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Chapter 19: Pricing Concepts Prepared by Amit Shah, Frostburg State University Designed by Eric Brengle, B-books, Ltd. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 1 Learning Outcomes LO1 Discuss the importance of pricing decisions to the economy and to the individual firm LO2 List and explain a variety of pricing objectives LO3 Explain the role of demand in price determination Copyright 2010 by Cengage Learning Inc. All Rights Reserved 2 Learning Outcomes LO4 Understand the concept of yield management systems LO5 Describe cost-oriented pricing strategies LO6 Demonstrate how the product life cycle, competition, distribution and promotion strategies, guaranteed price matching, customer demands, the Internet, and perceptions of quality can affect price Copyright 2010 by Cengage Learning Inc. All Rights Reserved 3 The Importance of Price LO1 Discuss the importance of pricing decisions to the economy and to the individual firm. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 4 The Importance of Price To the seller... Price is revenue To the consumer... Price is the cost of something Price allocates resources in a free-market economy 5 Copyright 2010 by Cengage Learning Inc. All Rights Reserved What is Price? Price is that which is given up in an exchange to acquire a good or service. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 6 The Importance of Price to Marketing Managers Revenue - The price charged to customers multiplied by the number of units sold. Profit - Revenue minus expenses. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 7 Trends Influencing Price Flood of new products Increased availability of bargain-priced private and generic brands Price cutting as a strategy to maintain or regain market share Internet used for comparison shopping Copyright 2010 by Cengage Learning Inc. All Rights Reserved 8 LO1 Review Learning Outcome The Importance of Pricing Decisions Price X Sales Unit = Revenue Revenue – Costs = Profit Profit drives growth, salary increases, and corporate investment Copyright 2010 by Cengage Learning Inc. All Rights Reserved 9 Pricing Objectives LO2 List and explain a variety of pricing objectives. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 10 Pricing Objectives Profit-Oriented Sales-Oriented Status Quo Copyright 2010 by Cengage Learning Inc. All Rights Reserved 11 Profit-Oriented Pricing Objectives Profit-Oriented Pricing Objectives Profit Maximization Satisfactory Profits Copyright 2010 by Cengage Learning Inc. All Rights Reserved Target Return on Investment 12 Profit Maximization Setting prices so that total revenue is as large as possible relative to total costs. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 13 Return on Investment Net profit after taxes divided by total assets. ROI = Net profit after taxes Total assets Copyright 2010 by Cengage Learning Inc. All Rights Reserved 14 Sales-Oriented Pricing Objectives Sales-Oriented Pricing Objectives Market Share Sales Maximization http://www.target.com http://www.walmart.com http://www.jcpenney.com Copyright 2010 by Cengage Learning Inc. All Rights Reserved Online 15 Market Share A company’s product sales as a percentage of total sales for that industry. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 16 Sales Maximization • Short-term objective to maximize sales • Ignores profits, competition, and the marketing environment • May be used to sell off excess inventory Copyright 2010 by Cengage Learning Inc. All Rights Reserved 17 Status Quo Pricing Objectives Status Quo Pricing Objectives Maintain existing prices Meet competition’s prices Copyright 2010 by Cengage Learning Inc. All Rights Reserved 18 Review Learning Outcome LO2 Pricing Objectives Profit-Oriented Profit Maximization Satisfactory Profits Target ROI Sales-Oriented Market Share Sales Maximization Copyright 2010 by Cengage Learning Inc. All Rights Reserved Status Quo Maintain Existing Price 19 The Demand Determinant of Price LO3 Explain the role of demand in price determination. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 20 The Demand Determinant of Price Demand - The quantity of a product that will be sold in the market at various prices for a specified period. Supply- The quantity of a product that will be offered to the market by a supplier at various prices for a specified period. http://www.ubid.com Online Copyright 2010 by Cengage Learning Inc. All Rights Reserved 21 The Demand Curve Copyright 2010 by Cengage Learning Inc. All Rights Reserved The Supply Curve Copyright 2010 by Cengage Learning Inc. All Rights Reserved How Demand and Supply Establish Price Price equilibrium - The price at which demand and supply are equal. Elasticity of Demand Consumers’ responsiveness or sensitivity to changes in price. