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Part 3: Develop the Value Proposition for the Customer Chapter 10 Price: What is the Value Proposition Worth? I. Chapter Overview The chapter begins by asking the question, “What is price?” At first glance, students may think the question has an obvious answer—the number printed on the price sticker. However, as students explore this chapter, they will discover that price is a whole lot more. Price is a function of demand, costs, revenue, and the environment. Pricing can be monetary or nonmonetary. Pricing decisions lead to specific pricing strategies and tactics, discussed in the chapter. Students also learn about the psychological aspect of pricing, as well as legal, and ethical aspects of pricing. II. CHAPTER OBJECTIVES 1. Explain the importance of pricing and how marketers set objectives for their pricing strategies. 2. Describe how marketers use costs, demands, revenue and the pricing environment to make pricing decisions. 3. Understand key pricing strategies and tactics. 4. Understand the opportunities for Internet pricing strategies. 5. Describe the psychological, legal, and ethical aspects of pricing. III. CHAPTER OUTLINE ►MARKETING MOMENT INTRODUCTION Your job is to buy the “best” Oriental rug. One rug is priced at $800 while another is priced at $1000. Which one is the best? How did you make that decision? This is an excellent time to introduce the concept of price as an extrinsic cue and the price/quality relationship. p. 279 REAL PEOPLE, REAL CHOICES— HERE’S MY PROBLEM AT CONVERSE COLLEGE In 2013, the administration of Converse College, a private master’s university located in South Carolina, realized that escalating tuition costs were creating serious problems for current and potential students. Betsy and her staff decided to take a serious look at the College’s pricing model. Their objective was threefold: (1) address the affordability concerns of private higher education within the marketplace, (2) recapture a greater portion of the middle class market that was feeling priced out of the private college experience, and (3) develop a more sustainable Copyright © 2016 Pearson Education, Inc. Chapter 10: Price: What is the Value Proposition Worth? and transparent operating model for the college. Betsy launched a strategic enrollment planning process that involved extensive research to guide data-driven decisions. The working group identified possible solutions to the high-tuition dilemma 1. Reset tuition to a significantly lower price for traditional undergraduate students. 2. Freeze tuition for each incoming student from the time she matriculated until she graduated. 3. Provide students with a Loan Repayment Program (LRP), p. 280 p. 281 p. 281282 p. 281282 p. 282 p. 283 The vignette ends by asking the student which option he/she would choose. Betsy chose Option #1 1. “YES, BUT WHAT DOES IT COST?” The question of what to charge for a product is a central part of marketing decision making. 1.1 What is Price? Price is the assignment of value, or the amount the consumer must exchange to receive the offering or product. Payment may be in the form of money, goods, services, favors, votes, or anything else that has value to the other party. Other non-monetary costs often are important to marketers. It is also important to consider an opportunity cost, or the value of something that is given up to obtain something else. 1.2 Step 1: Develop Pricing Objectives The first crucial step in price planning is to develop pricing objectives. These must support the broader objectives of the firm, such as maximizing shareholder value, as well as its overall marketing objectives, such as increasing market share. 1.2.1 Profit Objectives Often a firm’s overall objectives relate to a certain level of profit it hopes to realize. This is usually the case in B2B marketing. When pricing strategies are determined by profit objectives, the focus is on a target level of profit growth or a desired net profit margin. A profit objective is important to firms that believe profit is what motivates shareholders and bankers to invest in a company. 1.2.2 Sales or Market Share Objectives However, lowering prices is not always necessary to increase market share. If a company’s product has a competitive advantage, keeping the price at the same level as other firms may satisfy sales objectives. ►METRICS MOMENT Copyright © 2016 Pearson Education, Inc. The Cutting Edge Digital Currencies: Bitcoin Figure 10.1 Elements of Price Planning Figure 10.2 Pricing Objectives Exhibit 10. 1 Airplane passengers Part 3: Develop the Value Proposition for the Customer Market share is the percentage of a market (defined in terms of Exhibit 10. 2 either sales units or revenue) accounted for by a specific firm, Autoslash product lines, or brands. Market share is quoted within the context of a particular set of competitors. Applying the Metrics ● Pick any industry and identify the main competitors—this can be any type of product or service line of your choice as long as there are several easily identified competing brands (Hint: Publicly traded firms are easier to research then privately held firms.) ● Do a little research to find out how their market shares stack up. Then, for the same firms, take a look at their most recent reported profits. Based on your findings, does a higher market share translate into a better profit picture? p. 283 p. 284 p. 284 1.2.3 Competitive Effect Objectives Sometimes strategists design the pricing plan to dilute the competition’s marketing efforts. In these cases, a firm may deliberately try to preempt or reduce the impact of a rival’s pricing changes. 