Download Making Pricing Decision

Ashesi University
COURSE TITLE : MARKETING
SEMESTER : FIRST, 2010/2011
MODULE 7: Making Pricing Decisions
Lecturer: Ebow Spio
Lesson Outcomes
• Answer the question “ What is price? “ and appreciate the role
of pricing in product management
• Appreciate the nature of pricing objectives
• Identify and understand the internal & external factors that
affect a firm’s pricing decision
• Identify major strategies in pricing new and existing products
• Compare and evaluate the general approaches to price setting
• Explain how firms find a set of prices that maximize the profits
from the total product mix
• Discuss how companies adjust their prices to take into account
different types of customers and situations
• Appreciate the ethical issues involved in pricing
What is Price?
• Price : The amount of money charged for a
product or service. It is the sum of the values
that consumers exchange for the benefits of
having or using the product or service
• Price is the only element in the marketing mix
that produces revenue, all other elements
represent costs.
Factors affecting MarketingOrientated pricing decisions
Internal factors •Marketing
Strategy: Marketing
objectives
Marketing mix
•Costs
•Pricing-Quality
Relationships
•Product Line Pricing
•Negotiating Margins
•Explicability
Pricing
decisions
External factors •Nature of market &
demand
•Competition
•Political factors
•Effect on
distributors/retailers
•Value to Customers
Pricing Objectives
Pricing Objectives represent the measurable goals a company
wants to achieve through its pricing policy.
1. Profit Oriented Objectives
- Target Return
- Maximize Profit
- Survival
2. Cash Flow
3. Sales Oriented
- Unit Sales Growth
- Growth in Market share
4.
Status Quo Oriented
- Meeting Competition
- Non price competition e.g. product quality
Factors affecting pricing decisions: Internal Factors
Marketing Strategy
Business and Marketing Objectives: Pricing
aligned with or done to achieve specific
business or marketing objective. Pricing decision is
determined by decision on market positioning.
E.g. Toyota decides to produce its Lexus cars to compete
with European Luxury car in high income segment, this
suggests charging high price
Other Company Objectives: Survival, current Profit
Maximization, market share maximization, product –
quality leadership
Factors affecting pricing decisions: Internal Factors
Marketing Mix Strategy: To achieve effective and consistent
marketing programme price decisions must be coordinated with
Product design, distribution and promotion decisions.
Positioning decision/strategy informs how the marketing mix
elements including price are designed.
E.g. Mercedes Benz image of prestige and high performance will
mean that it must command high price to reflect its positioning
and to cover higher cost of providing features and imagery to
remain true to the positioning.
New Product Pricing Strategies
Promotion
Price
High
Low
High
Low
Rapid Skimming
Slow Skimming
Rapid Penetration
Slow Penetration
New Product Pricing Strategies
Market-penetration
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Low initial price charged (Price at a discount to competitors)
Attract large volume sales quickly
Large market share
High volume sales save costs
Economies of scale on production and distribution
It is also used if the competition is likely to follow quickly,
If a low price will give competitors less incentive to enter
New Product Strategies: Conditions for
Charging a low price
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Only feasible alternative
Market Penetration or domination
Experience curve effect/low costs
Make money later
Make money elsewhere
Barrier to entry
Predation : Put other competitors out of
business.
New Product Pricing Strategies
Market-skimming
Setting a high price for a new product to skim maximum
revenues layer by layer from the segments willing to pay
the high price, the company makes fewer but more
profitable sales. E.g. Intel
• As competitors enter market, price is lowered
More sensible when :
• Demand is inelastic
• There is an “elite” market that is less price sensitive
• Barriers to entry (patents, etc.)
New Product Strategies: Characteristics of
High Price Market Segments
• Products provides high value
• Customers have the ability to pay
• Consumer and bill payer are
different
• Lack of competition
• Excess Demand
• High pressure to buy
Pricing Existing Products
The pricing of existing products should also be set within the context of strategy. The
strategic objective of each product will have a major bearing on pricing strategy
The following strategic objectives are relevant to pricing :
Build Objective: Strategic objective is to grow sales and market share.
For price-sensitive markets, build objectives for product implies a lower price than
competition. If competition raises its price we would be slow to match it.
Hold Objective : Strategic Objective is to hold sales and or market share. The
appropriate pricing strategy is to maintain or match price relative to the competition.
Respond to competitors pricing moves.
Harvest Objective: Maintaining or raising of profit margins even though sales or market
share is falling. The implication for pricing strategy would be to set premium prices.
