Download I. Chapter Overview

Part 3: Create the Value Proposition
Chapter 11
Price the Product
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 non-monetary.
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
Tell students their 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 they make that decision? This is an excellent
time to introduce the concept of price as an extrinsic cue and the price/quality relationship.
p. 297
1. REAL PEOPLE, REAL CHOICES—
HERE’S MY PROBLEM AT TACO BELL
In the year 2000, Taco Bell abandoned its very successful 59¢–
79¢–99¢ menu and needed a new direction for a value menu. The
company looked at numerous alternatives, including new
products, new ways to price its menu, and new product
combinations. A pricing strategy began to take shape. Many
competitors continued to focus on the 99¢ price point but most of
Taco Bell’s products could not feasibly be offered at such a low
price. The company tested eight different price configurations that
made financial sense. Based on the results from the concept
testing of the eight different menus, Danielle Blugrind, a former
decision maker at Taco Bell, considered three possible options:
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Chapter 11: Price the Product
1. Price the entire menu at $1.29.
2. Price items at 99¢ and $1.29.
3. Price items at 99¢, $1.19, and $1.29.
p. 298
p. 298
p. 300
p. 300
p. 301
p. 301
p. 301
The vignette ends by asking the student which option he/she
would choose.
 Danielle chose Option #3—the mixed price menu.
2.
“YES, BUT WHAT DOES IT COST?”
The question of what to charge for a product is a central part of
marketing decision making.
2.1 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.
2.2
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.
2.2.1 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.
2.2.2 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.
2.2.3 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.
2.2.4 Customer Satisfaction Objectives
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Figure 11.1
Elements of
Price Planning
Figure 11.2
Pricing
Objectives
Airplane Cabin
Photo
Part 3: Create the Value Proposition
p. 301
p. 302
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.
2.2.5 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.
3.
COSTS, DEMAND, REVENUE, AND THE
MARKETING ENVIRONMENT
p. 302
3.1 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. 302
3.1.1 Demand Curves
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.
Figure 11.3
Factors in Price
Setting
Figure 11.4
Demand Curves
for Normal and
Prestige Products
The demand curve for most goods (Left side of Figure 11.2)
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. 302
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.
Figure 11.5
3.1.2 Shifts in Demand
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Chapter 11: Price the Product
The demand curves we have shown assume that all factors other
Shift in Demand
than price stay the same. However, what if they do not? What if
Curve
the company improves the product? What happens when there is a
glitzy new advertising campaign that turns a product into a “must- iPod Photo
have” 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.
p. 304
p. 304
Demand curves may also shift downward.
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.
Table 11.1
Estimating
Demand for
Pizza
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
factors that might affect demand, such as new competitors
entering the market, the state of the economy, and changing
customer tastes.
3.1.4 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.
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 11.6
Price Elasticity
of Demand
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 11.7
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
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Part 3: Create the Value Proposition
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.
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
recognize that doing so could result in less profit as consumers
switch from one brand to another.
p. 307
p. 307
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.
3.2
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.
3.2.1 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.
Fixed costs are costs that do not vary with the number of units
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Figure 11.8
Variable Costs at
Different Levels
of Production
The Cutting
Edge: Virtual
Chapter 11: Price the Product
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.
Wallets
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. 309
Combining variable costs and fixed costs yields total costs for a
given level of production. As a company produces more and more
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.
3.2.2 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.
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.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Figure 11.9
Break-Even
Analysis
Assuming a Price
of $100
Part 3: Create the Value Proposition
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.
p. 311
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.
3.2.3 Marginal Analysis
Marginal analysis provides a way for marketers to look at cost
and demand at the same time and to identify the output and the
price that will generate the maximum profit. When doing a
marginal analysis, marketers examine the relationship of
marginal cost (the increase in total costs from producing one
additional unit of a product) to marginal revenue (the increase in
total income or revenue that results from selling one additional
unit of a product).
Average revenue is also the demand curve and thus represents
that amount customers will buy at different prices—people buy
more only if price and thus revenue decrease. Thus, both average
revenue and marginal revenue decrease with each additional unit
sold.
If only one unit is produced, the average total cost per unit is the
same as the marginal cost per unit. After the first unit, the cost of
producing each additional unit (marginal cost) and the average
cost at first decreases. Eventually, however, both marginal costs
and average costs begin to increase because both average fixed
costs and average variable costs may increase in the long term.
Profit is maximized at the point at which marginal cost is exactly
equal to marginal revenue. At that point, the cost of producing
one unit is exactly equal to the revenue to be realized from selling
one unit. If, however, one additional unit is produced, the cost of
producing that unit is greater than the revenue from the sale of
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Figure 11.10
Marginal
Analysis
Chapter 11: Price the Product
the unit, and total profit actually begins to decrease. Firms try to
keep production and sales at the point of maximum profit.
Predicting demand, an important factor in marginal analysis, is
never an exact science. This makes marginal analysis a less-thanperfect way to determine the best price for a product.
p. 312
p. 312
p. 313
3.2.3 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.
3.3
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.
3.3.1 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.
