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Chapter 17 Pricing Concepts Lamb, Hair, McDaniel 2010-2011 Learning Outcomes CHAPTER 19 Pricing Concepts Learning Outcomes LO 1 Discuss the importance of pricing decisions to the economy and to the individual firm LO 4 Understand the concept of yield management systems LO 2 List and explain a variety of pricing objectives LO 5 Describe cost-oriented pricing strategies LO 3 Explain the role of demand in price determination 1 2 LO 6 Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet and extranets, and perceptions of quality can affect price 3 1 Chapter 17 Pricing Concepts The Importance of Price The Importance of Price To the seller... Price is revenue Discuss the importance of pricing decisions to the economy and to the individual firm LO1 What Is Price? To the consumer... Price is the cost of something Price Price is that which is given up in an exchange to acquire a good or service. Price allocates resources in a free-market economy 4 LO1 5 LO1 6 2 Chapter 17 Pricing Concepts What is Price? Fashion’s Elite Wage War on Discounts • Sacrifice Effect of Price • Anna Wintour and Diane von Furstenburg – What is sacrificed to get a good or service – Fashion’s Night Out: Joint effort between 700 stores in 11 countries • Money, Time, Dignity • Information Effect of Price Revenue • Feature extended store hours and special events – Infer quality information based on price – Giveaways and appearances by celebrities and designers. – Aims to attract customers – Reverse the trend of discounting – Hope to increase consumer demand by cutting back their orders by about 20%. – But if shoppers still won’t buy, there will be a need to offer sales in order to move inventory • Higher quality = higher price • Convey status • Value Based upon Perceived Satisfaction – Reasonable Price = Perceived Reasonable Value • Exchange based on expectation of satisfaction LO1 The Importance of Price to Marketing Managers 7 LO1 Source: Binkley, Christina. “Fashion’s Elite Wage a War on Discounts,” The Wall Street Journal, August 13, 2009, D1, D6. Profit 8 LO1 The price charged to customers multiplied by the number of units sold. Revenue minus expenses. 9 3 Chapter 17 Pricing Concepts The Importance of Pricing Decisions Trends Influencing Price Pricing Objectives Flood of new products Price X Sales Unit = Revenue Increased availability of bargain-priced private and generic brands List and explain a variety of pricing objectives Revenue – Costs = Profit Price cutting as a strategy to maintain or regain market share Profit drives growth, salary increases, and corporate investment Internet used for comparison shopping LO1 LO1 10 11 LO2 12 4 Chapter 17 Pricing Concepts Pricing Objectives Profit Maximization Profit-Oriented Pricing Objectives Profit-Oriented Profit Maximization Profit-Oriented Pricing Objectives Sales-Oriented Profit Maximization Status Quo LO2 Satisfactory Profits LO2 13 Setting prices so that total revenue is as large as possible relative to total costs. Target Return on Investment 14 LO2 15 5 Chapter 17 Pricing Concepts Sales-Oriented Pricing Objectives Return on Investment Return on Investment Market Share Market Share Sales-Oriented Pricing Objectives Net profit after taxes divided by total assets. ROI = LO2 Market Share Net Profit after taxes Total assets 16 LO2 Sales Maximization 17 LO2 A company’s product sales as a percentage of total sales for that industry. 18 6 Chapter 17 Pricing Concepts Sales Maximization Pricing during a Recession Status Quo Pricing Objectives Short-term objective to maximize sales Increase advertising when your competitors are cutting back to improve your market share and ROI at a lower cost. Status Quo Pricing Objectives Motivate distributors to stock your full product line: offer early-buy allowances, extended financing, and generous return policies. Ignores profits, competition, and the marketing environment Maintain existing prices May be used to sell off excess inventory LO2 Offer temporary price promotions, reduce quantity-discount thresholds, extend credit to long-standing customers, price smaller-pack sizes aggressively. Meet competition’s prices Know your cost structure to ensure that any cuts or consolidations will save money with minimum customer impact. LO2 19 20 LO2 Source: Professor John Quelch, “Marketing Your Way Through a Recession,” Harvard Business School, Working Knowledge, March 3, 2008. 