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FEMBA Class 9 Notes
Feb 15
Price as one of the four P's Distribution and Competitive Advantage Nagle,
10, 11, 12
How does price relate to the other P's (product, placement and promotion). Successful
pricing must be internally consistent with the other aspects of the marketing plan. They,
in turn, must be consistent with the pricing. Wal-Mart is known for its efficient
distribution. This is a major competitive advantage. This is why they can price compete
the way they do and remain profitable. How is price related to the distribution channel?
Nike is known for styling and quality and high advertising budget, allowing them to
command higher prices. What are the keys to sustainable profitable pricing? We will
also tie this discussion back to the earlier market structure discussion. These are the
issues addressed here.
Pricing as Part of the Marketing Mix
Correct Pricing requires addressing Price as one of the four P's:
Product
Price
Promotion
Place
Relationship of Price to Product:
The product will partially determine its own reference value in a number of ways:
1. Perceived quality will affect the value perceived with the product.
2. How it is used affects its value through the relationship with
a. Substitutes (goods that are alternatives to each other, e.g., coffee and
tea)
1. Close substitutes will set reference price
2. Alternative models within a brand and product will be
interdependent with the most expensive one affecting the
perceived value of the less expensive ones, inflating their
reference price. Excessively inexpensive models will cheapen
the brand image affecting all other models.
3. Products with multiple uses, especially in multiple markets will
face different competition in each market, changing the desired
price due to different alternatives for the respective consumers.
4. The extent of differentiation will determine how interdependent
the demands for substitutes are.
5. Marginal revenue will be decreased to the extent that the
substitute good is one of ours, decreasing sales of the substitute
product when one of this product is sold.
b. Complements (goods bought /used together) e.g., coffee and cream)
1. If there are complements for the product, the own price
elasticity will be lower due to the product being only part of the
cost.
2. If there are complements, Marginal revenue is higher to the
extent that the sale of this product attracts sale of the
complement from this firm.
3. The demand for this product can be autonomously affected by
price or other demand factors affecting the complementary
product.
4. Total cost of the complex good is likely to be the factor
determining whether the sale is made.
3. Loss Leaders - products priced low to attract customers to buy other
products. Called loss leader because sometimes the price is actually dropped
below average variable cost.
a. Goods with a lot of complements are good candidates for loss
leaders.
b. Another factor suggesting loss leader is high demand elasticity.
c. Frequently purchased items purchased by price sensitive customers
are the best loss leaders. High frequency increases price awareness
(hence sensitivity) and number of opportunities for price to have an
impact. Price sensitivity increases the extent of the effect on
behavior of a particular low price.
d. Multi-product firms are most likely to benefit from loss leader
pricing, since they will most likely have the most opportunity to
benefit from the additional customers.
4. Position in the product line affects perception of the product
a. Least expensive looks like a "deal," but possibly "cheap."
b. Most expensive raises reference price, but may not sell many units
because it is "most expensive."
c. The demand for the second most expensive item in the product line is
increased by the existence of the more expensive "covering" item.
Promotion
Advertising price increases the price sensitivity for the product by making comparison
easier and by educating the customer of what the price is. If the company has a cost
advantage, advertising price is beneficial (e.g., Wal-Mart)
Advertising increases the overall price sensitivity.
Advertising attracts new customers.
Advertising increases the impact of a price reduction.
Advertising is more effective when price is low.
Undifferentiated products need limited explanation and are therefore more appropriately
promoted through low cost methods or price. This is because customers will find it easier
to switch and therefore it is difficult to raise the price to reap the gains from additional
customers to cover high advertising expense. The higher price will drive the customers
away.
Differentiated products require more explanation of their benefits. Switching is harder or
less likely so price can be higher and can pay for more intensive advertising efforts.
High value can justify high price, if it is explained.
Promotional budget should be allocated by profit contribution and added to as long as the
marginal profit for additional advertising exceeds the marginal cost of the advertising.
