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CHAPTER 6
Pricing Products: Pricing
Considerations and Strategies
Objective: looking at the factors when setting
prices and examining the pricing strategies by
focusing on the problem of setting prices.
Factors to Consider
When Setting Prices
A company’s pricing decisions are affected
by;
• internal company factors
• external environmental factors
Internal Factors
Affecting Pricing Decisions
•
•
•
•
Internal factors that affect pricing decisions
include;
the company’s marketing objectives
marketing-mix strategy
costs
organization
Marketing Objectives
• Before setting a price, the company must decide
on its overall strategy (target market, and
positioning, then its marketing mix). E.g. if a car
manufacturer decides to produce a new sports car
for the high-income segment, then the company
must charge a high price.
• Then the company must consider its objectives,
before setting its price. Objectives would be;
– survival; if a company is in trouble because over
capacity, heavy competition, or changing consumer
wants, in order to survive and increase demand, the
company may set a low price. Here, the profits are less
important than survival. If the prices cover the costs,
they can stay in business but survival is only a shortterm objective.
– current profit maximization; some companies estimate
what demand and costs will be at different prices and
choose the price that will produce the maximum current
profit. Here, short-term financial results (cash flow) are
more important than long-run performance.
– market-share leadership; some companies believe that
the company with largest market share will enjoy the
lowest costs and highest long-run profit. That is why, in
order to become the market-share leader, they set their
prices as low as possible.
– product-quality leadership; if a company wants to
become the product-quality leader, it charges a high
price to cover the costs of R&D.
Marketing-Mix Strategy
• Decisions made for the other marketing mix
variables affect pricing decisions. The marketer
must consider the total marketing mix when
setting prices.
• There are two alternatives. Either price
positioning determines the product’s marketing
mix or nonprice positioning determines the
product’s marketing mix.
– In price positioning; the company makes its pricing
decision first and then makes other marketing-mix
decisions on the prices that they want to charge. This
technique is called target costing which reverses the
usual process of first designing a new product,
determining its cost, and then asking the consumers
how much they can pay for it. Instead it starts with a
target cost and price in mind and works back. E.g.
Compaq Computer Corporation calls this process
“design to price”. Starting with a price target set by
marketing, and with profit margin goals from
management, the company determine what costs had to
be in order to charge the target price for its “Prolinea
personal computer line”.
– In nonprice positioning; the company deemphasize
price and use other marketing-mix tools to differentiate
the marketing offer to make it worth a higher price.
They believe that the best strategy is not to charge the
lowest price because customers do not buy on price
alone. Instead they seek products that give them the
best value for their money.
Costs
• Costs set the floor for the price that the
company can charge for its product. The
company wants to charge a price that both
covers all its costs for producing,
distributing, and selling the product and
provides a fair profit.
• A company’s costs are two types: fixed and
variable.
– Fixed costs (also known as overhead) are those
that do not vary with production or sales level
e.g. rent, interest, heat, executive salaries.
– Variable costs vary directly with the level of
production e.g. supplies.
– Total costs are the sum of the fixed and variable
costs for any given level of production.
Management wants to charge a price that
will at least cover the total production costs
at a given level of production.
Organizational Considerations
• Management must decide who will set the prices in the
company.
• In small companies, prices are set by the top management.
• In large companies prices are set by divisional or product
line managers.
• In industrial markets, salespeople may be allowed to
negotiate with customers within certain price ranges set by
the top management.
• In industries where pricing is a key factor (railroads, oil
companies…) there are pricing departments reporting to
the marketing department or top management.
External Factors
Affecting Pricing Decisions
External factors that affect pricing decisions
include;
• the nature of the market and demand
• competition
• other environmental elements
The Market and Demand
• Before setting prices, the marketer must
understand the relationship between price
and demand for its product with the help of
the following;
– pricing in different types of markets
– consumer perceptions of price and value
– analyzing the price-demand relationship
Pricing in Different Types of Markets
• The seller’s pricing freedom varies with different
types of markets. Economists recognize four types
of markets which require different pricing
methods.