1.2.4 Customer Satisfaction Objectives Many quality-focused firms believe that profits result from making customer satisfaction the primary objective. These firms believe that by focusing solely on short-term profits, a company loses sight of keeping customers for the long term. 1.2.5 Image Enhancement Objectives Consumers often use price to make inferences about the quality of a product. In fact, marketers know that price is often an important means of communicating not only quality but also image to prospective customers. The image enhancement function of pricing is particularly important with prestige products (or luxury products), which have a high price and appeal to statusconscious consumers. 2. COSTS, DEMAND, REVENUE, AND THE MARKETING ENVIRONMENT p. 284 2.1 Step 2: Estimate Demand The second step in price planning is to estimate demand. Demand refers to customers’ desires for a product: How much of a product are they willing to buy as the price of the product goes up or down? p. 284- 2.1.1 Demand Curves Copyright © 2016 Pearson Education, Inc. Figure 10.3 Factors in Price Setting Figure 10.4 Chapter 10: Price: What is the Value Proposition Worth? 285 Economists use a graph of a demand curve to illustrate the effect of price on the quantity demanded of a product. The demand curve, which can be a curved or straight line, shows the quantity of a product that customers will buy in a market during a period at various prices if all other factors remain the same. Demand Curves for Normal and Prestige Products The demand curve for most goods (Left side of Figure 10.2) slopes downward and to the right. As the price of the product goes up (P1 to P2), the number of units that customers are willing to buy goes down (Q1 to Q2). If prices decrease, customers will buy more. This is the law of demand. For example, if the price of bananas goes up, customers will probably buy fewer of them. p. 285286 There are, however, exceptions to this typical price–quantity relationship. In fact, there are situations in which (otherwise sane) people desire a product more as it increases in price. For prestige products such as luxury cars or jewelry, a price hike may actually result in an increase in the quantity consumers demand because they see the product as more valuable. In such cases, the demand curve slopes upward. The higher-price/higher-demand relationship has its limits. If the firm increases the price too much, (say from P2 to P1) making the product unaffordable for all but a few buyers, demand will begin to decrease. 2.1.2 Shifts in Demand The demand curves we have shown assume that all factors other than price stay the same. However, what if they do not? What if the company improves the product? What happens when there is a glitzy new advertising campaign that turns a product into a “musthave” for many people? What if stealthy paparazzi catch Brad Pitt using the product at home? Any of these things could cause an upward shift of the demand curve. An upward shift in the demand curve means that at any given price, demand is greater than before the shift occurs. Demand curves may also shift downward. p. 286 3.1.3 Estimate Demand Marketers predict total demand first by identifying the number of buyers or potential buyers for their product and then multiplying that estimate times the average amount each member of the target market is likely to purchase. Once the marketer estimates total demand, the next step is to predict what the company’s market share is likely to be. The company’s estimated demand is then its share of the whole market. Such projections need to take into consideration other Copyright © 2016 Pearson Education, Inc. Figure 10.5 Shift in Demand Curve Table 10.1 Estimating Demand for Pizza Part 3: Develop the Value Proposition for the Customer p. 286 factors that might affect demand, such as new competitors entering the market, the state of the economy, and changing customer tastes. 2.1.4 Price Elasticity of Demand Marketers also need to know how their customers are likely to react to a price change. In particular, it is critical to understand whether a change in price will have a large or a small impact on demand. Exhibit 10. 3 Couple w/iPad p. 287 Price elasticity of demand is a measure of the sensitivity of customers to changes in price. The word elasticity indicates that changes in price usually cause demand to stretch or retract like a rubber band. Some customers are very sensitive to changes in price, and a change in price results in a substantial change in the quantity demanded. In such instances, we have a case of elastic demand. In other situations, we describe a change in price that has little or no effect on the quantity that consumers are willing to buy as inelastic demand. Figure 10.6 Price Elasticity of Demand p. 288 2.1.5 Demand curves When demand is elastic, changes in price and in total revenues work in opposite directions. If the price is increased, revenues decrease. If the price is decreased, total revenues increase. Figure 10.7 Price Elastic and Inelastic Demand Curves In some instances, demand is inelastic so that a change in price results in little or no change in demand. When demand is inelastic, price and revenue changes are in the same direction; that is, increases in price result in increases in total revenue, while decreases in price result in decreases in total revenue. Elasticity of demand for a product often differs for different price levels and with different percentages of change. As a rule, businesses can determine the actual price elasticity only after they have tested a pricing decision and calculated the resulting demand. To estimate what demand is likely to be at different prices for new or existing products, marketers often do research. p. 289 Other factors can affect price elasticity and sales. Consider the availability of substitute goods or services. If a product has a close substitute, its demand will be elastic; that is, a change in price will result in a change in demand, as consumers move to buy the substitute product. Marketers of products with close substitutes are less likely to compete on price because they Copyright © 2016 Pearson Education, Inc. Chapter 10: Price: What is the Value Proposition Worth? recognize that doing so could result in less profit as consumers switch from one brand to another. p. 289 p. 289 p. 289 Changes in prices of other products also affect the demand for an item, a phenomenon we label cross-elasticity of demand. When products are substitutes for each other, an increase in the price of one will increase the demand for the other. For example, if the price of bananas goes up, consumers may instead buy more strawberries, blueberries, or apples. However, when products are complements—that is, when one product is essential to the use of a second—an increase in the price of one decreases the demand for the second. 