21 7 Chapter 17 Pricing Concepts The Demand Determinant of Price The Demand Determinant of Price Demand Explain the role of demand in price determination LO3 Supply 22 LO3 The Demand Curve The quantity of a product that will be sold in the market at various prices for a specified period. The quantity of a product that will be offered to the market by a supplier at various prices for a specific period. LO3 23 24 8 Chapter 17 Pricing Concepts How Demand and Supply Establish Price The Supply Curve LO3 25 LO3 Price Equilibrium The price at which demand and supply are equal. Elasticity of Demand Consumers’ responsiveness or sensitivity to changes in price. Price Equilibrium 26 LO3 27 9 Chapter 17 Pricing Concepts Elasticity of Demand Elastic Demand Consumers buy more or less of a product when the price changes. Elasticity (E) Inelastic Demand Unitary Elasticity LO3 Elasticity of Demand Elasticity of Demand An increase or decrease in price will not significantly affect demand. = Price Goes... Revenue Goes... Demand is... Down Up Elastic Down Down Inelastic Up Up Inelastic Up Down Elastic 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. An increase in sales exactly offsets a decrease in prices, and revenue is unchanged. Up or Down 28 LO3 29 LO3 Stays the Same Unitary Elasticity 30 10 Chapter 17 Pricing Concepts Factors that Affect Elasticity of Demand Elasticity of Demand The Power of Yield Management Systems Availability of substitutes Price relative to purchasing power Understand the concept of yield management systems Product durability A product’s other uses Rate of inflation LO3 31 LO3 32 LO4 33 11 Chapter 17 Pricing Concepts Yield Management Systems Yield Management Systems Yield Management Systems Yield Management Systems Yield Management Systems (YMS) make it possible for a company to: Discounting early purchases A technique for adjusting prices that uses complex mathematical software to profitably fill unused capacity. 1. stimulate demand when demand is low, and 2. maximize profits when demand is high. Limiting early sales at discounted prices Overbooking capacity . LO4 34 LO4 35 LO4 36 12 Chapter 17 Pricing Concepts Demand Side of Product or Service High Office block House Airline seat Utilities Sport event Rental car Low Shirt Pencils Food Tropical fish Low High Variability of Demand Yield Management Systems Supply Side of Product or Service Capital Intensity Yield Management Systems Utilities Highway use Telephone Airline seat Sport event Rental car Mobile phone Low Food Music CD Shirt Office block Laptop House Low High Variability of Value Perishability SOURCE: “Dynamic Pricing Schemes—Established Supplier Led Pricing—Yield Management,” online at http://www.managingchange.com/hynamic/yieldmgt.htm, accessed November 7, 2007. LO4 High Yield Management Systems 37 SOURCE: “Dynamic Pricing Schemes—Established Supplier Led Pricing—Yield Management,” online at http://www.managingchange.com/hynamic/yieldmgt.htm, accessed November 7, 2007. LO4 38 LO4 39 13 Chapter 17 Pricing Concepts The Cost Determinant of Price The Cost Determinant of Price The Cost Determinant of Price Types of Costs Variable Cost Fixed Cost Varies with changes in level of output Does not change as level of output changes Describe cost-oriented pricing strategies LO5 40 Markup pricing LO5 Methods Used to Set Prices Keystoning Profit Maximization Pricing Break-Even Pricing 41 LO5 42 14 Chapter 17 Pricing Concepts Markup Pricing Markup Pricing Keystoning LO5 Profit Maximization The cost of buying the product from the producer plus amounts for profit and for expenses not otherwise accounted for. Profit Maximization Marginal Revenue The practice of marking up prices by 100%, or doubling the cost. 43 LO5 Break-Even Pricing A method of setting prices that occurs when marginal revenue equals marginal cost. The extra revenue associated with