is the source of profits. Marketing mangers find the task of setting prices a challenge.
  • Notes: Price is typically money exchanged for a good or service; however, it may also be time lost while waiting to acquire the good or service. Consumers are interested in obtaining a “reasonable price,” which means a perceived reasonable value at the time of the transaction. The price paid is based on the satisfaction consumers expect to receive from a product and not necessarily the satisfaction they actually receive. Price can relate to anything with perceived value, not just money. When goods or services are exchanged, the trade is called barter .
  • Notes: Prices are the key to revenues, which are the key to profits for an organization. Revenue is what pays for every activity of the company. What’s left over is profit. The price is set to earn a profit for the company. Managers strive to charge a price that will earn a fair profit. The price must not be too high or too low, and must equal a perceived value to consumers. Lost sales mean lost revenue; on the other hand, if a price is too low, the company loses revenue. Additionally, setting prices too low may not attract as many buyers as managers might think.
  • Notes: Setting the right price can be a stressful task of marketing managers, as demonstrated by the above trends in the consumer market. Consumers are using the Internet to make wiser and more informed purchasing decisions. Competition in general is increasing, and consequently many installations, accessories, and parts are being marketed like indistinguishable commodities.
  • Notes: Pricing objectives must be specific, attainable, and measurable to survive in today’s competitive market. Pricing objectives can be divided into three categories as shown above and described in the following slides.
  • Notes: Profit-oriented pricing objectives include profit maximization, satisfactory profits, and target return on investment. A discussion of each of these follows.
  • Notes: Although profit maximization aims at setting prices for a large total revenue, it does not always signify unreasonably high prices. Both price and profits depend on the competitive environment and the product’s perceived value. Remember, too, that a firm cannot charge a price higher than the product’s perceived value. Satisfactory profits represent a reasonable level of profits that is consistent with the level of risk an organization faces.
  • Notes: The most common profit objective is a target ROI, or the return on total assets. It represents a firm’s effectiveness in generating profits with the available assets. The higher the firm’s ROI, the better off the firm is. ROI puts a firm’s profits into perspective by showing profits relative to investment. ROI needs to be evaluated in terms of the competitive environment, risks in the industry, and economic conditions. In general, firms seek ROIs in the 10 to 30 percent range, depending on the industry. For example GE seeks a 25 percent ROI, while grocery chains obtain a return under 5 percent.
  • Online Target Wal-Mart JC Penney Shop for some kind of electronic device (DVD player, digital camera, MP3 player, etc.) on the Target, Wal-Mart, and JCPenney Web sites. How do the prices for the same product compare at the three retailers? Do they all even carry the same product? Compare the price on the Web with the price offered at the physical store and explain any discrepancies.
  • Notes: Market share can be reported in dollars or units of product, and the results may be different. Many companies believe that maintaining or increasing market share is an indicator of the effectiveness of their marketing mix. Larger shares often mean higher profits, thanks to economies of scale, market power, and ability to compensate top-quality management. However, this conventional wisdom is not always reliable. Many companies with low market share survive if they are in a slow growth industry and experience few product changes.
  • Notes: Maximization of cash should never be a long-run objective because cash maximization may mean little or no profitability. Without profits, a company cannot survive.
  • Notes: Status quo pricing seeks to maintain existing prices or to meet the competition’s prices. This category requires little planning, and is essentially a passive policy.
  • Notes: After pricing goals are established, specific prices are set. The price set for products depend on two factors: the demand for the good and the cost to the seller for that good.
  • Online uBid See how demand and supply establish prices by checking out the offerings at See a variety of products and identify the price and the number of items in the lot. Can you see a correlation between the price and the number of, say, printers uBid has on hand?
  • Notes: The quantity of a product that people will buy depends on its price. The higher the price, the fewer goods or services consumers will demand, and vice versa.
  • Notes: Exhibit 17.3 demonstrates the supply curve. At higher prices, manufacturers will obtain more resources and produce more product to sell.
  • Notes: The concepts of supply and demand are combined to see how competitive market prices are determined.
  • Notes: An equilibrium price is reached when supply and demand are equal. A price below equilibrium results in a shortage because the demand is greater than the available supply. A shortage puts upward pressure on price. At a price above equilibrium, the demand is less than the available supply, and a surplus is created. A surplus lowers the price. Establishing an equilibrium price may not be possible all at once. Prices may fluctuate as the market for a good moves toward equilibrium; however, demand and supply will settle into the proper balance.