2.2 Step 3: Determine Costs Estimating demand helps marketers determine possible prices to charge for a product. It tells them how much of the product they think they will be able to sell at different prices. Knowing this brings them to the third step in determining a product’s price: making sure the price will cover costs. Before marketers can determine price, they must understand the relationship of cost, demand, and revenue for their product. 2.2.1 Variable and Fixed Costs First, a firm incurs variable costs—the per-unit costs of production that will fluctuate depending on how many units or individual products a firm produces. Variable costs can go down with higher levels of production but do not always do so. p. 290 Fixed costs are costs that do not vary with the number of units produced—the costs that remain the same whether the firm produces 1,000 bookcases this month or only 10. Fixed costs include rent or the cost of owning and maintaining the factory, utilities to heat or cool the factory, and the costs of equipment such as hammers, saws, and paint sprayers used in the production of the product. p. 290 Average fixed cost is the fixed cost per unit produced, that is, the total fixed costs divided by the number of units produced. Although total fixed costs remain the same no matter how many units are produced, the average fixed cost will decrease as the number of units produced increases. As we produce more and more units, average fixed costs go down, and so does the price we must charge to cover fixed costs. In the long term, total fixed costs may change. p. 290 Combining variable costs and fixed costs yields total costs for a given level of production. As a company produces more and more Copyright © 2016 Pearson Education, Inc. Figure 10.8 Variable Costs at Different Levels of Production Part 3: Develop the Value Proposition for the Customer p. 291 p. 291 of a product, both average fixed costs and average variable costs may decrease. Average total costs may decrease, too, up to a point. As output continues to increase, average variable costs may start to increase. These variable costs ultimately rise faster than average fixed costs decline, resulting in an increase to average total cost. As total cost fluctuates with differing levels of production, the price that producers have to charge to cover those costs changes accordingly. Therefore, marketers need to calculate the minimum price necessary to cover all costs—the break-even price. 2.2.2 Break-Even Analysis Break-even analysis is a technique marketers use to examine the relationship between cost and price and to determine what sales volume must be reached at a given price before the company will completely cover its total cost and past which it will begin making a profit. Simply put, the break-even point is the point at with the company does not lose any money and does not make any profit. A break-even analysis allows marketers to identify how many units of a product they will have to sell at a given price to be profitable. p. 291 To determine the break-even point, the firm first needs to calculate the contribution per unit, or the difference between the prices the firm charges for a product (the revenue per unit) and the variable costs. This figure is the amount the firm has after paying for the goods that contribute to meeting the fixed costs of production. p. 292 Often a firm will set a profit goal, which is the dollar profit figure it desires to earn. The break-even point may be calculated with that dollar goal included in the figures. Sometimes the target return or profit goal is expressed as a percentage of sales. For example, a firm may say that it wants to make a profit of at least 10 percent on sales. In such cases, this profit is added to the variable cost in calculating the break-even point. Break-even analysis does not provide an easy answer for pricing decisions. It provides answers about how many units the firm must sell to break even and to make a profit, but without knowing whether demand will equal the quantity at that price, companies can make big mistakes. It is, therefore, useful for marketers to estimate the demand for their product and then perform a marginal analysis. Copyright © 2016 Pearson Education, Inc. Figure 10.9 Break-Even Analysis Assuming a Price of $100 Chapter 10: Price: What is the Value Proposition Worth? p. 292 2.2.3 Markups and Margins: Pricing Through the Channel So far, we have talked about costs simply from the manufacturer’s perspective. However, in reality, most products are not sold directly to the consumers or business buyers of the product. Instead, a manufacturer sells to a wholesaler, distributor, or jobber who in turn sells to a retailer who finally sells the product to the ultimate consumer. Setting prices means considering all of these steps. Each member of the channel of distribution buys a product for a certain amount and adds a markup amount to create the price at which they will sell a product. This markup amount is the gross margin, also referred to as the retailer margin or the wholesaler margin. The margin must be great enough to cover the fixed costs of the retailer or wholesaler and leave an amount for a profit. When a manufacturer sets a price, he or she must consider these margins. Many times, a manufacturer builds its pricing structure around list prices. A list price, which we also refer to as a manufacturer’s suggested retail price (MSRP), is the price that the manufacturer sets as the appropriate price for the end consumer to pay. p. 293 p. 293294 2.3 Step 4: Evaluate The Pricing Environment Marketers look at factors in the firm’s external environment when they make pricing decisions. The fourth step in developing pricing strategies is to examine and evaluate the pricing environment. Only then can marketers set a price that not only covers costs but also provides a competitive advantage—a price that meets the needs of customers better than the competition. 