selling an extra unit of output, or the change in total revenue with a one-unit change in output. LO5 44 45 15 Chapter 17 Pricing Concepts Break-Even Pricing REVIEW LEARNING OUTCOME Other Determinants of Price Cost-Oriented Pricing Strategies Break-Even Quantity Fixed cost Contribution LO5 = = Total fixed costs Fixed cost contribution Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet and extranets, and perceptions of quality can affect price Price - Avg. Variable Cost LO5 46 47 LO6 48 16 Chapter 17 Pricing Concepts Stages in the Product Life Cycle Other Determinants of Price Stages of the Product Life Cycle Introductory Stage Competition Distribution Strategy Growth Stage The Competition Maturity Stage Decline Stage Decrease $ $ $ High Stable Decrease High prices may induce firms to enter the market $ Competition can lead to price wars Stable Promotion Strategy Global competition may force firms to lower prices High Perceived Quality LO6 LO6 49 50 LO6 51 17 Chapter 17 Pricing Concepts Distribution Strategy Manufacturers Distribution Strategy The Impact of the Internet Wholesalers/Retailers Product selection Offer a larger profit margin or trade allowance Sell against the brand Selling against the brand Use exclusive distribution Franchising Second opinions from expert sites Stocking well-known branded items at high prices in order to sell store brands at discounted prices. Buy gray-market goods Shopping bots Avoid business with pricecutting discounters Internet auctions Develop brand loyalty LO6 52 LO6 53 LO6 54 18 Chapter 17 Pricing Concepts The Relationship of Price to Quality Impact of the Internet on Book Distribution Online 13% Online 2% Non-bookstore Retail 1. Ease of use Schools and Libraries 24% Schools and Libraries 27% Book Clubs 16% Prestige Pricing Book Clubs 5% 2. Versatility Non-bookstore Retail 18% 3. Durability Charging a high price to help promote a highquality image. 13% Traditional Retail 42% Dimensions of Quality Traditional Retail 38% 4. Serviceability [+ 2% direct-to-consumer sales] 1998 $22.5 Billion LO6 5. Performance 2006 $28.5 Billion Net Publisher Revenue 6. Prestige SOURCE: Jeffrey A. Trachtenberg, “Borders Business Plan Gets a Rewrite,” Wall Street Journal, March 22, 2007 B1 55 LO6 56 LO6 57 19 Chapter 17 Pricing Concepts Lamb, Hair, McDaniel REVIEW LEARNING OUTCOME Factors Affecting Price 2010-2011 Learning Outcomes CHAPTER 20 PLC Price/quality relationship Demands of large customers Large customers pressure suppliers for price reductions and guaranteed margins Promotion strategy LO6 Uncertain consumers tend to rely on price to indicate quality (“You get what you pay for.”) Introduction Growth Maturity Decline LO 1 Describe the procedure for setting the right price Setting the Right Price – Other firms enter market – Price wars Competition LO 2 Identify the legal and ethical constraints on pricing decisions Price – Convenience – Selling against the brand – Exclusive Distribution distribution Price used as a promotional – Consumers use shopping tool for bargains – Increased competition – Internet auctions LO 3 Explain how discounts, geographic pricing, and other special pricing tactics can be used to fine-tune the base price Intranet and extranets 58 59 60 20 Chapter 17 Pricing Concepts How to Set a Price on a Product or Service How to Set a Price on a Product or Service Learning Outcomes Establish pricing goals LO 4 Discuss product line pricing Estimate demand, costs, and profits Describe the procedure for setting the right price LO 5 Describe the role of pricing during periods of inflation and recession Choose a price strategy Fine tune with pricing tactics Results lead to the right price 61 LO1 62 LO1 63 21 Chapter 17 Pricing Concepts Establish Pricing Goals Profit-Oriented Price Strategy Sales-Oriented Status Quo LO1 Choose a Price Strategy Choose a Price Strategy 64 LO1 A basic, long-term pricing framework, which establishes the initial price for a product and the intended direction for price movements over the product life cycle. 