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Chapter 11
Pricing
Decisions
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
A Process for Making Pricing Decisions
• Price approaches should consider:
– The business strategy and the other
components of the marketing mix with which it
must be compatible.
– The extent to which the product is perceived
to differ from competitive offerings in quality or
level of customer service.
– Competitors’ costs and prices.
– Availability and prices of possible substitutes.
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A Process for Making Pricing Decisions
• Strategic pricing objectives should reflect
what the firm hopes to accomplish with the
product in its target market.
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A Process for Making Pricing Decisions
• Maximize sales growth
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An early entrant into a new product-market
with the potential for growth, may look to
maximize its product’s rate of sales growth.
It should set a relatively low price to attract as
many new customers as quickly as possible.
This low-priced strategy is called penetration
pricing.
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A Process for Making Pricing Decisions
• Maintain quality or service differentiation
– When a firm has a strong competitive position
based on superior product quality or customer
service, its primary pricing objective is to
generate sufficient revenue to maintain that
advantage.
– Set price relatively high to cover high
production, distribution, and advertising costs.
– Set price high to reinforce prestige image.
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A Process for Making Pricing Decisions
• Maximize current profit: Skimming
– Skimming price policy: Setting the price very
high and appealing to only the least pricesensitive segment of potential customers.
• Maximize current profit: Harvesting
– Attempts to maximize short-term profits before
demand for the product disappears.
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A Process for Making Pricing Decisions
• Survival
– Adopted when the businesses run into trouble
because of strategic mistakes.
– The pricing objective is to keep the product
alive, with a low price, while strategic
adjustments are made.
• Social objectives
– Offering a low price to customers to achieve
some broader social purpose.
– Common among not-for-profit organizations.
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A Process for Making Pricing Decisions
• Estimating demand and perceived value
– The inverse relation between a product’s price
and the quantity demanded: the higher the
price, the less people want to buy.
– Thus, the typical demand curve has a
negative, or downward, slope.
– Prestigious products and those whose quality
is difficult to objectively judge sometimes have
positively sloping demand curves.
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A Process for Making Pricing Decisions
• Factors affecting customers’ price
sensitivity
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Buyers’ willingness to pay a given price is
influenced by their perceptions and
preferences.
The price, availability, and attractiveness of
alternative brands and substitute products.
The size of their incomes relative to the price
influences customers’ ability to pay for a
product or service.
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A Process for Making Pricing Decisions
• Price Elasticity of Demand
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The degree of responsiveness of demand to a
price change.
Elastic
Inelastic
Unitary
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A Process for Making Pricing Decisions
• Methods for Estimating Demand
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Survey a sample of consumers, or bring them
into a laboratory setting, and ask them how
much of the product they would buy at
different possible prices.
Other approaches include estimating the
price–quantity relationship, in-store
experiments or multiple test markets.
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A Process for Making Pricing Decisions
• Estimating Costs
– Fixed costs (or overhead) are constant in the
short term, regardless of production volume or
sales revenue.
– Fixed cost per unit declines as a firm
produces and sells more of the product in a
given period.
– Variable costs vary in magnitude directly with
the level of production, but they remain
constant per unit.
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A Process for Making Pricing Decisions
• Estimating costs
– Total costs equal the sum of fixed and
variable costs for a given level of production.
– Marketing mix costs must also be considered.
• Measuring Costs
– The firm’s cost accounting system.
– Activity-based costing systems.
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A Process for Making Pricing Decisions
• Cost and volume relationships
– Economies of scale
– The experience curve
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A Process for Making Pricing Decisions
• Analyzing competitors’ costs and prices
– The manager needs to learn and track the
price, cost, and relative quality of each
competitor’s offer.
– Reverse engineering can be used to take
apart competing products and estimate the
cost of their components, packing, and
production processes.
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Methods Managers Use to Determine
an Appropriate Price Level
• Cost-oriented methods
– Adding a standard markup to the cost of the
product.