2.3.1 The Economy Broad economic trends tend to direct pricing strategies. The business cycle, inflation, economic growth, and consumer confidence all help to determine whether one pricing strategy or another will succeed. Exhibit 10. 4 Progressive Exhibit 10. 5 ForceFlex Garbage Bag ad During recessions, consumers grow more price sensitive. Many firms find it necessary to cut prices to levels at which costs are covered but the company does not make a profit to keep factories in operation. Inflation may give marketers cause to either increase or decrease prices. First, inflation gets customers used to price increases. They may remain insensitive to price increases, even when inflation goes away, allowing marketers to make real price increases. In periods of recession, inflation may cause marketers to lower prices and temporarily sacrifice profits in order to Copyright © 2016 Pearson Education, Inc. Exhibit 10. 7 P&G Pampers ad Part 3: Develop the Value Proposition for the Customer p. 294295 maintain sales levels. 2.3.2 The Competition Marketers try to anticipate how the competition will respond to their pricing actions. It is not always a good idea to fight the competition with lower prices. Pricing wars can change consumers’ perceptions of what is a “fair” price, leaving them unwilling to buy at previous price levels. Exhibit 10. 8 Starbuck Coffee Store Photo Generally, firms that do business in an oligopoly (in which the market has few sellers and many buyers) are more likely to adopt status quo pricing objectives in which the pricing of all competitors is similar. Avoiding price competition allows all players in the industry to remain profitable. p. 295 Firms in a purely competitive market have little opportunity to raise or lower prices. Price is directly influenced by supply and demand. 2.3.3 Government Regulation Governments in the U.S. and other countries develop two different types of regulations, which have an effect on pricing. First, a large number of regulations increase the costs of production. Regulations for health care, environmental protection, occupational safety, and highway safety, just to mention a few, cause the costs of producing many products to increase. Other regulations of specific industries such as those imposed by the Food and Drug Administration (FD) on the production of food and pharmaceuticals increase the costs of developing and producing those products. In addition, some regulations directly address prices. p. 296 2.3.4 Consumer Trends Consumer trends also can strongly influence prices. Culture and demographics determine how consumers think and behave and so these factors have a large impact on all marketing decisions. p. 296 2.3.5 The International Environment The marketing environment often varies widely from country to country. This can have important consequences in developing pricing strategies. 3. IDENTIFY STRATEGIES AND TACTICS TO PRICE THE PRODUCT In modern business, there seldom is any one-and-only, now-andforever, and best pricing strategy. Like playing a game of chess, making pricing moves and countermoves requires thinking two and three moves ahead. p. 297 Copyright © 2016 Pearson Education, Inc. Figure 10.10: Pricing Strategies and Tactics Chapter 10: Price: What is the Value Proposition Worth? p. 297 3.1 Step 5: Choose a Pricing Strategy The next step in price planning is to choose a pricing strategy. p. 297 3.1.1 Pricing Strategies Based on Cost Marketing planners often choose cost-based strategies because they are simple to calculate and relatively risk free. They promise that the price will at least cover the costs the company incurs in producing and marketing the product. Cost-based pricing methods have drawbacks, however. They do not consider such factors as the nature of the target market, demand, competition, the product life cycle, and the product’s image. The calculations for setting the price may be simple and straightforward but accurate cost estimating may prove difficult. p. 298 p. 298 The most common cost-based approach to pricing a product is cost-plus pricing in which the marketer totals all the costs for the product and then adds an amount (or marks up the cost of the item) to arrive at the selling price. Many marketers use cost-plus pricing because of its simplicity—users need only estimate the unit cost and add the markup. To calculate cost-plus pricing, marketers usually calculate either a markup on cost or a markup on selling price. 3.1.2 Pricing Strategies Based on Demand Demand-based pricing means that the firm bases the selling price on an estimate of volume or quantity that it can sell in different markets at different prices. Firms must determine how much product they can sell in each market and at what price. Today, firms find that they can be more successful if they match price with demand using a target costing process. They first determine the price at which customers would be willing to buy the product and then works backward to design the product in such a way that it can produce and sell the product at a profit. With target costing, firms first use marketing research to identify the quality and functionality needed to satisfy attractive market segments and what price they are willing to pay before the product is designed. The next step is to determine what margin retailers and dealers require as well as the profit margin the company requires. Based on this information, managers can calculate the target cost—the maximum it will cost the firm to manufacture the product. If the firm can meet customer quality and functionality requirements and control costs to meet the required price, it will manufacture the product. Copyright © 2016 Pearson Education, Inc. Figure 10.11 Target Costing Using a Jeans Example Part 3: Develop the Value Proposition for the Customer p. 299 p. 299 p. 299 p. 300 p. 300 p. 300 Yield management pricing, another type of demand-based pricing, is a pricing strategy used by airlines, hotels, and cruise lines. Firms charge different prices to different customers in order to manage capacity while maximizing revenue. This strategy works because different customers have different sensitivities to price. The goal of yield management pricing is to accurately predict the proportion of customers who fall into each category and allocate the percentage of the airline or hotel’s capacity accordingly so that no product goes unsold. 