65 Price Skimming A firm charges a high introductory price, often coupled with heavy promotion. Penetration Pricing A firm charges a relatively low price for a product initially as a way to reach the mass market. Status Quo Pricing Charging a price identical to or very close to the competition’s price. LO1 66 22 Chapter 17 Pricing Concepts Price Skimming Inelastic Demand Situations When Price Skimming Is Successful Status Quo Pricing Advantages Advantages Discourages or blocks competition from market entry Boosts sales and provides large profit increases Unique Advantages/Superior Legal Protection of Product Technological Breakthrough Penetration Pricing Disadvantages Requires gear up for mass production Selling large volumes at low prices Strategy to gain market share may fail Simplicity Safest route to long-term survival for small firms Disadvantages Strategy may ignore demand and/or cost Can justify production expansion Blocked Entry to Competitors LO1 67 LO1 68 LO1 69 23 Chapter 17 Pricing Concepts Establish price goals The Legality and Ethics of Price Strategy The Legality and Ethics of Price Strategy Setting the Right Price Unfair Trade Practices High $ Estimate demand, costs, and profits Skimming Choose a price strategy Price Fixing Identify the legal and ethical constraints on pricing decisions Status quo Penetration Price Discrimination Low $ Evaluate results LO1 Fine-tune base price Predatory Pricing Set price $x.yy 70 LO2 71 LO2 72 24 Chapter 17 Pricing Concepts The Legality and Ethics of Price Strategy Price Discrimination Price Discrimination The Robinson-Patman Act of 1936: LO2 Unfair Trade Practices Laws that prohibit wholesalers and retailers from selling below cost. Price Fixing An agreement between two or more firms on the price they will charge for a product. The Robinson-Patman Act of 1936: There must be price discrimination. Transaction must occur in interstate commerce. Seller must discriminate by price among two or more purchasers. Products sold must be commodities or tangible goods. Products sold must be of like grade and quality. There must be significant competitive injury. 73 LO2 Seller Defenses Cost 74 LO2 Market Conditions Competition 75 25 Chapter 17 Pricing Concepts Tactics for Fine-Tuning the Base Price Tactics for FineFine-Tuning the Base Price Predatory Pricing Predatory Pricing Discounts Explain how discounts, geographic pricing, and other special pricing tactics can be used to fine-tune the base price The practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market. LO2 76 LO3 Geographic pricing Special pricing tactics 77 LO3 78 26 Chapter 17 Pricing Concepts Discounts, Allowances, Rebates, and Value-Based Pricing Quantity Discounts Promotional Allowances Cash Discounts Rebates Functional Discounts Zero Percent Financing Seasonal Discounts Value-Based Pricing LO3 Value-Based Pricing Value-based Pricing: Step 1 Companies that set prices using a cost-plus model—adding a predetermined percentage to a product’s cost/unit to produce a profit—may be leaving money on the table. Value-Based Setting the price at a level that seems to the Pricing customer to be a good price compared to the prices of other options. 79 LO3 Instead, a company should use the cost-plus model to determine its pricing threshold and then use valuebased pricing to set the best price. 80 LO3 Source: Elisabeth A. Sullivan, “Value Pricing: Smart Marketers Know Cost-Plus Can Be Costly,” MarketingNews, January 15, 2008. 81 27 Chapter 17 Pricing Concepts Value-based Pricing: Step 2 Now, ask customers what would be an acceptable price, what would be an expensive price, and what would be a prohibitively expensive price. How to determine value? It’s simple. Really. Ask your customers: What do they like about you? What don’t they like? Their responses represent the perceived value of your product in the marketplace. 