  • Notes: 1. To appreciate demand analysis, the concept of elasticity should be understood.
  • Discussion/Team Activity: Identify products and/or services which illustrate the elasticity of demand.
  • Notes: Exhibit 17.5 (a) shows a very elastic demand curve. Decreasing the price of the good increases sales and revenue substantially.
  • Online Columbia House How can Columbia House offer so many CDs, videos, or DVDs for one cent? Go to the Web site to see what kind of deals Columbia House is offering right now. Compare the introductory offers to the pricing for subsequent purchases. What conclusions can you draw about Columbia House and about the elasticity of demand for CDs based on the posted pricing for the initial sign-up and for subsequent purchases? Notes: Factors that affect elasticity of demand are: Availability of substitutes: When many substitutes are available, it is easy to switch products, making demand elastic. The same is true in reverse, if no substitutes are available. Price relative to purchasing power: If a price is so low that it is an inconsequential part of an individual’s budget, demand will be inelastic and people are not sensitive to the price increase. Product durability: Repairing durable products rather than replacing them prolongs their useful life. If the cost of a new product increases, people might elect to repair the old product. Thus, people are sensitive to the price increase, and the demand is elastic. A product’s other uses: The greater the number of uses for a product, the more elastic demand tends to be. If a product has only one use, the quantity purchased probably will not vary as price varies. Discussion/Team Activity: Discuss examples of price inelasticity and elasticity. Include zero percent automobile financing, the price of vehicle models, cell phone rates, prestige watches, cigarettes, health care, etc.
  • Notes: When competitive pressures are high, a company must know when it can raise prices to maximize its revenues. Yield management systems, which were first developed by the airline industry, utilize complex mathematical software to profitably fill unused capacity. Yield management systems have spread beyond the service industries, and used by companies to set prices based on a number of variables.
  • Notes: The software employs techniques such as discounting early purchases, limiting early sales at these discounted prices, and overbooking capacity.
  • Notes: Sometimes the importance of demand is ignored when prices are decided, based largely or solely on the basis of costs. Prices set on the basis of cost may be too high for the target market. On the other hand, if prices are set too low, the firm will earn a lower return than it should. Costs should be determined as part of any price determination, in part to determine the floor below which a good or service must not be priced in the long run. 4. Variable and fixed costs are important aspects of price determination.
  • Notes: Costs can be used to set prices in a variety of ways. Markup pricing is fairly simple. The others—profit maximization pricing and break-even pricing--use more complicated concepts of costs. A description of these methods is shown on the following slides.
  • Notes: Markup pricing is the most popular method to establish a selling price. Instead of using the costs of production to set price, it uses the costs of buying the product from the producer, plus amounts for profit and expenses. The total determines the selling price. Keystoning is a method based on experience, with many small retailers doubling the cost. Other factors that influence markups are the merchandise’s appeal to customers, past response to the markup, the item’s promotional value, the seasonality of the goods, their fashion appeal, the product’s traditional selling price, and competition. The biggest advantage of markup pricing is its simplicity. The primary disadvantage is that it ignores demand and may result in overpricing or underpricing the merchandise.
  • Notes: Profit maximization occurs when marginal revenue equals marginal cost. Marginal cost is the change in total costs associated with a one-unit change in output. Marginal revenue is the extra revenue associated with selling an extra unit of output. As long as the revenue of the last unit produced and sold is greater than the cost of the last unit produced and sold, the firm should continue manufacturing and selling the product.
  • Notes: Break-even analysis determines what sales volume must be reached before the company breaks even and no profits are earned. (Its total costs equal total revenue.)
  • Notes: Break-even analysis provides a quick estimate of how much the firm must sell to break even and how much profit can be earned if a higher sales volume is obtained. It is useful to see what can be done to reduce costs or increase sales. However, it has limitations such as the difficulty in determining whether a cost is fixed or variable. Additionally, break-even analysis ignores demand.
  • Notes: Other factors besides demand and costs can influence price. A description of these determinants follows.