3.1.3 Pricing Strategies Based on the Competition Sometimes a firm’s pricing strategy involves pricing its wares near, at, above, or below the competition. A price leadership strategy, which usually is the rule in an industry dominated by few firms and called an oligopoly, may be in the best interest of all firms because it minimizes price competition. Price leadership strategies are popular because they provide an acceptable and legal way for firms to agree on prices without ever talking with each other. 3.1.4 Pricing Strategies Based on Customers’ Needs When firms develop pricing strategies that cater to customers, they are less concerned with short-term results than with keeping customers for the long term. Exhibit 10. 6 Priceline Firms that practice value pricing or everyday low pricing (EDLP), develop a pricing strategy that promises ultimate value to consumers. What this means is that, in the customer’s eyes, the price is justified by what they receive. When firms base price strategies solely or mainly on cost, they are operating under the old production orientation and not a customer orientation. Value-based pricing begins with customer, then considers the competition, and then determines the best pricing strategy. 3.1.5 New Product Pricing When a product is new to the market or when there is no established industry price norm, marketers may use a skimming price strategy, a penetration pricing strategy, or trial pricing when they first introduce the item to the market. Setting a skimming price means that the firm charges a high, premium price for its new product with the intention of reducing it in future response to market pressure. If a product is highly desirable and it offers unique benefits, Copyright © 2016 Pearson Education, Inc. Exhibit 10. 10 Dank Furniture ad Chapter 10: Price: What is the Value Proposition Worth? demand is price inelastic during the introductory stage of the product life cycle, allowing a company to recover research-anddevelopment and promotion costs. When rival products enter the market, the price is lowered in order for the firm to remain competitive. Firms focusing on profit objectives in developing their pricing strategies often set skimming prices for new products. A skimming price is more likely to succeed if the product provides some important benefits to the target market that make customers feel they must have it no matter what the cost. For a skimming price to be successful there should also be little chance that competition can get into the market quickly. In addition, the market should consist of several customer segments with different levels of price sensitivity. p. 300 Penetration pricing is the opposite of skimming pricing. In this situation, the company prices a new product very low to sell more in a short time and gain market share early on. One reason marketers use penetration pricing is to discourage competitors from entering the market. The firm first out with a new product has an important advantage. Experience shows that a pioneering brand often is able to maintain dominant market share for long periods. Penetration pricing may act as a barrier-to-entry for competitors if the prices the market will bear are so low that the company will not be able to recover development and manufacturing costs. p. 300 Trial pricing means that a new product carries a low price for a limited time to generate a high level of customer interest. Unlike penetration pricing, in which the company maintains the low price, in this case it increases the trial price after the introductory period. The idea is to win customer acceptance first and make profits later 3.2 Step 6: Develop Pricing Tactics Once marketers have developed pricing strategies, the last step in price planning is to implement them. The methods companies use to set their strategies in motion are their pricing tactics. 3.2.1 Pricing for Individual Products The way marketers present a product’s price to a market can make a big difference. The following are two examples: p. 300 p. 301 Two-part pricing requires two separate types of payments to purchase the product. Payment pricing makes the consumer think the price is “do-able” by breaking up the total price into smaller Copyright © 2016 Pearson Education, Inc. Part 3: Develop the Value Proposition for the Customer amounts payable over time. ►Marketing Moment In-Class Activity Ask students to think of examples of products (besides cars) that use payment pricing. Who is the target market (people who may not be able to afford the product)? Are there any ethical concerns to this tactic? How would you advertise the price? p. 301 3.2.2 Pricing for Multiple Products A firm may sell several products that consumers typically buy at one time. Price bundling means selling two or more goods or services as a single package for one price—a price that is often less than the total price of the items if bought individually. Captive pricing is a pricing tactic a firm uses when it has two products that work only when used together. The firm sells one item at a very low price and then makes its profit on the second high-margin item. Marketing Moment