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Introduction to Marketing
Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.
Chapter 15 Objectives
1. Define price and explain why costbased pricing methods are used so
widely, and understand the
drawbacks of these methods.
2. Incorporate demand considerations
into pricing and determine shortterm profit maximizing price.
Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.
Chapter 15 Objectives
3. Identify and explain strategic drivers
of prices.
4. Explain and evaluate reasons why
base prices change over time in
both business and consumer
markets.
5. Explain basic legal and ethical
constraints on pricing behavior.
Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.
Pricing Strategies and Determination
• Pricing decisions are complex and
driven by many different factors
including:
– Cost
– Competitors
– Customer price-sensitivity or
elasticity
Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.
Defining Price and Determining Base Prices
•
Price is a monetary value charged by an
organization for the sales of its
products.
•
Market prices are determined by both
the buyer’s choice behavior and the
seller’s willingness to supply the
product.
Objective 1
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Defining Price and Determining Base Prices
•
Studies of managerial pricing have
found cost to be a dominant
consideration in pricing decisions.
Objective 1
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Cost-Plus Pricing
•
Fixed costs- costs that have no
relationship to volume.
•
Variable costs- costs that are incurred
for each customer.
Objective 1
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Average Total Cost
Average total cost = Variable cost + Fixed Cost
Unit Sales
Objective 1
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Cost-Based Pricing Approaches
•
Two common approaches to setting
prices based upon cost:
1. To use a standard rule-of-thumb mark-up.
2. To build up the price by adding together
both cost per unit and desired profit.
Objective 1
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Standard Mark-Up
Unit Cost
=
Selling Price
Unit Cost
(1 – Markup %)
Objective 1
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Target Return Pricing
Selling Price = Unit Cost + Desired Profit
per Unit
Objective 1
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Drawbacks of Cost-plus Pricing
•
The fundamental flaw of this
approach to pricing is that it ignores
demand.
– Price determines demand, not the other
way around.
•
In addition, a cost-plus pricing rule
fails to account for competition.
Objective 1
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Drawbacks of Cost-plus Pricing
•
Cost-plus pricing generally involves
allocating fixed costs on a per-unit
basis even though fixed costs do
not change with the number of units
sold.
Objective 1
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Demand Considerations: The Relationship
between Price and Sales
•
If your price is lower, demand is
usually higher, and vice versa.
•
Elasticity of demand helps us better
understand the relationship between
changes in price and quantity sold.
Objective 2
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Break-even Analysis
•
Break even analysis tells what sales
level you need for a particular price to
be profitable.
Break-even sales =
Fixed Costs
Selling Price – Variable Costs
Objective 2
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The Demand Schedule
•
Demand schedules provide a
systematic look at the relationship
between price and quantity sold.
Objective 2
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Elasticity of Demand
•
Economists quantify the relationship
between price and quantity sold
using a concept called elasticity.
Elasticity coefficient E = Percentage change in Q
Percentage change in P
Objective 2
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Elasticity of Demand
•
Inelastic demand is reflected by an
elasticity coefficient of less than 1.
•
Elastic demand is reflected by an
elasticity coefficient of greater than 1.
•
Unitary elasticity means that the
coefficient is exactly equal to 1.
Objective 2
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Profit Maximization
•
Given the information contained in a
demand curve, the firm can determine
the profit-maximizing price by simply
calculating the profit at each point
and determining which price
produces the highest profit.
Objective 2
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Profit Maximization
•
Marginal revenues- the change in a
firm’s total revenue per-unit change in
its sales level.
•
Marginal costs- the change in a firm’s
total costs per-unit in its output level.
Objective 2
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Profit Maximization
•
Isolating the effect of price can be
done several ways:
1.
2.
3.
4.
Analytic modeling
Experiments
Customer surveys
Managerial judgment
Objective 2
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Strategic Drivers of Price
•
Important strategic factors that will
play a role in setting a base price are
positioning strategy, objectives,
specific new product pricing
strategies, and price-quality
inferences.
Objective 3
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Positioning Strategy/Competition
•
A competitive strategy positioning
continuum is anchored by “low cost
leadership” on one end and
“differentiation” on the other.
•
Competitive positioning strategy is an
important determinant of base price
level.
Objective 3
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Pricing to Meet Objectives
•
Goal-setting is an important part of a firm’s
strategic planning process.
•
Objectives in pricing:
–
–
–
–
–
–
Achieve a target return on investment
Create stabilization of price and margin
Reach a market share target
Meet or prevent competition
Profit maximization
Survival
Objective 3
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Pricing to Meet Objectives
•
Pricing to achieve a target ROI- assuming a
standard volume, firms add a particular
margin to standard cost, which is expected
to produce a target profit rate on
investment.
Objective 3
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Pricing to Meet Objectives
•
Pricing to create stabilization of price and
margin- this approach reflects the goal of
avoiding the fluctuations in prices that are
characteristic of a commodity market.
•
The theory of dual entitlement argues that
concerns about fairness may constrain
price increases.
Objective 3
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Pricing to Meet Objectives
•
Pricing to reach a market share targetParticularly when there is no patent
protection on a product, firms may pursue
a market share target.
•
Pricing to meet or prevent competitionMeeting price cuts will eliminate a
competitive disadvantage, while meeting
price increases can fatten margins.
Objective 3
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Pricing to Meet Objectives
•
Pricing for profit maximization- The pursuit
of this objective requires substantial cost
and demand information. It has rarely
been articulated as a goal by executives
being interviewed about their pricing.