Prices increases by competitors would be swiftly matched whereas the firm may not
readily respond to price cut by competition.
Reposition Objective: Changing market circumstances and product fortunes may
necessitate the repositioning of an existing product. This may involve a price change.
The direction and magnitude of the change will be dependent on new positioning
strategy.
Repositioning
Repositioning Strategies
Product
Same
Different
Image
Repositioning
Product
Repositioning
Different Intangible
Repositioning
Tangible
Repositioning
Same
Target
Market
Repositioning involves changing the target markets and differential
advantage or both
Factors affecting pricing decisions: Internal Factors
Costs: Costs set the floor for the price that the company can charge
for its product. The company wants to charge a price that both
covers all its costs for producing, distributing and selling the
product, and delivers a fair rate of return for its effort and risk.
Fixed Costs: Cost that do not vary with production or sales level
e.g. rent, depreciation, managers salaries, property rate,
insurance
Variable Costs : Costs that vary directly with the level of production
e.g. raw materials, packaging, sales commissions, hourly wages
etc.
Total Costs : The sum of the fixed and variable costs for any given
level of production.
Factors affecting pricing decisions: Internal Factors
Price –Quality Perception : Many people use price as an indicator of
quality. This is particularly the case for products where objective
measurement of quality is not possible e.g. perfume. It is also the
same for consumer durable
A study of price and quality perceptions of cars e.g. found that higherpriced cars are perceived to possess (unjustified) high quality.
Explicability : The capability of the salespeople to explain a high price
to customers may constrain price flexibility. In markets where
customers demand economic justification of prices, the inability to
produce cost and/or revenue arguments may mean that high
prices cannot be set.
Negotiating Margins : There could be difference between list price
and realized price or transaction price. The difference can be
accounted for by order-size discounts, competitive discounts (a
discretionary discount negotiated before the order is taken), a fast
payment discount, an annual volume bonus and promotional
allowance
Factors affecting pricing decisions:
External Factors
Nature of Market & Demand : Whereas costs set the lower limits of
prices, the market and demand set the upper limit. Before setting
the price the marketer must understand the relationship the price
and demand for its products. This is determined by the type of
market a firm operates in
E.g. Pure Monopoly, Monopolistic Competition, Pure Competition,
Oligopolistic, Competition
Pure competition is a market with few many buyers and sellers
trading uniform commodities where no single buyer or seller has
much effect on market price
Monopolistic competition is a market with many buyers and sellers
who trade over a range of prices rather than a single market
price with differentiated offers.
Factors affecting pricing decisions:
External Factors
Oligopolistic competition is a market with few sellers because it is
difficult for sellers to enter who are highly sensitive to each
other’s pricing and marketing strategies
Pure monopoly is a market with only one seller. In a regulated
monopoly, the government permits a price that will yield a fair
return. In a non-regulated monopoly, companies are free to set a
market price.
The demand curve shows the number of units the market will buy in
a given period at different prices
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Normally, demand and price are inversely related
Higher price = lower demand
For prestige (luxury) goods, higher price can equal higher
demand when consumers perceive higher prices as higher
quality
Factors affecting pricing decisions:
External Factors
Price elasticity of demand illustrates the response of demand to a change in price
Inelastic demand occurs when demand hardly changes when there is a small change in
price
Elastic demand occurs when demand changes greatly for a small change in price
Price elasticity of demand= % change in quantity demand
% change in price
Factors that affect Price Elasticity:
• Availability of Substitutes
• Comparison Difficulty
• Who Pays?
• Size of Total Expenditure or Cost Relative to Income
• Significance of End Benefit /Quality
• Sunk Investment
• Switching Costs
• Brand Equity or Loyalty
Factors affecting pricing decisions:
External Factors
Competition :
• Firms make effort to know and understand the costs,
price and quality of competitors offering
• Knowledge of serves as input in setting own price.
Pricing is used to position the firm’s offer relative to
the competition
• Price affects nature of competition it faces. High
price, high margin strategy may attract competition,
low-price, low margin strategy, may stop competition
or drive competitors out of the market
Factors affecting pricing decisions:
External Factors
• Economic Factors: Inflation, boom, interest rates
affect pricing decision
• Resellers/Intermediary: Price to give resellers fair
margin & encourage their support & help them to
sell the product effectively
• Government or Political
• Social Concerns: A firm’s short-term sales, market
share and profit goals may have to be tempered by
broader societal considerations
Factors affecting pricing decisions: External
Factors
Value to Customers or Perceived Value for Money
Value is the benefit the customer derives from the purchase of the
product. The firm needs to understand the value that the
customer places on the benefits received and then price
accordingly. Effectively, customers assess the price and measure
the benefits received.