  • Notes: As a product moves through its life cycle, the demand for the product and the competitive conditions change: During the introductory stage, prices are set high to recover development costs. Demand originates in the core of the market and is relatively inelastic. As the product enters the growth stage, prices tend to stabilize due to the increased product supply as new competitors enter the market. Second, the product begins to appeal to a broader market, often lower income groups. Last, economies of scale are lowering costs, and the savings can be passed on to the consumer. Maturity brings about further decreases in price, as competition increases and high-cost firms are eliminated. However, distribution channels become a significant cost factor because of the need to offer wide product lines. Usually, only the most efficient manufacturers remain. The decline stage may see further price decreases until only one firm is left in the market. At that time, prices begin to stabilize and may even increase as the product moves into the specialty goods category. Discussion/Team Activity: Identify and discuss products in various stages of the product life cycle. Relate the pricing of these products to the product life cycle shown above.
  • Notes: Competition varies during the product life cycle. Although a firm may not have competition at first, the high prices obtained may induce other firms to enter the market. Sometimes competition can lead to price wars. Global competition has often forced firms to lower prices. Even Wal-mart has seen price cutting by the second largest world-wide competitor Carrefour.
  • Notes: Adequate distribution for a new product can be obtained by offering a larger-than-usual profit margin to distributors, or by offering a large trade allowance to defray the costs of promotion. However, some distributors use “selling against the brand” strategies to promote their own private-label brands. They place well-known brands at high prices while offering other brands at higher prices. Distributors may also go outside traditional channels and buy “gray-market goods” at lower prices so they can sell the goods with a large markup or at a reduced price.
  • Notes: The Internet connects sellers and buyers quickly, and allows product and price comparison, putting them in a better bargaining position. Numerous Web sites provide information regarding product selection, and a second opinion for brand selection. However, quality of reviews vary. Shopping bots search the Web for the best price. The two types of shopping bots are broad-based types and niche-oriented types. Most shopping bots give preferential listings to e-tailers who pay for the privilege, and not necessarily the lowest-priced retailer. Internet auctions, such as eBay, are huge. Business-to-business auctions are likely to be the dominant form in the future.
  • Online Vivre Ashford Vivre is a luxury lifestyle catalog and Web site. Visit and review the product offerings. Pick a product and then see if you can get it cheaper at, a luxury brand discounter. What luxury brands are offered on both sites? How do the prices compare? Can you identify tiers of luxury brands? Notes: When a purchase decision involves uncertainty, consumers tend to rely on a high price as a predictor of good quality. Consumers assume that “you get what you pay for.” Prestige pricing takes these consumer attitudes into account when devising price strategies. A successful prestige pricing strategy requires a retail price that is reasonably consistent with consumers’ expectations.
  • Notes: In a recent study to ascertain the dimensions of quality revealed the factors shown on this slide, in order of importance, beginning with ease of use. When consumers focused on prestige and/or durability to assess quality, price was a strong indicator of perceived quality. Price was less important as an indicator of quality if the consumer was focused on the other four dimensions of quality.
  • Pricing Concepts

    1. 1. CHAPTER 17 Pricing Concepts Designed by Eric Brengle B-books, Ltd. Prepared by Deborah Baker Texas Christian University Introduction to Marketing McDaniel, Lamb, Hair 9
    2. 2. Learning Outcomes LO I LO 2 LO 3 Discuss the importance of pricing decisions to the economy and to the individual firm List and explain a variety of pricing objectives Explain the role of demand in price determination
    3. 3. Learning Outcomes Understand the concept of yield management systems Describe cost-oriented pricing strategies Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet and extranets, and perceptions of quality can affect price LO 5 LO 6 LO 4
    4. 4. The Importance of Price Discuss the importance of pricing decisions to the economy and to the individual firm LO I
    5. 5. The Importance of Price LO I Price allocates resources in a free-market economy To the consumer... Price is the cost of something To the seller... Price is revenue
    6. 6. What Is Price? Price LO I Price is that which is given up in an exchange to acquire a good or service.
    7. 7. The Importance of Price to Marketing Managers LO I Revenue The price charged to customers multiplied by the number of units sold. Profit Revenue minus expenses.
    8. 8. Trends Influencing Price LO I Flood of new products Increased availability of bargain-priced private and generic brands Price cutting as a strategy to maintain or regain market share Internet used for comparison shopping
    9. 9. REVIEW LEARNING OUTCOME The Importance of Pricing Decisions LO I Price X Sales Unit = Revenue Revenue – Costs = Profit Profit drives growth, salary increases, and corporate investment
    10. 10. Pricing Objectives List and explain a variety of pricing objectives LO 2
    11. 11. Pricing Objectives LO 2 Profit-Oriented Sales-Oriented Status Quo
    12. 12. Profit-Oriented Pricing Objectives LO 2 Profit-Oriented Pricing Objectives Profit Maximization Satisfactory Profits Target Return on Investment
    13. 13. Profit Maximization LO 2 Profit Maximization Setting prices so that total revenue is as large as possible relative to total costs.