1. Managers attempt to buy market share through aggressive pricing. The best price usually falls between “expensive” and “prohibitively expensive.” The attributes that will determine the perceived value of your product include product quality, on-time delivery, customer service, technical service, and price. LO3 Pricing Products Too Low Value-based Pricing: Step 3 2. Managers tend to make pricing decisions based on current costs, current competitor prices, and shortterm share gains rather than on long-term profitability. Customers want value and they’re willing to pay for it. 82 LO3 83 LO3 84 28 Chapter 17 Pricing Concepts Other Pricing Tactics Geographic Pricing FOB Origin Pricing The buyer absorbs the freight costs from the shipping point (“free on board”). Uniform Delivered Pricing The seller pays the freight charges and bills the purchaser an identical, flat freight charge. Zone Pricing The U.S. is divided into zones, and a flat freight rate is charged to customers in a given zone. Freight Absorption Pricing The seller pays for all or part of the freight charges and does not pass them on to the buyer. Basing-Point Pricing The seller designates a location as a basing point and charges all buyers the freight costs from that point. LO3 Single-Price Tactic All goods offered at the same price Flexible Pricing Different customers pay different price Professional Services Pricing Used by professionals with experience, training or certification Price Lining Several line items at specific price points Leader Pricing Sell product at near or below cost Bait Pricing Odd-Even Pricing Price Bundling Two-Part Pricing 85 LO3 Consumer Penalties Businesses Impose Consumer Penalties If... An irrevocable loss of revenue is suffered Lure customers through false or misleading price advertising Odd-number prices imply bargain Even-number prices imply quality Combining two or more products in a single package Two separate charges to consume a single good Additional transaction costs are incurred LO3 86 87 29 Chapter 17 Pricing Concepts Fine-Tuning the Base Price Product Line Pricing Product Line Pricing Pricing Tactics Discounts Quantity • cumulative • noncumulative Cash Geographic FOB origin Seasonal Consumer Penalties Single price Flexible Uniform delivered Functional (trade) Promotional (trade) Other Tactics Zone Discuss product line pricing Price lining Leader Freight absorption Product Line Pricing Professional services Setting prices for an entire line of products. Bait Rebate 0% Financing Value-based LO3 Basingpoint Odd–even Bundling Unbundling Two-part 88 LO4 89 LO4 90 30 Chapter 17 Pricing Concepts Relationships among Products Pricing during Difficult Economic Times Joint Costs Complementary Joint Costs Substitutes Costs that are shared in the manufacturing and marketing of several products in a product line. Describe the role of pricing during periods of inflation and recession Neutral LO4 91 LO4 92 LO5 93 31 Chapter 17 Pricing Concepts Inflation Cost-Oriented Tactics Cost-Oriented Tactics Problems with CostCost-Oriented Tactics Cost-Oriented Tactics High Inflation Demand-Oriented Tactics LO5 94 Delayed-quotation pricing • A high volume of sales on an item with a low profit margin may still make the item highly profitable. • Eliminating a product may reduce economies of scale. Escalator pricing • Eliminating a product may affect the price-quality image of the entire line. Hold prices constant, but add new fees LO5 95 LO5 96 32 Chapter 17 Pricing Concepts Cost-Oriented Tactics Demand-Oriented Tactics Demand-Oriented Tactics Cultivate selected demand Price Shading Maintaining a Fixed Gross Margin LO5 Increased Production Costs Strategies to Make Demand More Inelastic The use of discounts by salespeople to increase demand for one or more products in a line. Create unique offerings Change the package design Heighten buyer dependence 97 LO5 98 LO5 99 33 Chapter 17 Pricing Concepts Pricing During Inflation and Recession Supplier Strategies during Recession Recession Inflation Recession Contract product lines Renegotiating contracts Cost-oriented tactics Delayedquotation pricing Value-based Price Bundling Unbundling Value-Based Pricing Escalator pricing Offering help Select demand Demand-oriented tactics Keeping the pressure on Bundling or Unbundling New products Product New product categories Unique offering Renegotiate contracts Change package design Offer help Suppliers Increase buyer dependence Paring down suppliers LO5 100 LO5 LO5 101 Keep pressure on suppliers Reduce number of suppliers 102 34