Factors that affect the value they place on the product:
1. Status
2. Service and after sales service quality
3. Level of differentiation from competitor products
4. Quality of any packaging
5. Product functionality
6. Any substitute products which may be available
General Pricing Approaches
• Cost-plus pricing : This adding a standard mark-up to the cost of the
product. This is done by Construction Companies, Lawyers, Advertising
Agencies, Accountants etc.
Mark-Up: The difference between selling price and cost as a percentage of selling
price or cost.
Mark –Up price on sales (also known as Margin) = Unit Cost/(1.0-desired return
on sales).
Mark-up price on cost = Unit Cost X (1.0+desired return)
- Very simple
- It ignores demand and competitor’s prices & not likely to lead to the best price
- When firms in industry apply this method, prices tend to be similar and price
competition is minimized
- It is seen to be fairer to both buyers and sellers. Sellers make a fair
return on investment but do not take advantage of buyers when demand
becomes great.
General Pricing Approaches
Break-even analysis & target profit pricing:
Setting price to break even on the costs of making
and marketing a product or setting price to make
a target profit. It is used by public utilities
Break-even volume= Fixed Cost/(price-variable
cost)
Breakeven analysis identifies the level of output
where total revenue equals total cost. Sales of
output beyond this level starts to generate profit.
General Pricing Approaches
Value-based pricing: Setting price based on buyers’ perceptions
of product values rather than on cost.
The targeted value and price then drive decisions about product
design and what costs can be incurred. Pricing begins with
analysing consumers needs and value perceptions and a price
is set to match consumers’ perceived value
- Market research is required to ascertain the value buyers
assign to product and that of competitors. This can be
difficult.
- If a seller charges more than buyers’ perceived value, the
company’s sales will suffer.
General Pricing Approaches
Going-rate pricing: Setting price based largely on
following competitors prices rather than on company
costs or demand.
The firm might charge the same as, more , or less than its
chief competitors. The smaller firms follow the leader.
They change their prices when the market leader’s
prices change, rather than when their own demand or
costs change E.g. Petrol Retailers.
• Sealed-bid pricing: Where buyers submit secret bids
for a product
Product Mix Pricing Strategies
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Product-line pricing - setting the price steps between various products in a product
line based on cost differences between the products, customer evaluations of
different features, and competitor prices
Optional product pricing – The pricing of optional or accessory products sold along
with main product .e.g. car companies use this strategy. Basic product may be
stripped of many comforts and conveniences.
Captive product pricing – Setting a price for products that must be used along with
a main product, such as blades for a razor and film for a camera
By-product pricing – Setting a price for a by-product in order to make the main
product’s price more competitive. Products produced as part of the process
involved in producing another product. Manufacturer seeks market for byproducts and should accept any price that covers more than cost of storing and
delivering them. The practice allows the seller to reduce the main product’s price
to make it more competitive.
Product-bundle pricing - combining several products and setting a discounted price
e.g. theatres & sports team sell season tickets at less than cost of a single tickets.
Hotels , Computer Maker etc.
It used to sell more than the consumer really want
Price Adjustments Strategies
Cash Discount: A price reduction to buyers who pay the bills promptly
Quantity Discount: A price reduction to buyers who buy large volumes.
Functional Discount (Trade Discount) A price reduction offered by the seller to
trade channel members that perform certain functions such as selling,
storing, and record keeping
Seasonal Discount: A price reduction to buyers who buy merchandise or
services out of season
Trade in allowance: A price reduction given for turning in an old item when
buying a new one.
Promotional Allowance: A payment or price reduction to reward dealers for
participating in advertising and sales support programmes
Segmented Pricing : Pricing that allows differences in customers, products
and locations. The differences in prices are not based on differences in
costs.
Price Adjustments Strategies
• Psychological Pricing: A pricing approach that
considers the psychology of prices and not simply
economics; the price is used to say something about
the product
• Reference Prices: Prices that buyers carry in their
minds and refer to when they look at a given product
• Promotional Pricing: Temporarily pricing products
below the list price, and sometimes even below cost,
to increase short-run sales.
• Differential Pricing: A different price is charged to
different purchasers of the same product i.e. price
can vary
Ethical Issues in Pricing
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Predatory Price
Deceptive Pricing
Penetration Pricing and Obesity
Price Discrimination
Product Dumping