– under pure competition; the market consists of many
buyers and sellers trading in a uniform commodity such
as wheat, copper… No single buyer or seller has much
effect on the going price.A seller cannot charge more
than the going price because buyers can obtain as much
as they need at the going price. A seller cannot charge
less as well, because they can sell all they want at this
price. Here, marketing research, product development,
pricing, advertising and sales promotion play little or no
role.
– under monopolistic competition; the market consists
of many buyers and sellers who trade over a range of
prices than a single market price. A range of prices
occurs when buyers see differences in sellers’ products
and are willing to pay different prices form them.
Sellers try to develop differentiated offers (with
advertising, branding…) for different customer
segments.
– under oligopolistic competition; the market consists of
a few sellers who are highly sensitive to each other’s
pricing and marketing strategies. The product can be
uniform (steel, aluminum...) or nonuniform (cars,
computers…). There are few sellers because it is
difficult for new sellers to enter the market. Each seller
is alert to competitors’ strategies and moves. If a steel
company decreases its price by 10 percent, buyers
quickly switch to this supplier. So that the other
steelmakers must respond by lowering their prices or
increasing their services. Here it is not certain that they
will get permanent results through such price cuts.
– In a pure monopoly, the market consists of one seller.
It would be a government monopoly, a private regulated
monopoly, or a private nonregulated monopoly. Pricing
is handled differently in each case. A government
monopoly may have three objectives. (1) It might set a
price below cost because the product is important for
the buyers who cannot afford to pay full cost. (2) Or the
price might be set either to cover costs
or to produce good revenue. (3) It can be set quite high to
slow down consumption. In a regulated monopoly, the
government permits the company to set rates (but that
should yield a “fair return”). In a nonregulated monopoly,
the company is free to set a price at what the market will
bear. But they may not charge the highest price for a
number of reasons: (1) not to attract competition, (2) to
penetrate the market faster with a low price, or (3) to
prevent government regulation.
Consumer Perceptions of Price and Value
• The consumer decides whether a product’s price is right.
That is why, pricing decisions are buyer oriented like the
other marketing-mix decisions.
• Effective buyer-oriented pricing involves understanding
how much value consumers give to the product and setting
a price that fits this value. But is not easy to measure the
value (intangible values are included e.g. taste,
environment, status…) that consumers give to the product.
• If consumers perceive that the price is greater than the
product’s value, they do not buy the product. If consumers
perceive that the price is below the product’s value, they
buy but then the seller loses from its profit opportunities.
Analyzing The Price-Demand Relationship
• Each price that the company might charge will lead to a
different level of demand.
• In the normal case, demand and price are inversely related:
the higher the price, the lower the demand.
• In the case of prestige goods, the demand curve sometimes
slopes upward e.g. one perfume company found that by
raising its price, it sold more perfume rather than less.
Consumers thought that the higher price meant a better
perfume.
• Most companies try to measure their demand curves by
estimating demand at different prices.
Price Elasticity of Demand
• Marketers need to know price elasticity - how
responsive demand will be to a change in price. If
demand hardly changes with a small change in
price, we say that the demand is inelastic. If
demand changes greatly, we say that the demand is
elastic.
• Buyers are less price sensitive;
– when the product is unique or high quality or prestige
– when substitute products are hard to find or when they
cannot easily compare the quality of substitutes
– when the total expenditures for a product is low relative
to their income or when the cost of buying a product is
shared by another party.
• If demand is elastic, sellers lower their price. A
lower price produces more total revenue when the
extra costs of producing and selling do not exceed
the revenue.
A. Inelastic demand
P2
P1
B. Elastic Demand
P2
P1
Q2 Q1
Quantity demanded per period
Q2
Q1
Quantity demanded per period
Competitors’ Costs, Prices, and
Offers
• Another external factor affecting the company’s
pricing decisions is competitors’ costs and prices and
reactions to the company’s own pricing moves.
• The company’s pricing strategy may affect the nature
of the competition e.g. if a company follows a highprice strategy, it may attract competition. A low-price
strategy may stop competitors or drive them out of the
market. Here, the company must learn the price and
quality of each competitor’s offer and price its offer
relative to competition.