In-Class Activity Identify how fast food restaurants use product bundling? (Example: Happy Meal) Are there any ethical concerns (i.e., people eating more because they ‘get a deal’)? p. 301 3.2.3 Distribution-Based Pricing Distribution-based pricing is a tactic that establishes how firms handle the cost of shipping products to customers near as well as far. F.O.B. pricing is a tactic used in business-to-business marketing. Often a company states a price as F.O.B. factory or F.O.B. delivered. F.O.B. stands for “free on board,” which means the supplier pays to have the product loaded onto a truck or some other carrier. Also—and this is important—title passes to the buyer at the F.O.B. location. F.O.B. factory or F.O.B. origin pricing means that the cost of transporting the product from the factory to the customer’s location is the responsibility of the customer. F.O.B. delivered pricing means that the seller pays both the cost of loading and the cost of transporting to the customer, amounts it includes in the selling price. p. 302 International Delivery Pricing Terms of Sale CIF (cost, insurance, freight) is used for ocean shipments. It means the seller quotes a price for the goods (including insurance), all transportation, and miscellaneous charges to the point of debarkation from the vessel. CFR (cost and freight) means the quoted price covers the goods and the cost of transportation to the named Copyright © 2016 Pearson Education, Inc. Chapter 10: Price: What is the Value Proposition Worth? p. 302 p. 302 p. 302 p. 302 point of debarkation but the buyer must pay the cost of insurance. This term is typically used only for ocean shipments. CIP (carriage and insurance paid to) and CPT (carriage paid to) include the same provisions as CIF and CFR. However, they are used for shipment by modes other than water. When a firm uses uniform delivered pricing, it adds an average shipping cost to the price, no matter what the distance from the manufacturer’s plant—within reason. Freight absorption pricing means the seller takes on part or all of the cost of shipping. This policy works well for high-ticket items, for which the cost of shipping is a negligible part of the sales price and the profit margin. 3.2.4 Discounting for Channel Members A list price, also referred to as a suggested retail price, is the price that the manufacturer sets as the appropriate price for the end consumer to pay. In pricing for members of the channel, marketers recognize that retailers and wholesalers have costs to cover and profit targets to reach as well. They often begin with the list price and then use a number of discounting tactics to implement pricing to members of the channel of distribution. Such tactics include the following: Trade or functional discounts: Because the channel members perform selling, credit, storage, and transportation services that the manufacturer would otherwise have to provide, manufacturers normally offer trade or functional discounts to channel intermediaries. These discounts are usually set percentage discounts off the suggested retail or list price for each channel level. Quantity discounts: To encourage larger purchases from distribution channel partners or from large organizational customers, marketers may offer quantity discounts, or reduced prices for purchases of larger quantities. Cumulative quantity discounts are based on a total quantity bought within a specified time, often a year/. They encourage a buyer to stick with a single seller instead of moving from one supplier to another. Cumulative quantity discounts often take the form of rebates, in which case the firm sends the buyer a rebate check at the end of the discount period or, alternatively, gives the buyer credit against future orders. Non-cumulative quantity discounts are based only on the quantity purchased Copyright © 2016 Pearson Education, Inc. Part 3: Develop the Value Proposition for the Customer p. 303 with each individual order and encourage larger single orders but do little to tie the buyer and the seller together. Cash discounts: Many firms try to entice their customers to pay their bills quickly by offering cash discounts. Seasonal discounts: Seasonal discounts are price reductions offered only during certain times of the year. 4. PRICING AND ELECTRONIC COMMERCE Because sellers are connected to buyers around the globe as never before through the Internet, corporate networks, wireless setups, and marketers can offer deals tailored to a single person at a single moment. Many experts suggest that technology is creating a consumer revolution that might change pricing forever—and perhaps create the most efficient market ever. The Internet also enables firms that sell to other businesses (B2B firms) to change their prices rapidly as they adapt to changing costs. p. 303 4.1 Dynamic Pricing Strategies One of the most important opportunities the Internet offers is dynamic pricing, in which the seller can easily adjust the price to meet changes in the marketplace. p. 303 4.2 Internet Price Discrimination Internet price discrimination is an Internet pricing strategy that charges different prices to different customers for the same product. Is price discrimination illegal? As long as the company doesn’t charge different prices based on a demographic characteristic such as gender or race, it is not. Whether it is ethical, however, is debatable. p. 304 4.3 Online Auctions On-line auctions allow shoppers to bid on everything from bobbleheads to health-and-fitness equipment to a Sammy Sosa home-run ball. Auctions provide a second Internet pricing strategy. Perhaps the most popular auctions are the C2C auctions such as those on eBay. The eBay auction is an open auction, meaning that all the buyers know the highest price bid at any point in time. On many Internet auction sites, the seller can set a reserve price, a price below which the item will not be sold. A reverse auction is a tool used by firms to manage their costs in business-to-business buying. While in a