Weak brands warrant tepid advertising due to limited profit potential. Strong brands
warrant strong advertising due to the high profit potential. These statements are qualified
to the extent that the advertising responsiveness is different.
Price can be a promotional tool
1. Specially marked packages (introductory offer, one time offer, special price,
20% more).
The key here is to be sure that the price is seen as temporary. If it is not, it will
decrease the reference price for the product, and may dilute the quality image. The goal is
to attract future sales (a complementary product to the current sale). Designing the price
reduction is important as it needs to limit multiple access, maintain the reference price,
and target new customers.
2. Coupons ($1 off on two, second one half price)
Coupons and rebates became popular marketing techniques after President Nixon
implemented price controls in 1971. After they were lifted, companies that had been
caught with low prices raised their prices above the desired level and gave rebates as a
hedge against the re-imposition of the price controls. They proved to be such good
marketing tools that they stuck.
Coupons are costly to administer and are subject to fraud.
3. Rebates ($1,000 cash back, $20 rebate)
Rebates avoid the cost and the fraud issues of coupons, and they serve as a
marketing survey device as well. The allow control of who can use them. And many
consumers fail to send them in even though they may have helped induce purchase.
4. Defensive dealing (decreasing price in response to competitive price drop)
Can be expensive for companies with a large customer base. Can tarnish product
or company image or decrease customer loyalty. This may not be the most cost-effective
way to defend a brand.
5. Trade discounts (discounts to wholesalers that lead to price reductions or
additional sales effort in the distribution channel).
These can be effective in preempting a distribution channel. It also may be a way to
prompt initial use or to get the distributor to advertise or otherwise push the product.
Channel strategy
The channel is the means by which the product or service is delivered to the customer.
Internet and e-commerce have made significant changes in the distribution channel. This
makes this issue much more important and complex. Typical distribution is one-to-many
(for the firm) as the supplier sells ultimately to many customers, and many to many for
the market, as many firms serve many customers (often with overlap). The length and
breadth of distribution channel appropriate will vary with the nature of the product, the
nature of the customer, the cost structure of the firm, the firm’s goals, and competition.
The primary value of the distribution channel is its facilitating the exchange of
information and its making the exchange between provider and ultimate customer more
efficient.
Channel policy affects:
Reference value
Product immage
Ability to differentiate
Ability to target specific segments
Ability to implement desired pricing strategy
Ability to control distribution of profits within the channel
Pricing should encompass the whole channel
The distribution channel must be efficient (have no non-value-added elements)
Superior value must be delivered to capture this value
The marketing effort of the firm is distributed throughout the distribution channel. That
is, anyone in the channel who makes money is working for you. You should understand
the incentives you have created in the channel to motivate their behavior.
Direct – no intermediaries
Indirect – uses intermediaries
Mixed – uses both
Dispersed customer base often requires intermediaries (or Internet)
Customer preferred buying method may direct desired channel.
Size of order can affect channel (larger customers more likely to buy direct to save cost)
Are there established channels? Are they efficient? Do they provide market access?
Legal issues preclude resale price maintenance, but not “suggested retail price”
Too high a price (providing margins for the distributors) may laed to too low
volume.
Too low price may affect product image
What are the information needs of the customer to warrant purchase – Choose and use
channel to provide these (Experience good? Technical product needing training? High or
low cost?)
Push or pull through marketing
Push provides incentives for the distributors (sample texts to professors)
-costs largely variable, allows costs to vary with volume as it develops
-if distributors come with access to markets (candy machines)
-if distributors “augment” product (bottlers)
-good for niches
-good for complex products that need to be explained
Pull through markets directly to consumer so that they will request from distributors
(Intel, prescription drugs)
-require more sophisticated marketing – need larger market to pay for
-good for mass marketing
-good for easy to explain products
Channels earn by
-providing augmentation
-high margins between input price and sale price
-volume
-efficiency in distribution activities
Success factors:
-understand customer value
-successful bundling through the channel (product, service, information)
-design pricing to compensate successful distribution
Example:
Walmart -provides customers to their suppliers in return for low wholesale prices.