    14. 14. Return on Investment Return on Investment LO 2 ROI = Net Profit after taxes Total assets Net profit after taxes divided by total assets.
    15. 15. Sales-Oriented Pricing Objectives LO 2 Market Share Sales Maximization Sales-Oriented Pricing Objectives Online
    16. 16. Market Share Market Share LO 2 A company’s product sales as a percentage of total sales for that industry.
    17. 17. <ul><li>Short-term objective to maximize sales </li></ul><ul><li>Ignores profits, competition, and the marketing environment </li></ul><ul><li>May be used to sell off excess inventory </li></ul>Sales Maximization LO 2
    18. 18. Status Quo Pricing Objectives LO 2 Maintain existing prices Meet competition’s prices Status Quo Pricing Objectives
    19. 19. REVIEW LEARNING OUTCOME Pricing Objectives LO 2 Profit Maximization Satisfactory Profits Target ROI Profit-Oriented Sales-Oriented Market Share Sales Maximization Status Quo Maintain Existing Price
    20. 20. The Demand Determinant of Price Explain the role of demand in price determination LO 3
    21. 21. The Demand Determinant of Price LO 3 Demand The quantity of a product that will be sold in the market at various prices for a specified period. Supply The quantity of a product that will be offered to the market by a supplier at various prices for a specific period. Online
    22. 22. The Demand Curve LO 3
    23. 23. The Supply Curve LO 3
    24. 24. Tyson’s Meat Glut <ul><li>Tyson Foods, the world’s largest processor, has an oversupply of meat: </li></ul><ul><ul><li>Lower chicken consumption due to avian flu fears </li></ul></ul><ul><ul><li>export restrictions to Japan and South Korea due to mad cow disease </li></ul></ul><ul><li>Mismatch between oversupply and reduced demand has created tremendous financial losses for the company. </li></ul><ul><li>Tyson produces 25% of meats that Americans eat, and small price changes impact company profit significantly. </li></ul><ul><li>To reverse trend, company is taking a commodity approach to the primary business, while marketing more value-added products. </li></ul>LO 3 SOURCE: Richard Gibson, “Tyson Looks for Way Out of Meat Glut ,” Wall Street Journal, June 28 , 2006, B9A.
    25. 25. How Demand and Supply Establish Price LO 3 Price Equilibrium The price at which demand and supply are equal. Elasticity of Demand Consumers’ responsiveness or sensitivity to changes in price.
    26. 26. Price Equilibrium LO 3
    27. 27. Elasticity of Demand LO 3 Elastic Demand <ul><li>Consumers buy more or less of a product when the price changes. </li></ul>Inelastic Demand <ul><li>An increase or decrease in price will not significantly affect demand. </li></ul>Unitary Elasticity <ul><li>An increase in sales exactly offsets a decrease in prices, and revenue is unchanged. </li></ul>
    28. 28. Elasticity of Demand LO 3 Elasticity ( E ) = Percentage change in quantity demanded of good A Percentage change in price of good A If E is greater than 1, demand is elastic. If E is less than 1, demand is inelastic. If E is equal to 1, demand is unitary.
    29. 29. Elasticity of Demand LO 3 Price Goes... Revenue Goes... Demand is... Down Up Elastic Down Down Inelastic Up Up Inelastic Up Down Elastic Up or Down Stays the Same Unitary Elasticity
    30. 30. Biz Flix The Money Pit LO 3
    31. 31. Elasticity of Demand LO 3
    32. 32. Factors that Affect Elasticity of Demand LO 3 Availability of substitutes Price relative to purchasing power Product durability A product’s other uses Rate of inflation Online
    33. 33. The Power of Yield Management Systems Understand the concept of yield management systems LO 4
    34. 34. Yield Management Systems LO 4 A technique for adjusting prices that uses complex mathematical software to profitably fill unused capacity. Yield Management Systems
    35. 35. Yield Management Systems LO 4 Discounting early purchases Limiting early sales at discounted prices Overbooking capacity
    36. 36. Yield Management Systems <ul><li>Rental property landlords use yield management systems to raise rents at a faster pace. </li></ul><ul><li>The M/PF Yield-Star Price Optimizer is similar to pricing systems used by airlines and car-rental companies. </li></ul><ul><li>It uses data such as number of vacancies and forecasted market conditions to determine the optimal rent. </li></ul><ul><li>Tenants can also take advantage of the technology. </li></ul>LO 4 SOURCE: Kemba J.Dunham, “Technology Proves a Boon for Some Landlords ,” Wall Street Journal, June 28, 2006, B10.