ForceFlex
Garbage Bag ad
Pampers Diapers
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.
p. 314
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
maintain sales levels.
3.3.2 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.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Starbuck Coffee
Store Photo
Part 3: Create the Value Proposition
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. 314
Firms in a purely competitive market have little opportunity to
raise or lower prices. Price is directly influenced by supply and
demand.
3.3.3 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. 315
3.3.4 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. 315
3.3.5 The International Environment
The marketing environment often varies widely from country to
country. This can have important consequences in developing
pricing strategies.
4.
PRICING THE PRODUCT: ESTABLISHING
STRATEGIES AND TACTICS
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. 316
p. 316
4.1
Step 5: Choose a Pricing Strategy
The next step in price planning is to choose a pricing strategy.
p. 316
4.1.1 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
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Figure 11. 11:
Pricing Strategies
and Tactics
Chapter 11: Price the Product
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. 317
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.
4.1.2 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.
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
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Figure 11.12
Target Costing
Using a Jeans
Example
Part 3: Create the Value Proposition
p. 318
p. 318
and allocate the percentage of the airline or hotel’s capacity
accordingly so that no product goes unsold.
4.1.3 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.
4.1.4 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.
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.
p. 319
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.
4.1.5 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,
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
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Furniture Store
in Turkey ad
Chapter 11: Price the Product
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.
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. 320
p. 320
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
4.2
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.
4.2.1 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:
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
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. 320
4.2.2 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.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Part 3: Create the Value Proposition
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
Ask students to 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. 321
4.2.3 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.
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
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.
Another distribution-based pricing tactic used primarily in B2B
marketing, basing-point pricing, means marketers choose one or
more locations to serve as intermediate delivery locations.
Customers pay shipping charges from these basing points to their
final destinations, whether the goods are actually shipped from
these points or not.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Chapter 11: Price the Product
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.
p. 322
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.
4.2.4 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
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.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Part 3: Create the Value Proposition

p. 323
Seasonal discounts: Seasonal discounts are price
reductions offered only during certain times of the year.
5.
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. 323
5.1
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. 323
5.2 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.
p. 323
5.3 Freenomics: What If We Just Give It Away?
This new business model of freenomics is based on the idea that
economists call externalities; this means that the more people you
get to participate in a market, the more profitable it is. So, for
example, the more people Google convinces to use its Gmail
service the more eyeballs it attracts which in turn boosts the rates
advertisers are willing to pay to talk to those people.
p. 324
5.4 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
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Figure 11.13
Internet Pricing
Strategies
Chapter 11: Price the Product
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. 325
Figure 11.14
6.
PSYCHOLOGICAL, LEGAL AND ETHICAL
Psychological
ASPECTS OF PRICING
Pricing
p. 325
6.1 Psychological Issues in Setting Prices
6.1.1 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
Ask students to write down their “internal reference price” for products they are likely to
purchase (i.e., CD, can of pop, fast food dinner, computer, jeans, shoes). Compare prices between
students. Why are some internal reference prices consistent while others are different?
p. 326
6.1.2 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. 325
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
display a product next to a higher-priced version of the same or a
different brand.
p. 326
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.
6.1.3 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
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Part 3: Create the Value Proposition
p. 326
p. 327
thing. Researchers call this the price-placebo effect.
6.2
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.
6.2.1 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. 327
6.2.2 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.
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.
6.2.3 Prestige Pricing
p. 327
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-- http://www.landsend.com/cd/frontdoor. Lands’ End website
p. 327
6.3
Legal and Ethical Considerations in 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
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Chapter 11: Price the Product
necessary to enact legislation to protect consumers and to protect
businesses from predatory rivals.
p. 328
6.3.1 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.
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.
p. 328
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
advertised product; disparages it; or penalizes salespeople who do
sell it.
6.3.2 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. 328
6.4 Legal Issues in B2B Pricing
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Ripped From the
Headlines:
Ethical/
Sustainable
Decisions in the
Real World
Part 3: Create the Value Proposition
p. 328
6.4.1 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. 329
6.4.2 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.
p. 329
6.4.3 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 Taco Bell
p. 330
Danielle chose option #3.
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 11 in Brand You.
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Chapter 11: Price the Product
IV. END-OF-CHAPTER ANSWER GUIDE
CHAPTER REVIEW
 CONCEPTS: TEST YOUR KNOWLEDGE
1. What is price, and why is it important to a firm? What are some examples of monetary and
non-monetary prices?
Price is the value that customers give up or exchange to obtain a desired product. Price not
only brings revenue into the firm but it also matches competitive offerings and often
establishes an image for the firm and its products. Price may be monetary (for example, dues,
tuition, professional fees, rent, donations, etc.) or non-monetary (for example, a vote for a
candidate, or contribution of time and effort).
2. Describe and give examples of some of the following types of pricing objectives: profit,
market share, competitive effect, customer satisfaction, and image enhancement.
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.
Market share involves having a pricing strategy to maximize sales (either in dollars or in
units) or to increase market share.
Competitive effect objectives mean that the pricing plan is intended to have a certain effect
on the competition’s marketing efforts.