typical auction, buyers compete to purchase a product, in reverse auctions; sellers compete for the right to provide a product at, hopefully, a low price. Copyright © 2016 Pearson Education, Inc. Chapter 10: Price: What is the Value Proposition Worth? p. 304 4.4 Freemium Pricing Strategies A freemium strategy is a business strategy in which a product in its most basic version is provided free of charge but the company charges money (the premium) for upgraded versions of the product with more features, greater functionality, or greater. The freemium pricing strategy has been most popular in digital offerings such as software media, games, or Web services where the cost of one additional copy of the product is negligible. p. 304 4.5 Pricing Advantages for Online Shoppers The Internet creates unique pricing challenges for marketers because consumers and business customers are gaining more control over the buying process. Consumers have become more price sensitive. ►Marketing Moment In-Class Activity Ask if a student or someone the student knows participated in an e-bay auction. How is it emotionally different from just going to the store and paying the price on the price tag (emotional excitement)? How does this kind of consumer behavior exemplify the “experience economy?” p. 305 5. PSYCHOLOGICAL, LEGAL AND ETHICAL ASPECTS OF PRICING p. 305 5.1 Psychological Issues in Setting Prices Much of what we’ve said about pricing depends on economists’ notion of a customer who evaluates price in a logical, rational manner. Figure 10.12 Psychological, Legal, and Ethical Aspects of Pricing 5.1.1 Buyers’ Pricing Expectation Often consumers base their perceptions of price on what they perceive to be the customary or fair price. When the price of a product is above or sometimes even when it is below what consumers expect they are less willing to purchase the product. ►Marketing Moment In-Class Activity Write down your “internal reference price” for products you are likely to purchase (i.e., CD, can of pop, fast food dinner, computer, jeans, shoes). Why are some internal reference prices consistent while others are different? p. 306 5.1.2 Internal Reference Prices Sometimes consumers’ perceptions of the customary price of a product depend on their internal reference price. That is, based on experience, consumers have a set price or a price range in mind that they refer to in evaluating a product’s cost. p. 305 In some cases, marketers try to influence consumers’ expectations of what a product should cost when they use reference-pricing strategies. For example, manufacturers may compare their price to competitors’ prices when they advertise. Similarly, a retailer may Copyright © 2016 Pearson Education, Inc. Part 3: Develop the Value Proposition for the Customer display a product next to a higher-priced version of the same or a different brand. p. 306 p. 307 p. 307 Two results are likely: On the one hand, if the prices (and other characteristics) of the two products are close, the consumer will probably feel the product quality is similar. This is an assimilation effect. On the other hand, if the prices of the two products are too far apart, a contrast effect may result, in which the customer equates the gap with a big difference in quality. 5.1.3 Price-Quality Inferences Consumers make price-quality inferences about a product when they use price as a cue or an indicator of quality. If consumers are unable to judge the quality of a product through examination or prior experience, they usually will assume that the higher-price product is the higher-quality product. Brain scans show that—contrary to conventional wisdom— consumers who buy something at a discount experience less satisfaction than people who pay full price for the very same thing. Researchers call this the price-placebo effect. 5.2 Psychological Pricing Strategies Setting a price is part science, part art. Marketers must understand psychological aspects of pricing when they decide what to charge for their products or services. 5.2.1 Odd-Even Pricing Marketers have assumed that there is a psychological response to odd prices that differ from the responses to even prices. Habit may also play a role. Research on the difference in perceptions of odd versus even prices indeed supports the argument that prices ending in 99 rather than 00 lead to increased sales. Some prices are set at even numbers because of necessity. Lottery tickets and admission to sporting events are two examples. Many luxury items such as jewelry, golf course fees, and resort accommodations use even dollar prices to set them apart. When prices are given with dollar signs or even the word dollar, customers spend less. p. 307 5.2.2 Price Lining Marketers often apply their understanding of the psychological aspects of pricing in a practice they call price lining, whereby items in a product line sell at different prices, or price points. If you want to buy a new digital camera, you will find that most manufacturers have one “stripped-down” model for $100 or less. Copyright © 2016 Pearson Education, Inc. Chapter 10: Price: What is the Value Proposition Worth? A better-quality but still moderately priced model likely will be around $200, while a professional quality camera with multiple lenses might set you back $1,000 or more. Price lining provides the different ranges necessary to satisfy each segment of the market. For marketers this technique is a way to maximize profits. A firm charges each customer the highest price the he is willing to pay. p. 308 5.2.3 Prestige Pricing Sometimes luxury goods marketers use a prestige pricing strategy that turns the typical assumption about price-demand relationships on its head: Contrary to the “rational” assumption that we value a product or service more as the price goes down, in these cases, believe it or not, people tend to buy more as the price goes up! Use Website Here-- www.landsend.com Lands’ End website p. 308 5.3 Legal and Ethical Considerations in B2C Pricing The free enterprise