    37. 37. REVIEW LEARNING OUTCOME Yield Management Systems LO 4
    38. 38. The Cost Determinant of Price Describe cost-oriented pricing strategies LO 5
    39. 39. The Cost Determinant of Price LO 5 Varies with changes in level of output Types of Costs Variable Cost Fixed Cost Does not change as level of output changes
    40. 40. The Cost Determinant of Price LO 5 Break-Even Pricing Profit Maximization Pricing Keystoning Markup pricing Methods Used to Set Prices
    41. 41. Markup Pricing LO 5 Markup Pricing The cost of buying the product from the producer plus amounts for profit and for expenses not otherwise accounted for. Keystoning The practice of marking up prices by 100%, or doubling the cost.
    42. 42. Profit Maximization LO 5 Profit Maximization A method of setting prices that occurs when marginal revenue equals marginal cost. Marginal Revenue The extra revenue associated with selling an extra unit of output, or the change in total revenue with a one-unit change in output.
    43. 43. Break-Even Pricing LO 5
    44. 44. Break-Even Pricing LO 5 Break-Even Quantity = Total fixed costs Fixed cost contribution Fixed cost Contribution = Price - Avg. Variable Cost
    45. 45. REVIEW LEARNING OUTCOME Cost-Oriented Pricing Strategies LO 5
    46. 46. Other Determinants of Price Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet and extranets, and perceptions of quality can affect price LO 6
    47. 47. Other Determinants of Price LO 6 Perceived Quality Promotion Strategy Distribution Strategy Competition Stages of the Product Life Cycle
    48. 48. Stages in the Product Life Cycle LO 6 $ Decrease Stable High Introductory Stage Growth Stage Decline Stage $ High $ Stable $ Decrease Maturity Stage
    49. 49. The Competition <ul><li>High prices may induce firms to enter the market </li></ul><ul><li>Competition can lead to price wars </li></ul><ul><li>Global competition may force firms to lower prices </li></ul>LO 6
    50. 50. Distribution Strategy <ul><li>Offer a larger profit margin or trade allowance </li></ul><ul><li>Use exclusive distribution </li></ul><ul><li>Franchising </li></ul><ul><li>Avoid business with price-cutting discounters </li></ul><ul><li>Develop brand loyalty </li></ul>LO 6 Manufacturers Wholesalers/Retailers <ul><li>Sell against the brand </li></ul><ul><li>Buy gray-market goods </li></ul>
    51. 51. Distribution Strategy LO 6 Stocking well-known branded items at high prices in order to sell store brands at discounted prices. Selling against the brand
    52. 52. The Impact of the Internet LO 6 Internet auctions Shopping bots Second opinions from expert sites Product selection
    53. 53. The Relationship of Price to Quality LO 6 Prestige Pricing Charging a high price to help promote a high-quality image. Online
    54. 54. The $100,000 Family Car <ul><li>The auto industry has a new sticker price on luxury: $100,000. </li></ul><ul><li>These cars are powerful mass market sedans, targeting households with incomes of $300,000 or more. </li></ul><ul><li>With sales of 9,000 cars sold last year, and 17,000 being built, it looks like massive oversupply. </li></ul><ul><li>The expensive models could lure buyers into the showroom. </li></ul>LO 6 SOURCE: “The $100,000 Family Car ,” Wall Street Journal, March 12, 2006, W1.
    55. 55. Dimensions of Quality <ul><li>Ease of use </li></ul><ul><li>Versatility </li></ul><ul><li>Durability </li></ul><ul><li>Serviceability </li></ul><ul><li>Performance </li></ul><ul><li>Prestige </li></ul>LO 6
    56. 56. REVIEW LEARNING OUTCOME Factors Affecting Price LO 6