Customer satisfaction means that 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.
Image enhancement is when the consumers use price to make inferences about the quality of
a product. Marketers know that price is often an important means of communicating not only
quality but also image to prospective customers.
3. Explain how the demand curves for normal products and for prestige products differ. What
are demand shifts and why are they important to marketers? How do firms go about
estimating demand? How can marketers estimate the elasticity of demand?
For normal products the demand curve slopes downward and to the right—as price goes up,
demand goes down. For prestige products such as luxury cars or jewelry, the demand curve
slopes upward--an increase in price may actually result in an increase in the quantity
demanded because consumers see the products as more valuable.
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Part 3: Create the Value Proposition
Demand shifts mean the quantity demanded a given price is greater (an upward shift) or less
(a downward shift). Marketing activities such as a great ad campaign can cause an upward
shift. Downward shifts may occur if a new technology is developed or other external factors.
Marketers estimate demand 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.
Marketers often do research to determine demand at different prices, thus estimating demand.
One type of research is to ask consumers how much they would buy at different prices.
Alternatively, marketers may conduct field studies in which they vary the price of a product
in different stores and measure how much is actually purchased.
4. Explain variable costs, fixed costs, average variable costs, average fixed costs, and average
total costs.





Variable costs are the costs of production tied to and vary depending on the number
of units produced. Variable costs typically include raw materials, processed materials,
component parts, and labor.
Fixed costs are the costs of production that do not change with the number of units
produced. A CEOs salary is a fixed cost.
Average variable costs are the total spent on raw materials, labor, and so on divided
by the number of items produced.
Average fixed costs (fixed costs remain the same no matter the level of production)
will decrease as the number of units produced increases. To calculate, divide fixed
costs by the number produced.
Average total costs are the total costs (the total of the fixed costs and the variable
costs for a set number of units produced) divided by the number of units produced.
5. What is break-even analysis? What is marginal analysis? What are the comparative
advantages of break-even analysis and marginal analysis for marketers?
Break-even analysis is a method for determining the number of units that will have to be
produced and sold at a given price to break even—that is, to neither make a profit nor suffer
a loss. Marketers use break-even analysis to help them in establishing and deciding on the
price for a product. For details on calculations, see the chapter material.
Marginal analysis is a method of analysis that uses costs and demands to identify the price
that will maximize profits. Marketers use marginal analysis in the same way as they use
break-even analysis—to aid them in deciding and setting a price for the product. Changes in
costs often cause this method to be in error. Therefore, all pricing must be flexible and
responsive to changes in the environment and demand.
6. What are trade margins? How do they relate to the pricing for a producer of goods?
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Chapter 11: Price the Product
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. Channels of distribution
often vary in both the types and sizes of available intermediaries and in the availability of an
infrastructure to facilitate product distribution. Often these differences can mean that trade
margins will be higher as will the cost of getting the products to consumers.
7. How does recession affect consumers’ perceptions of prices? How does inflation influence
perceptions of prices? What are some ways that the competitive environment, government
regulations, consumer trends and the global environment influence a firm’s pricing
strategies?
During recessions, consumers grow more price sensitive. They may switch to generic brands
to get a better price and patronize discount stores and warehouses. During inflation,
consumers get used to price increases. They may even become insensitive to price increases.
Marketers may also lower prices in the inflationary periods and temporarily sacrifice profits
to maintain sales levels.
Marketers try to anticipate how the competition will respond to their pricing actions. They
know that consumers’ expectations of what constitutes a fair price largely depend on what
the competition charges. However, it is not always a good idea to fight the competition with
lower and lower prices. Pricing wars such as those in the fast-food industry can change
consumers’ perceptions of what is a “fair” price, leaving them unwilling to buy at previous
price levels.
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.
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. For example, an important trend is that even well off people no longer consider it
shameful to hunt for bargains—in fact, it is becoming fashionable to boast that you found
one. As a marketing executive for a chain of shopping malls observed, “Everybody loves to
save money. It’s a badge of honor today.” Luxury consumers are looking for prestigious
brands at low prices, though they are still willing to splurge for some high-ticket items.
The marketing environment often varies widely from country to country. This can have
important consequences in developing pricing strategies. Can prices be standardized for all
global markets or must there be localization in pricing? For products including most
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Part 3: Create the Value Proposition
consumer goods, unique environmental factors in different countries mean marketers must
adapt their pricing strategies.
8. Explain cost-plus pricing, target costing, and yield management pricing. Explain how a price
leadership strategy works.




Cost-plus pricing means marketers total all the costs for the product then add an
amount to arrive at the selling price.
Target costing occurs when a firm first determines 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.
Yield management 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 revenues.
Price leadership is usually the rule in an industry dominated by few firms (called an
oligopoly) and may be in the best interest of all firms because it minimizes price
competition. It involves a firm pricing its wares near, at, above, or below the
competition.
9. For new products, when is skimming pricing more appropriate, and when is penetration
pricing the best strategy? When would trial pricing be an effective pricing strategy?