Other External Factors
Some other factors must be considered when
pricing;
• economic conditions; such as boom or recession,
inflation, and interest rates affect pricing because
they affect (1) the costs of production and (2)
consumer perceptions of the product’s price and
value.
• resellers; should be considered in pricing because
they should get a fair profit so that they help the
company to sell its products.
• government; laws that affect pricing must be
known so that the company makes sure that their
pricing policies are defensible.
• social concerns; the company’s sales, market
share, profit goals must be viewed by societal
considerations.
General Pricing Approaches
• Companies set prices by selecting a general
pricing approach that includes one or more of the
following factors: (1) product cost, (2) consumer
perceptions of the product’s value - demand, (3)
competitor’s prices and other external and internal factors.
• Following pricing approaches are possible to use;
– the cost-based approach (cost-plus pricing, break-even
analysis, and target profit pricing)
– the buyer-based approach (value-based pricing)
– the competition-based approach (going-rate and
sealed-bid pricing)
Major Considerations in Setting Price
LOW PRICE
No possible
profit at
this price
Product
costs
Competitor’s prices
and other external
and internal factors
Consumer
perceptions
of value
HIGH PRICE
No possible
demand at
this place
Cost-Based Pricing
Cost-plus pricing “markup pricing”
• is the simplest pricing method in which a standard
mark-up (profit margin) is added to the cost of the
product e.g. the cost of producing a toaster is $16
and the producer wants to make a 25% profit,
therefore sets the price at $20.
• the biggest benefits of this approach is that when
all the companies use this approach, price
competition is minimized.
Break-even pricing or target profit pricing
• in which the firm tries to determine the price at
which it will break even or make the target profit
that it wants.
• Target pricing uses the concept of a break-even
chart, which shows the total cost and total revenue
expected at different sales volume levels.
• E.g. fixed costs are $6 million, variable costs are
$5 per unit. The total revenue curve reflects the
price. If the revenue is $12 million on 800.000
units, the price is $15 per unit.
At the $15 price, the company must sell at least
600.000 units to break even where the total
revenues equal to total costs, $9 million. If the
company wants to target $2 million profit, it must
sell at least 800.000 units to obtain $12 million
total revenue needed to cover $10 million total
costs.
• The higher the price, the lower the company’s
break-even point. But as the price increases,
demand decreases. Although this approach helps
the company to determine minimum prices needed
to cover its expected costs and profits, they do not
take the price-demand relationship into
consideration.
Break-even Chart for Determining Target
Price
Dollars
Total revenue
Target profit ($2 million)
12
10
8
6
4
2
0
Total cost
Fixed cost
200
400
600
800
1000
Sales volume in units
(thousands)
Buyer-Based Pricing
• uses buyer’s perceptions of value as the key to
pricing. Here, the marketer set the price based
on the consumer’s desires and then design the
product and the other marketing-mix variables.
• Cost-based pricing is product driven, but
buyer-based pricing is consumer driven.
Therefore, it begins with analyzing consumer
needs and value perceptions.
Competition-Based Pricing
Going-rate pricing
• in which a firm bases its prices on competitor’s
prices. The firm might charge the same, more
or less than its competitors.
• Going-rate pricing is popular when elasticity
of demand is hard to measure and when the
firms do not want harmful price wars.
Pricing Strategies
Basic pricing strategies are;
• New-product pricing
• Product-bundle pricing
• Price-adjustment pricing
New-Product Pricing Strategies
• Pricing strategies usually change as the
product passes through its life-cycle. At
the introduction stage, basically there are
three types of pricing for new products;
– prestige pricing
– market-skimming pricing
– market-penetration pricing
Prestige Pricing
• Hotels or restaurants seeking to position
themselves as luxurious and elegant will enter the
market with a high price. This is called prestige
pricing. Some nightclubs may charge high prices
to attract a certain type of customers. E.g.
Sherlock Holmes.