system is founded on the idea that the marketplace will regulate itself. Unfortunately, the business world includes the greedy and unscrupulous. Government has found it necessary to enact legislation to protect consumers and to protect businesses from predatory rivals. p. 308 5.3.1 Deceptive Pricing Practices Unscrupulous businesses may advertise or promote prices in a deceptive way. The Federal Trade Commission (FTC), state lawmakers, and private bodies such as the Better Business Bureau have developed pricing rules and guidelines to meet the challenge. p. 308 Another deceptive pricing practice is the bait-and-switch tactic, whereby a retailer will advertise an item at a very low price—the bait—to lure customers into the store. However, it is almost impossible to buy the advertised item—salespeople like to say (privately) that the item is “nailed to the floor.” The salespeople do everything possible to get the unsuspecting customers to buy a different, more expensive, item—the switch. It is complicated to enforce laws against bait-and-switch tactics because these practices are similar to the legal sales technique of “trading up.” Simply encouraging consumers to purchase a higher-priced item is acceptable, but it is illegal to advertise a lower-priced item when it’s not a legitimate, bona fide offer that is available if the customer demands it. The FTC may determine if an ad is a bait-and-switch scheme or a legitimate offer by checking to see if a firm refuses to show, demonstrate, or sell the Copyright © 2016 Pearson Education, Inc. Part 3: Develop the Value Proposition for the Customer p. 308 advertised product; disparages it; or penalizes salespeople who do sell it. 5.3.2 Loss-Leader Pricing and Unfair Sales Acts Some retailers advertise items at very low prices or even below cost and are glad to sell them at that price because they know that once in the store, customers may buy other items at regular prices. Marketers call this loss leader pricing; they do it to build store traffic and sales volume. Some states frown on loss leader practices so they have passed legislation called unfair sales acts (also called unfair trade practices acts). These laws or regulations prohibit wholesalers and retailers from selling products below cost. These laws aim to protect small wholesalers and retailers from larger competitors because the “big fish” have the financial resources that allow them to offer loss leaders or products at very low prices—they know that the smaller firms can’t match these bargain prices. p. 309 5.4 Legal Issues in B2B Pricing Some of the more significant illegal B2B pricing activities include price discrimination, price fixing, and predatory pricing. 5.4.1 Illegal Business-to-Business Price Discrimination The Robinson-Patman Act includes regulations against price discrimination in interstate commerce. Price discrimination regulations prevent firms from selling the same product to different retailers and wholesalers at different prices if such practices lessen competition. p. 309 p. 310 5.4.2 Price-Fixing Price fixing occurs when two or more companies conspire to keep prices at a certain level. Horizontal price-fixing occurs when competitors making the same product jointly determine what price they each will charge. Sometimes manufacturers or wholesalers attempt to force retailers to charge a certain price for their product. When vertical price-fixing occurs, the retailer that wants to carry the product has to charge the “suggested” retail price. ►ETHICS CHECK If you were advising Uber’s executives, would you encourage them to end the service’s surge pricing strategy to prevent the company from losing customers who are angry about such price hikes? Copyright © 2016 Pearson Education, Inc. Ripped From the Headlines: Ethical/ Sustainable Decisions in the Real World Chapter 10: Price: What is the Value Proposition Worth? p. 310 p. 310 5.4.3 Predatory Pricing Predatory pricing means that a company sets a very low price for the purpose of driving competitors out of business. Later, when they have a monopoly, they turn around and increase prices. Real People, Real Choices: Here’s My Choice at Converse Betsy chose option #1. ►MARKETING METRICS: HOW CONVERSE MEASURES SUCCESS Converse received immediate increased interest from prospective students, and recruitment numbers are significantly ahead of previous years. The school showed a 6 percent increase in applications and an 11 percent increase in the number of prospective students who visited the campus and is projecting an increase of 5 percent in undergraduate enrollment for the first year. More broadly, here are some important measures the school uses to determine how its new pricing model is working: ● Enrollment funnel. ●Retention numbers. ●Revenue generation. ●Student billing. ●Demographic shifts in student body makeup that may be attributed to the tuition reset. Exhibit 10.11 Converse College Chart Brand You: Do you know how much you are worth? The first step in getting the salary you want, is knowing how much you are worth. Find out the latest in salary trends, how and when to negotiate your offer and what else you can ask for as part of your compensation in Chapter 10 in Brand You. WEB RESOURCES Pearson Education, Inc: www.mymktlab.com Converse College: www.converse.edu Accenture (global management consulting, technology services and outsourcing company website): www.newsroom.accenture.com Proctor & Gamble; www.p&G.com Saturn website: www.saturn.com Bitcoins: www.thebitcoinsecrets.com/ Wal-Mart website: www.walmart.com Copyright © 2016 Pearson Education, Inc. Part 3: Develop the Value Proposition for the Customer Priceline ticket sales: www.priceline.com iTunes website: www.apple.com/itunes Online tickets website: www.tickets.com Consumer Reports website: www.consumerreports.org Better Business Bureau website: www.welcome.bbb.org Lands End website: www.landsend.com National Association of Trade Exchanges website: www.nate.org Copyright © 2016 Pearson Education, Inc.