Skimming price works best when a product is highly desirable and offers unique benefits,
demand is price inelastic during the introductory stage of the product life cycle and if the
product provides some important benefits to the target market that make customers feel they
must have the product no matter what it costs. In addition, there must be little chance that
competitors can get into the market quickly.
Penetration pricing is used to discourage competitors from entering the market and because
of the low price may actually be a barrier to entry for competitors.
With trial pricing a new product carries a low price for a limited period to attract the
customer. The idea is to win customer acceptance first and make profits later.
10. Explain two-part pricing, payment pricing, price bundling, captive pricing, and distributionbased pricing tactics. Give an example of when each would be a good pricing tactic for
marketers to use.
Two-part pricing requires two separate types of payments to purchase the product. An
example would be a cellular phone company that offers customers a set number of minutes
usage plus a per-minute rate for extra minutes used. Two-part pricing makes sense when
consumption differs among consumers but the firm must have a base income to cover fixed
costs.
Payment pricing breaks up the total price into smaller amounts payable over time, thus
making the consumer think the price is “do-able.” Payment pricing makes sense for a
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Chapter 11: Price the Product
product that is high priced, that consumers think as important, and that lasts a long time. An
example would be a car.
Price bundling means selling two or more goods or services as a single package for one price.
From a marketing standpoint, price bundling makes sense. If products are priced separately,
then it is likely that customer will buy some but not all the items. An example would be a
phone company now offering cable services for TV and an Internet connection in one bill.
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. An example would be a razor and blade, neither individually is
useful, but together they have great value. Captive pricing makes sense for a consumer
necessity that can be individualized and still meet the needs of the mass market.
Distribution-based pricing is a tactic that establishes how firms handle the cost of shipping
products to customers near as well as far. FOB delivered pricing means the seller pay for the
cost of loading and the cost of transporting the item to the customer.
11. Why do marketers use trade or functional discounts, quantity discounts, cash discounts, and
seasonal discounts in pricing to members of the channel?
In pricing for members of the channel, marketers recognize that retailers and wholesalers
have costs to cover and profit targets to reach. Thus, they often begin with the list price and
then use a number of trade or functional discounts to implement pricing to members of the
channels of distribution. Quantity discounts are used to encourage buyers to buy larger
quantities from a single seller. Cash discounts encourage customers to pay quickly, thus
lowering the seller firm’s need for cash. Season discounts either encourages purchase offseason to lessen the manufacturer’s need to warehouse product or encourage purchase inseason to counter competitive products.
12. What is dynamic pricing? Why does the Internet encourage the use of dynamic pricing?
Dynamic pricing can occur when the price can easily be adjusted to meet changes in the
marketplace. Because the cost of changing prices on the Internet is practically zero, firms are
able to respond quickly and, if necessary, frequently to changes in costs, changes in supply,
and/or changes in demand.
13. Explain these psychological aspects of pricing: price-quality inferences, odd-even pricing,
internal reference price, price lining, and prestige pricing.
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-priced product is
the higher-quality product.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Part 3: Create the Value Proposition
Marketers use odd-even pricing when they assume that there is a psychological response to
odd prices that differs from the responses to even prices. Research on the difference in
perceptions of odd versus even prices supports the argument that prices ending in 99 rather
than 00 lead to increased sales. Habit may play a role.
Internal reference price means, based on experience, consumers have a set price or a price
range in their mind that they refer to in evaluating a product’s cost. The reference price may
be the last price paid. It may also be the average of all the prices they know of similar
products.
Price-lining is a practice where items in a product line sell at different prices called price
points.
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!
14. Explain how unethical marketers might use bait-and-switch tactics, price-fixing, and
predatory pricing. What is loss-leader pricing? What are unfair sales acts?
Bait-and switch is an illegal marketing practice in which an advertised price special is used
as bait to get customers into the store when the intention of switching them to a higher priced
item.
Price fixing occurs when two or more companies conspire to keep prices at a certain level.
Predatory pricing means the company sets a very low price for a purpose of driving the
competition out of business. This tactic could lead to monopoly in the future.
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.
ACTIVITIES: APPLY WHAT YOU’VE LEARNED
1. Assume that you are the director of marketing for a firm that manufactures candy bars. Your
boss has suggested that the current economic conditions merit an increase in the price of your
candy bars. You are concerned that increasing the price might not be profitable because you
are unsure of the price elasticity of demand for your product. Develop a plan for the
measurement of price elasticity of demand for your candy bars. What findings would lead
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Chapter 11: Price the Product
you to increase the price? What findings would cause you to rethink the decision to increase
prices? Develop a presentation for your class outlining (1) the concept of elasticity of
demand, (2) why raising prices without understanding the elasticity would be a bad move, (3)
your recommendations for measurement, and (4) the potential impact on profits for elastic
and inelastic demand.
Students should first approach this question in terms of elasticity of demand and the effect of
such a move on revenues and profits. Students may suggest conducting a study to determine
the elasticity of demand. One way to do this is to conduct a study in which they ask
consumers how much they would buy at different prices. Alternatively, they may decide to
conduct a field experiment in which they vary the price in different stores. If they find that
demand is price inelastic, then the price increase will increase revenues and they should
increase the price. If they find demand is elastic, then increasing the price would greatly
decrease sales and thus decrease revenues and the decision should be not to raise the price.