– Rate-of-return, or target return, pricing brings
the cost of capital tied up in producing and
distributing the product into the decision.
– The impact of variations in volume can be
examined by preparing a break-even analysis.
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Methods Managers Use to Determine
an Appropriate Price Level
• Competition-oriented methods
– Firms try to control costs to make adequate
returns at prices consistent with competition.
– Going-rate, or competitive parity, pricing
approach: Maintaining prices equal to those of
one or more major competitors.
– Prices are usually stable in industries until a
price leader decides an increase in prices is
required.
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Methods Managers Use to Determine
an Appropriate Price Level
• Competition-oriented methods
– Discount or premium price policies
– Sealed bidding
– Expected value model
– Internet auction sites make accurate cost
estimates more critical.
– Seller’s auctions and buyer’s auctions
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Methods Managers Use to Determine
an Appropriate Price Level
• Customer-oriented methods
– Pricing to capture the value perceived by the
customer.
– Estimating customer value by assessing
value-in-use.
– Difference between the value perceived by
the customer and the manufacturer’s marginal
cost defines the range of possible prices.
– Single customary price, price lining,
psychological pricing and promotional pricing.
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Deciding on a Price Structure: Adapting
Prices to Market Variations
• Geographic adjustments
– In FOB origin pricing, the manufacturer places
the goods “free on board” a transportation
carrier.
– At this point, the title and responsibility passes
to the customer, who pays the freight from the
factory to the destination.
– In freight absorption pricing, the seller picks
up all or part of the freight charges.
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Deciding on a Price Structure: Adapting
Prices to Market Variations
• Geographic adjustments
– In uniform delivered pricing, a standard freight
charge is assessed every customer,
regardless of location.
– In zone pricing the company divides the
country into two or more pricing zones.
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Deciding on a Price Structure: Adapting
Prices to Market Variations
• Global adjustments
– Prices in different countries may have to be
adjusted for:
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Transportation costs.
Exchange rates.
Variations in competition.
Market demand, or strategic objectives.
Different governmental tax policies or legal
regulations.
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Deciding on a Price Structure: Adapting
Prices to Market Variations
• Discounts and Allowances
– Trade Discounts
– Quantity Discounts
– Cash Discounts
– Allowances
– Price-Off Promotions
– Coupons, Rebates, and Refunds
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Deciding on a Price Structure: Adapting
Prices to Market Variations
• Differential Pricing
– Occurs when a firm sells a product or service
at two or more prices not determined by
proportional differences in cost.
– Common adjustments include:
• Location pricing.
• Time pricing.
• Customer segment pricing.
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Deciding on a Price Structure: Adapting
Prices to Market Variations
• Product-line pricing adjustments
– Required when a firm produces a line of
several models that customers perceive as
bearing some relationship to one another.
– A cross-elasticity is the percentage change in
sales of one product induced by a 1 percent
change in the price of another product that is
assumed to be a close substitute.
– Bundling
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Take-Aways
• Pricing decisions involve an inherent
conflict between:
– The need to win customers by allowing them
to retain a portion of the value inherent in a
product or service and
– The need to maintain profit margins sufficient
to compensate employees, fund growth, and
satisfy the firm’s various stakeholders.
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Take-Aways
• The price of a good or service must be
high enough to cover per unit costs—at
least in the long term—but cannot exceed
its value as perceived by the customer
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Take-Aways
• The decision about what price to select
from within the range of feasible prices
should be based on a careful analysis of:
– Competitors’ costs and prices,
– The product’s strategic objectives, and
– Consistency with other components of the
marketing plan.
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Take-Aways
• Perhaps the key concept in setting a price
is the notion of perceived value.
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Take-Aways
• The final step in deciding what price to
charge for a product or service involves
the development of a price structure that
adapts the price to variations in cost and
demand across geographic territories,
national boundaries, customer segments,
and items within the product line.
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