Objective 3
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Pricing to Meet Objectives
•
Pricing for survival- A company
experiencing trouble may seek to
produce an acceptable cash flow, to
cover margin costs, and simply
survive. This may result when
competition is especially intense,
when consumer needs are changing,
and/or when there exists substantial
excess capacity.
Objective 3
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New Product Pricing
•
Two classic pricing strategies are
commonly discussed for new
products:
– Skimming
– Penetration
Objective 3
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Price Skimming
•
Market (price) skimming is a strategy
of pricing the new product as a
relatively high level and then
gradually reducing it over time.
Objective 3
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Price Penetration
•
A penetration strategy requires that a
firm enter the market at a relatively
low price in an attempt to obtain
market share and expand demand for
its product.
Objective 3
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Price-quality Inferences
•
Customers may infer low quality from
low price under the following
circumstances:
1. When customers are uncertain about
brand quality prior to purchase.
2. When the risk to customers of a bad
decision is high.
Objective 3
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Price-quality Inferences
•
Although there continues to be a
debate about how frequently
customers use price as a signal of
quality, it is fairly safe to assume that
customer uncertainty about quality
for a new brand is often very high, so
that price-quality inference is a
concern.
Objective 3
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Explaining Adjustments to Base Price Over
Time
•
Most of the pricing decisions that are made
for a product in its lifetime are price
change decisions.
•
Base price may change because of:
–
–
–
Variation in objectives over the product life
cycle
Competitive price moves
Price Flexing
Objective 4
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Variations in Objectives over the Product Life
Cycle
•
The firm’s objectives in pricing
and other elements of the
marketing mix will vary over the
product life cycle.
•
Predicting when and how much
to cut prices is an important task.
Objective 4
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Competitive Price Moves
•
Very often, one firm’s price change
prompts a reaction from the other.
•
When competitors enter and
improve products as an industry
moves into the growth phase of its
life cycle, the incumbent almost
always has to respond with price
and/or innovation.
Objective 4
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Price Flexing
•
Prices are not static—they may
change in response to changes in the
firm’s objectives over the product life
cycle and in response to competitive
price moves.
•
Even more variation in prices is
introduced by both established
promotion and discount practices,
and innovative pricing practices
related primarily to new information
technology.
Objective 4
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Price Flexing to Business Customers
•
Traditional approaches that result in
flexible prices include:
–
–
–
–
–
–
–
Price Shading
Cash or payment discounts
Volume discounting
Geographic pricing
Sales promotion allowances
Creative alternatives to discounting
Price customization
Objective 4
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Price Flexing to Business Customers
•
Price Shading- Occurs when, during
negotiation, a salesperson reduces
the base price of a product.
•
Cash Payment or Discounts- These
are discounts the buyer receives for
either paying in cash or paying
promptly.
–
“Two-ten, net thirty”
Objective 4
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Price Flexing to Business Customers
•
Volume Discounting- Customers who
buy in larger volumes are often given
more favorable terms.
•
Geographic Pricing- It is common for
business customers in different
regions to receive different prices
since transportation costs may be
accounted for in pricing.
–
–
Free on board (FOB) pricing
Uniform delivered pricing
Objective 4
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Price Flexing to Business Customers
•
Sales Promotion Allowances- These
are discounts that business
customers receive for putting the
manufacturer’s product on sale to
consumers for a particular period of
time.
Objective 4
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Price Flexing to Business Customers
•
Creative Alternatives to Discounting1. Some manufacturers provide generous
financing for buyers.
2. Some customers are requiring long-term
contracts with suppliers that guarantee
no price increases for the life of the deal.
3. Suppliers may provide services at no
cost.
4. An increasing number of customers are
demanding promises of quality
improvement over the course of a
contract at the same or lower price.
Objective 4
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Price Flexing to Business Customers
•
Price Customization- New
technology may make it possible for
prices to be literally customized on a
transaction-by-transaction basis,
depending upon the conditions of
supply and demand at the moment.
Objective 4
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Price Flexing to Consumers
•
There is more price-flexing
taking place in consumer
markets than meets the eye:
–
–
–
–
Price promotion
Couponing
Pricing for different segments
Customization
Objective 4
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Price Flexing to Consumers
•
Price promotion is a ubiquitous
and effective practice in many
situations, particularly early in a
product’s life, where the
objective would be to encourage
trial and to allow the seller to
maintain a higher list price.
– Prisoner’s dilemma
Objective 4
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Price Flexing to Consumers
•
Couponing provides another
means of price discrimination in
that it gives some consumers—
those who wish to take the time
and effort to clip coupons—the
capability of paying lower prices.
Objective 4
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Price Flexing to Consumers
•
Pricing for different segmentsMarketers very often have
different marketing programs for
different consumer segments.
–
–
–
–
Geographic segments
Usage segments
Demographic segments
Time segments
Objective 4
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Price Flexing to Consumers
•
Customization- new technology
may have a significant effect on
the prices consumers pay for
products and may lead to
significant variation in the prices
that consumers pay for the same
item.
Objective 4
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Legal and Ethical Issues in Pricing
•
Prudent marketers must be attentive
to legal and ethical concerns in
pricing.
–
–
–
–
–
Price Fixing
Price Discrimination
Resale Price Maintenance
Predatory Pricing
Exaggerated Comparative Price
Advertising
Objective 5
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Ethical Concerns
•
There are many questions raised by
customers and public policy groups
about pricing practices, primarily
concerning what often appears to be
exorbitant prices charged by firms.
Objective 5
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Ethical Concerns
•
•
Regarding ethical standards, the law
defines minimally acceptable behavior.
Business common sense defines another
standard:
–
•
One does not want to alienate customers and
lose them.
There are also personal standards of
ethics, which each of us needs to think
about and develop.
Objective 5
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