Students should be encouraged to consider the type if industry (oligopoly, monopolistic
competition, etc.) and think about whether such a move would mean losing market share to
competitors or whether competitors in the industry would follow with their own price
increases.
2. As the vice president for marketing for a firm that markets computer software, you must
regularly develop pricing strategies for new software products. Your latest product is a
software package that automatically translates any foreign language e-mail messages to the
user’s preferred language. You are trying to decide on the pricing for this new product.
Should you use a skimming price, a penetration price, or something in between? Argue in
front of your class the pros and cons for each alternative.
Students must think about whether or not this product has unique benefits, is highly
desirable, and is price inelastic. In addition, the target market must feel that this product has
important benefits that they must have no matter the cost. The company must research the
market and determine if competitors are poised to enter this market. If these conditions are
met, students will recommend a skimming strategy.
If, on the other hand, the company wants to gain early market share and set a low price
prohibiting competition, they might consider penetration pricing. Being a pioneering brand
may help them dominate market share for a long time. Students may also consider a trial
pricing strategy.
3. Assume that you have been hired as the assistant manager of a local store that sells fresh
fruits and vegetables. As you look over the store, you notice that there are two different
displays of tomatoes. In one display, the tomatoes are priced at $1.39 per pound, and in the
other, the tomatoes are priced at $.89 per pound. The tomatoes look very much alike. You
notice that many people are buying the $1.39 tomatoes. Write a report explaining what is
happening and give your recommendations for the store’s pricing strategy.
Students need to review the chapter section of psychological issues in pricing, paying
particular attention to sections on internal reference prices including the assimilation and
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall
Part 3: Create the Value Proposition
contrast effects and price-quality inferences. You might also want to ask the students about
their buying experience and the occasion for which they are purchasing. If students regularly
purchase tomatoes and are confident in their decisions, then they will most likely buy the
lower-priced tomatoes. However, if they do not frequently purchase tomatoes and are not
confident of their knowledge, they may buy the higher-priced tomatoes, especially if they are
trying to impress someone. In this case, the concept of price-quality kicks in.
4. We know that marketers must consider not only the monetary costs of products but also the
non-monetary costs. Take for example, the cost of your college education. While you pay
tuition and other fees, there are also non-monetary costs that students must bear. Talk with
five to ten of your fellow university students. Ask them what non-monetary costs they feel
are important and would like reduced. Develop a report with your recommendations for how
your university might change policies or practices that would reduce non=monetary costs.
Examples of non-monetary costs for students may include:
 A significant amount of “sweat and pain” writing papers, studying for exams, etc. in
their various courses (i.e., time and stress related to the work associated with college)
 The stress of an annoying and unaccommodating roommate
 The opportunity cost of giving up potential income lost while attending college and
not working a full-time job (this is perhaps the biggest non-monetary cost to most
college students!)
5. Select one of the product categories below. Identify two different firms that offer consumers
a line of product offerings in the category. For example, Dell, HP, and Toshiba each market a
line of laptop computers while Hoover, Eureka and Bissell offer lines of vacuum cleaners.
Using the Internet or by visiting a retailer who sells your selected product, research the
product lines and pricing of the two firms. Based on your research, develop a report on the
price lining strategies of the two firms. Your report should discuss (1) the specific price
points of the product offerings of each firm and how the price lining strategy maximizes
revenue, (2) your ideas for why the specific price points were selected, (3) how the price
lining strategies of the two firms are alike and how they are different, and (4) possible
reasons for differences in the strategies.
a. Laptop computers
b. Vacuum cleaners
c. Refrigerators
d. HD televisions
The main reason for price lining is that different customers are willing to pay different prices
for the same item. For example, you may only be willing to spend up to $500 for a new
computer, whereas I am willing to pay up to $1500 for a new computer. Therefore, a
computer brand is likely to satisfy our different desires to spend money on a computer to the
extent that a product line of computers has various price points that match our perception of
the maximum amount we are each willing to pay.
One key analysis for each of the different types of products in this activity is for students to
estimate the variability of desired price points in each type—for example, how many
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Chapter 11: Price the Product
different price points are required to satisfy different types of consumers in the refrigerator
category? Should refrigerator brands offer a wide or narrow variety of price points? Should
refrigerator brands offer even more price points?
6. Assume that you are the V.P. of marketing for a firm that produces refrigerated prepared
pasta dishes for sale to consumers through various retail channels. You are considering
producing a new line of all natural one-serving pasta dishes. Your research suggests that
consumers would only be willing to buy the pasta if the price is less than $6.00 per package.
You will be selling the pasta through specialty food brokers who will distribute to natural
food stores who will sell to consumers. The natural food stores require a 30 percent retailer
margin and the brokers require a 20 percent wholesaler margin.
a. Assuming the natural food stores will sell the product for $5.99 per package, what
price will the specialty food brokers charge the food stores for the product?
b. What price will the manufacturer charge the specialty food brokers?
c. If the manufacturer costs are $0.95 per package, what will the manufacturer’s
contribution per unit be?