Market-Skimming Pricing
• When a new product is introduced, the company
charges the highest price that it can to skim (as
skimming the cream on the top of the fresh milk)
the market. The objective is to earn the highest
possible gross profit. As initial sales slow down,
and competitors start to introduce similar
products, the company must lower its prices.
• Here, the company skim off small but profitable
market segments.
• Market skimming makes sense; (1) when the
product’s quality and image support its high price
and enough buyers want it at that price, (2) when
the costs of producing a smaller volume are not so
high that they eliminate the advantages of
charging more, (3) when competitors do not enter
the market easily and cut the prices.
Market-Penetration Pricing
• Market-penetration pricing is that setting a low
price for a new product in order to attract a large
number of buyers and a large market share.
• The high sales volume results in falling costs
which helps the company to cut its price even
more.
• Market-penetration makes sense; (1) when the
market is price sensitive (2) when production and
distribution costs fall as sales volume increases,
(3) when the low price keeps the competitors
away.
Product-Bundle Pricing
• Sellers who use product-bundle pricing combine
several of their products and offer the bundle at a
reduced price. For example, hotels sell specially
priced weekend packages that include room,
meals, and entertainment. Fast food restaurants
offer “menus” that include hamburger, french fries
and a drink. Package tour of travel agencies
include hotel accommodation, transportation and
meals.
• Price bundling can promote the sales of of
products consumers might not otherwise buy, but
the combined price must be low enough to
convince them them to buy the bundle.
Price-Adjustment Strategies
• Companies adjust their prices according to
the differences in customers and changing
situations. There are several price
adjustment strategies;
–
–
–
–
discount pricing
discriminatory pricing
psychological pricing
promotional pricing
Discount pricing
• Volume discounts: Most hotels have special rates
to attract customers who may purchase a large
quantity of hotel rooms. Hotels usually offer
specials prices for travel agencies (group rate),
meeting planners and companies (corporate rate).
• Discounts based on time of purchase: Hotels,
motels and airlines offer seasonal discounts, when
the demand is lower. Seasonal discounts allow the
hotel to keep demand steady during the year.
Discriminatory pricing
Adjusting the basic prices to allow differences in
customers, products, and locations. In this
approach, the company sells a product or service
at two or more prices. There are different
discriminatory pricing forms;
• in customer-segment pricing; different customers
pay different prices for the same product or
service e.g. museums charge students and senior
citizens lower, hotels charge rack rate, corporate
rate, children rate… The least price sensitive
customers are offered the highest prices.
• in product-form pricing; different versions of the
product are priced differently but not according to
differences in their costs e.g. the most favorite or
top model of the product line may have higher
price.
• in location pricing; a company charges different
prices for different locations, even though the cost
of offering each location is the same e.g. theatres
vary their seat prices, hotels vary their room prices
based on the room’s view.
Yield Management
One application of discriminatory pricing is yield
management. A yield management system is used
to maximize a hotel’s revenue. If low occupancy is
projected, the hotel will keep lower rates to
increase occupancy. The idea is to create extra
demand with low rates attracting guests that the
hotel would not have received otherwise. If the
projected occupancy is high, the lower rates will
be closed and only the high rates will be offered to
maximize revenue.
Psychological Pricing
Price says something about the product, especially
about its quality.
• in psychological pricing; sellers consider the
psychology of prices rather than economics.
• The difference between $300 and $299.95 is just
five cents but the psychological difference can be
much greater. Some consumers will see the
$299.95 as a price in the $200 range rather than
the $300 range.
Promotional pricing
Temporarily pricing products below list price, and
sometimes even below cost, to increase short-run
sales. There are several forms;
• loss leaders; fast-food restaurants price a few
items as loss leaders to attract customers to the
store in the hope that they will buy other items at
the normal price. Casinos offer free rooms to their
gaming customers.
• special-event pricing; during slow periods, hotels
may offer a special promotional rate to increase
business. Rather than just discount prices, wellmanaged hotels will create special events. A
Valentine’s weekend special including a room,
champagne upon arrival, a dinner for two, and
breakfast in the room.