-deals directly with suppliers shortening the distribution chain
-buys in bulk and int4ernalizes distribution to allow suppliers economies of scale
which are passed on
-product selection designed to maximize price elasticity and cross price elasticity
(using price of one product to pull in customer so they will buy multiple products)
e-commerce
-efficient channel
-promotes price comparison, increase price elasticity
-reverse auctions increases competition, driving down price
Summary:
The successful distribution channel strategy
Comprehends what drives customer value
Creates bundles that provide this value
Communicates this value throughout the channel
Convinces target customers to pay for the value (and distributors to provide it)
Captures the reward for successful provision of value
Chapter 12 still to come
Competitive Advantages
Competitive advantage is the one of the few lasting ways to be profitable (without
governmental involvement). That is, competitive advantage is a potential lasting barrier
to entry, preserving profit.
There are two categories of competitive advantage:Cost and Product Characteristics
Cost
Internal cost efficiencies
Scope (the selection of products) can allow sharing of costs across product, providing
efficiencies to each.
Scale (the volume of operation) may allow
Specialization
Spreading overhead
Efficient organization of production
Incremental costs below average costs
Size (how much does cost per unit fall as volume rises)
Extent (what percent of market needed to reap economies)
Limit-entry pricing – price so that there is limited incentive to enter due to the
scale necessary to make a profit.
With limited market size, and large economies of scale, entry is difficult.
Risk – economies of scale make drops in quantity sold costly, may leverage the firm.
Experience
Related to total volume over time, not rate per period. Learning curve—costs drop
permanently with additional experience.
With Experience economies Next-in-First-Out should be practiced to foster the
continued decline in costs through increased volume.
Risk – buyers may not be price sensitive, decreasing the value of price drops
-if value added is a small part of cost, so economies will be limited
-competitors may respond, limiting expansion from price drops
-experience advantages may be publicly achievable.
-experience may be multiproduct
-may not be related to volume, but some covariate. (If caused by individual
learning of employees, turnover could cause a loss of this advantage)
External
Buyer Focus – by focusing on one buyer or type of buyer, the firm can develop specific
procedures to make the interaction efficient (transportation, bargaining, material waste,
training). For example, Southwest focuses on short-haul private (as opposed to business)
travel.
Logistical Integration – economize on the methods or processes rather than the input
use. Walmart = efficient distribution; Dell = efficient parts inventory usage (minimized);
standardization allows minimizing inventory.
Transfer Pricing – integrate vertically (input to consumer) to allow most efficient
quantity selection at each level. Price inputs of the next level at marginal cost at earlier
level so accumulated MC = MR can be accomplished. Avoids excess profit taking at any
level due to monopoly at this level (this would cause Q to be too low).
Alternatively, paying fixed costs of supplier directly may allow correct pricing between
levels.
Negotiate high initial price and low marginal price to make sure that marginal
units are priced close to marginal cost.
Pay supplier fixed profit for specific volume – to avoid profit being included in
marginal cost.
Temporary Cost Advantages – be wary of pricing based upon short term advantages:
may affect perceived value; may affect long term ability to price.
Product Competitive Advantages
Product Superiority – Intel (requires constant R&D and staying ahead of
evolution of market
Product augmentation (bundle features that are cost efficient providers of client
value)
How to sustain
1. First-mover advantage
a. Name recognition –need to sustain image and customer perceived
value (IBM).
b. Switching Cost effect for customer (product design)
c. Channel preemption – compensate channel providers to preempt other
providers (airline reservation systems, soft drink machines)
d. Scarce resources – buy up rights (Debeers), patent fences (drugs)
e. Niche – segment market and occupy limited niche (L.L.Been)
f. Image – Once image is developed, price-quality effect may preclude
competitive incursions. (Intel, Snap-on tools)