Price to the food stores = $5.99 x (1.00 - .30)
= $5.99 x .70
= $4.19
Price to the food brokers = $4.19 x (1.00 - .20)
= $4.19 x .80
= $3.35
If the manufacturer’s variable costs are $.95, then the manufacturer’s contribution per unit is
$2.40.
METRICS
MOMENT
Contribution analysis and break-even analysis are surely the most important and most frequently
used marketing metrics. These analyses are essential to determine if a firm is a marketing
opportunity will mean a financial loss or be profitable. As explained in the chapter, contribution
is the difference between the selling price per unit and the variable cost per unit. Break-even
analysis that includes contribution tells marketers how much must be sold to break even or to
earn a desired amount of profit. Happy Days Dairy is a producer of high quality organic yogurt,
sour cream and crème fraiche. They are considering marketing a new line of drinkable yogurt for
children. The new yogurt will be offered in packages of six 6-ounce individual containers and it
will be available in four flavors. The company plans to use TV and newspaper advertising to
promote the new product. Distribution will be through major supermarket chains which currently
have over 90 percent of the U.S. yogurt market. The suggested retail price for each 6-ounce
individual container will be $0.60. Because the retailer requires a 30 percent markup, Happy
Days’ price to the supermarkets will be $0.42 per six-ounce container. The unit variable costs for
the product including packaging will be $0.15. The company estimates its advertising and
promotion expenses for the first year will be $1,500,000.
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Part 3: Create the Value Proposition
1. What is the contribution per unit for the new children’s yogurt product?
2. What is the break-even unit volume for the first year that will cover the planned
advertising and promotion? The break-even in dollars?
3. How many units of the yogurt must Happy Days sell to earn a profit of $800,000?
Using the formulas presented in the chapter, the answers to these questions are as
follows:
a. Contribution per unit = $.42 – $.15 = $.27
b. Break-even point in units = TFC ($1,500,000) divided by contribution ($.42 – $.15)
Break-even point in units = 5,555,556 units.
Break-even point in dollars = TFC ($1,500,000) divided by (1 minus (variable cost
per unit divided by price)) = $2,332,815
c. Profit = quantity above break-even point x contribution margin
$800,000 = units above break-even point x $.27
Units to make $800,000 in profit = 2,962,963 + 5,555,556 = 8,518,519 total units
 CHOICES: WHAT DO YOU THINK?
1. Governments sometimes provide price subsidies to specific industries; that is, they reduce a
domestic firm’s costs so that they can sell products on the international market at a lower
price. What reasons do governments (and politicians) use for these government subsidies?
What are the benefits and disadvantages to domestic industries in the end? To international
customers? Who would benefit and who would lose if all price subsidies were eliminated?
Governments (and politicians) say that subsidies are necessary in order to protect industries
and the jobs they provide. The benefit to the domestic industry is that subsidies help them to
be competitive in the international market. The disadvantage is that the industry may grow
dependent on the subsidy and hence may not be as financially strong. International customers
benefit by having more product choices at affordable prices available. If all price subsidies
were eliminated, there would be both winners and losers. The winners would be competitors
in the foreign industry that would not have to worry about competition from U.S. firms.
Customers in the international environment and the U.S. industry would both be losers.
2. In many oligopolistic industries, firms follow a price leadership strategy, in which an
accepted industry leader sets, raises, or lowers prices and the other firms follow. Why is this
a good policy for the industry? In what ways is this good or bad for consumers? What is the
difference between price leadership and price fixing? Should governments allow industries to
use price leadership strategies?
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Chapter 11: Price the Product
Oligopolistic firms can avoid price competition, which allows all players in the industry to
remain profitable. A price leadership strategy, which usually is the rule in an oligopolistic
industry dominated by a few firms, may be in the best interest of all players 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 others.
From a consumer standpoint there are limited firms to work with which might be viewed as
good, but the negative side would be that there are limited opportunties for cost savings since
the oligoploy has a large share of the market. Price-fixing occurs when two or more
companies conspire to keep prices at a certain level (There’s a good reason to avoid
explicitly working together to set rates: that’s called collusion and it’s illegal in most cases).
As far as govenrment allowing price leadership, this could lead to varying positions from the
students.
3. Many very successful retailers use a loss leader pricing strategy in which they advertise an
item at a price below their cost and sell the item at that price to get customers into their store.
They feel that these customers will continue to shop with their company and that they will
make a profit in the end. Do you consider this an unethical practice? Who benefits and who is
hurt by such practices? Do you think the practice should be made illegal, as some states have
done? How is this different from “bait-and-switch” pricing?
Students will have varying opinions on this topic. For some, free enterprise will be their main
consideration. For others looking after the underdog will be a priority and they will be
concerned that smaller retailers cannot afford to compete with loss-leader pricing. As
different states regulate this practice differently, no single opinion is particularly wrong or
right. The difference between loss-leader pricing and bait-and-switch is that the latter seeks
to bring customers in and sell them a more expensive product, not the one advertised; the
advertised item is “nailed to the floor.”
4. Consumers often make price-quality inferences about products. What does this mean? What
are some products for which you are likely to make price-quality inferences? Do such
inferences make sense?
Price-quality inferences relate to the perception of quality we attach to a product based on
price. Often this occurs when consumers cannot judge the quality of a product through
experience or examination of the product. This concept will not be new to students.
However, some will be prone to falling into this situation and others will always buy based
on price. This question should make for an interesting discussion, as opinions should be
plentiful.
5. In pricing new products, marketers may choose a skimming or a penetration pricing strategy.
While it is easy to see the benefits of these practices for the firm, what are the advantages
and/or disadvantages of the practice for consumers? For the industry as a whole?
Setting a skimming price means that the firm charges a high, premium price for its new
product with the intention of reducing it in the future in response to market pressures. If a
product is highly desirable and it offers unique benefits, demand is price inelastic during the
introductory stage of the product life cycle, allowing a company to recover research-and-
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Part 3: Create the Value Proposition
development and promotion costs. When rival products enter the market, the price is lowered
in order for the firm to remain competitive.
Penetration pricing is the opposite of skimming pricing. This strategy means that a new
product is priced very low in order to sell more in a short time, thus gaining 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.
 MINI-PROJECTS: LEARN BY DOING
The purpose of this mini-project is to help you become familiar with how consumers respond to
different prices by conducting a series of pricing experiments. For this project, you should first
select a product category that students such as yourself normally purchase. It should be a
moderately expensive purchase such as athletic shoes, a bookcase, or a piece of luggage. You
should next obtain two photographs of items in this product category or, if possible, two actual
items. The two items should not appear to be substantially different in quality or in price.
Note: You will need to recruit separate research participants for each of the activities listed in the
next section.
1. Experiment 1: Reference Pricing
a. Place the two products together. Place a sign on one with a low price. Place a sign on
the other with a high price (about 50 percent higher will do). Ask your research
participants to evaluate the quality of each of the items and to tell which one they
would probably purchase.
b. Reverse the signs and ask other research participants to evaluate the quality of each of
the items and to tell which one they would probably purchase.
c. Place the two products together again. This time place a sign on one with a moderate
price. Place a sign on the other that is only a little higher (less than 10 percent higher).
Again, ask research participants to evaluate the quality of each of the items and to tell
which one they would probably purchase.
d. Reverse the signs and ask other research participants to evaluate the quality of each of
the items and to tell which one they would probably purchase.
2. Experiment 2: Odd-Even Pricing. For this experiment, you will only need one of the items
from experiment 1.
a. Place a sign on the item that ends in $.99 (e.g., $62.99). Ask research participants to
tell you if they think the price for the item is very low, slightly low, moderate, slightly
high, or very high. Also ask them to evaluate the quality of the item and to tell you
how likely they would be to purchase the item.
b. This time place a sign on the item that ends in $.00 (e.g., $60.00). Ask different
research participants to tell you if they think the price for the item is very low,
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Chapter 11: Price the Product
slightly low, moderate, slightly high, or very high. Also ask them to evaluate the
quality of the item and to tell you how likely they would be to purchase the item.
Develop a presentation for your class in which you discuss the results of your experiments
and what they tell you about how consumers view prices.
This mini-project will help students understand the concepts of psychological pricing. They
will be able to test the concept of odd-even pricing, and reference pricing; whether the
concepts work or not. In addition, they will be asked to think about pricing as it relates to
quality. The experimental nature of this project will aid in reinforcing many of the concepts
presented in the text.
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Part 3: Create the Value Proposition
V. MARKETING IN ACTION CASE: REAL CHOICES AT
AMAZON
Summary of Case
As the print industry declines, the e-book reader may exert a dramatic impact on book, magazine,
and newspaper pricing. Amazon.com jumped into this market with the Kindle, which consists of
a hardware and software device that displays content from various e-books and other digital
media. It can access content through downloads using the Sprint EVDO network. Free access to
the Internet via cellular networks is available at no cost to the consumer. The goal of Amazon is
to change the way people enjoy media content. Amazon offers over 540,000 titles for the Kindle,
containing the largest selection of the books available for reading devices, including U.S. and
international newspapers, magazines, and blogs. New York Times best sellers and new releases
sell for $9.99, most daily newspapers are available for $5 to $10 per month, and magazines are
approximately $1.50 per month. The Kindle store offers thousands of free popular classics
including titles such as The Adventures of Sherlock Holmes, Pride and Prejudice, and Treasure
Island. In addition, customers can download over 1.8 million free, pre-1923, out-of-copyright
titles from other websites. In 2010, Macmillan, a group of publishing companies in the United
States, requested that Amazon increase the price of its book selections from $9.99 to around $15.
Amazon, in response to the request for new pricing, temporarily removed Macmillan books from
the Kindle store. Another key player in the e-book pricing environment is Apple. Apple offers
publishers the chance to sell their content through its new iBooks store. All publishers who
choose the iBooks store to distribute their content have the ability to set the retail price. Apple
would also collect 30 percent of the retail price using the agency model. This agency model used
by Apple gives publishers more control in pricing. Typically, the prices for newly released ebook editions are $12.99 to $14.99. Amazon's introduction of the Kindle is a response to the new
market dynamics. Amazon’s insistence of a $9.99 price point was an attempt to offer a flat, easyto-understand rate to help build a new market. However, the correct retail price, along with its
impact on publisher pricing, has yet to be determined for the long run. How much power do
publishers have over the retailers. What pricing strategy should Amazon adopt for the long-term
success of the Kindle and e-books?
Suggestions for Presentation
This case could be assigned for various out-of-class or in-class discussion activities.
Out of class
Search the Internet for e-books and e-book readers. Describe the psychological, legal, and ethical
aspects of pricing.
Do a literature review of the history of e-books/readers. Evaluate using what you have learned on
key pricing strategies.
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Chapter 11: Price the Product
On the internet, view Amazon’s Web site. In your opinion does it contain any unique
information that would lead you to saving your money to purchase an e-book/reader? Support
your position either with supporting a purchase or why you would not.
In class
Discuss in class how can the company can build on the current consumer sentiment with a future
approach to pricing that assures long term success for the brand? Evaluate from both the
monetary and nonmonetary forms discussed in this chapter.
Describe how marketers use costs, demands, and revenue to make pricing decisions.
Suggested Answers for Discussion Questions
1. What is the decision facing Amazon
Students may come up with a number of different decisions that Amazon might make such as:

Amazon needs to develop a long-term marketing strategy that will include a future
approach to pricing that assures long-term success for the brand.
2. What factors are important in understanding this decision situation?
The following factors are important in understand this decision situation:




Amazon offers over 540,000 titles for the Kindle, containing the largest selection of the
books available for reading devices, including U.S. and international newspapers,
magazines, and blogs.
Customers can download over 1.8 million free, pre-1923, out-of-copyright titles from
other Web sites
In 2010, Macmillan, a group of publishing companies in the United States, requested that
Amazon increase the price of its book selections from $9.99 to around $15. Amazon, in
response to the request for new pricing, temporarily removed Macmillan books from the
Kindle store. Macmillan proposed using an agency model in which the publisher sets the
retail price and collects 70 percent of the sale. Amazon would receive the remaining 30
percent of the proceeds. If Amazon did not agree to the proposal, Macmillan would offer
Amazon the opportunity to purchase e-books using the current wholesale model and pay
50 percent of the hardcover list price. Amazon would be free to set the retail price at any
level; however, Macmillan would only allow access to the e-book version seven months
after the hardcover release.
Another key player in the e-book pricing environment is Apple. Apple offers publishers
the chance to sell their content through its new iBooks store. All publishers who choose
the iBooks store to distribute their content have the ability to set the retail price. Apple
would also collect 30 percent of the retail price using the agency model. This agency
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Part 3: Create the Value Proposition

model used by Apple gives publishers more control in pricing. Typically, the prices for
newly released e-book editions are $12.99 to $14.99.
Amazon’s insistence of a $9.99 price point was an attempt to offer a flat, easy-tounderstand rate to help build a new market.
3. What are the alternatives?
Students might recommend a variety of different alternatives. Some possibilities are:




Now that the brand has been established as a popular product, the company can lower
their prices to attract a wider market of consumers who are interested in e-books/readers
but cannot afford the product at its current prices.
Amazon can leverage its brand equity and diversify into other Internet product lines for
consumers.
Amazon can continue their business as they have been doing, confident that they have a
formula that is working and will continue to work in the future.
Amazon should realize that competition in this market is expanding at an exponential rate
and do extensive marketing research to determine the appropriate pricing strategies.
4. What decision(s) do you recommend?
Students may focus on one or more of the alternatives developed. They should be encouraged to
discuss which alternative actions are more critical.
5. What are some ways to implement your recommendations?
Students may make a variety of suggestions for implementation depending on their
recommendations. These may include specific promotion activities, specific pricing, research
activities and many others.
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Chapter 11: Price the Product
WEB RESOURCES
Accenture (global management consulting, technology services and outsourcing company
website): http://newsroom.accenture.com/index.cfm
Saturn website: http://www.saturn.com
Kelley Blue Book website: http://www.kbb.com/kbb/NewCars
Taco Bell.com: http://www.tacobell.com
Top Flite Strata Golf Balls website: http://www.we-got-your-balls.com/Golf-Balls/TopFlite+Strata+Golf+Balls.html?pid=77&src=GoogleDC-GBP
Wal-Mart website: http://www.walmart.com
Priceline ticket sales: http://www.priceline.com
iTunes website: http://www.apple.com/itunes
Online tickets website: http://www.tickets.com
Consumer Reports website: http://www.consumerreports.org/cro/index1.htm
Better Business Bureau website: http://welcome.bbb.org
Lands End website: http://www.landsend.com/cd/frontdoor
National Association of Trade Exchanges website: http://www.nate.org
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