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 24 Price Equilibrium Copyright 2010 by Cengage Learning Inc. All Rights Reserved Elasticity of Demand Elastic Demand Inelastic Demand Unitary Elasticity Consumers buy more or less of a product when the price changes. An increase or decrease in price will not significantly affect demand. An increase in sales exactly offsets a decrease in prices, and revenue is unchanged. 26 Copyright 2010 by Cengage Learning Inc. All Rights Reserved Elasticity of Demand Elasticity (E) = Percentage change in quantity demanded of good A Percentage change in price of good A If E is greater than 1, demand is elastic. If E is less than 1, demand is inelastic. If E is equal to 1, demand is unitary. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 27 Elasticity of Demand Price Goes... Revenue Goes... Demand is... Down Up Elastic Down Down Inelastic Up Up Inelastic Up Down Elastic Up or Down Stays the Same Unitary Elasticity Copyright 2010 by Cengage Learning Inc. All Rights Reserved 28 Elasticity of Demand Copyright 2010 by Cengage Learning Inc. All Rights Reserved Factors that Affect Elasticity of Demand Availability of substitutes Price relative to purchasing power Product durability A product’s other uses Rate of inflation http://www.columbiahouse.com Online Copyright 2010 by Cengage Learning Inc. All Rights Reserved 30 Creating Pricing Power Copyright 2010 by Cengage Learning Inc. All Rights Reserved LO3 Review Learning Outcome Role of Demand in Price Determination Copyright 2010 by Cengage Learning Inc. All Rights Reserved 32 The Power of Yield Management Systems LO4 Understand the concept of yield management systems. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 33 Yield Management Systems A technique for adjusting prices that uses complex mathematical software to profitably fill unused capacity. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 34 Yield Management Systems Discounting early purchases Limiting early sales at discounted prices Overbooking capacity Copyright 2010 by Cengage Learning Inc. All Rights Reserved 35 Yield Management Systems • Rental property landlords use yield management systems to raise rents at a faster pace. • The “M/PF Yield-Star Price Optimizer” is similar to pricing systems used by airlines and car-rental companies. • It uses data such as number of vacancies and forecasted market conditions to determine the optimal rent. • Tenants can also take advantage of the technology. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 36 LO4 Review Learning Outcome Yield Management Systems Copyright 2010 by Cengage Learning Inc. All Rights Reserved 37 The Cost Determinant of Price LO5 Describe cost-oriented pricing strategies. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 38 The Cost Determinant of Price Types of Costs Variable Cost Fixed Cost Varies with changes in level of output Does not change as level of output changes 39 Copyright 2010 by Cengage Learning Inc. All Rights Reserved The Cost Determinant of Price Markup pricing Methods Used to Set Prices Keystoning Profit Maximization Pricing Break-Even Pricing Copyright 2010 by Cengage Learning Inc. All Rights Reserved 40 Markup Pricing Markup Pricing – The cost of buying the product from the producer plus amounts for profit expenses n ot otherwise accounted for. Keystoning – The practice of marking up prices by 100%, or doubling the cost. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 41 Profit Maximization Profit Maximization – The method of setting prices that occurs when marginal revenue equals marginal cost. Marginal Revenue – The extra revenue associated with selling an extra unit of output, or the change in total revenue with a one-unit change in output. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 42 Break-Even Pricing Copyright 2010 by Cengage Learning Inc. All Rights Reserved Break-Even Pricing Break-Even Quantity Fixed cost Contribution = = Total fixed costs Fixed cost contribution Price - Avg. Variable Cost Copyright 2010 by Cengage Learning Inc. All Rights Reserved 44 LO5 Review Learning Outcome Cost-Oriented Pricing Strategies Copyright 2010 by Cengage Learning Inc. All Rights Reserved 45 Other Determinants of Price LO6 Demonstrate how the product life cycle, competition, distribution and promotion strategies, guaranteed price matching, customer demands, the Internet, and perceptions of quality can affect price. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 46 Other Determinants of Price Stages of the Product Life Cycle Competition Distribution Strategy Promotion Strategy Perceived Quality 47 Copyright 2010 by Cengage Learning Inc. All Rights Reserved Stages in the Product Life Cycle Introductory Stage Growth Stage Maturity Stage Decline Stage $ $ $ $ High Stable Decrease Decrease Stable High Copyright 2010 by Cengage Learning Inc. All Rights Reserved 48 The Competition • High prices may induce firms to enter the market • Competition can lead to price wars • Global competition may force firms to lower prices Copyright 2010 by Cengage Learning Inc. All Rights Reserved 49 Distribution Strategy Manufacturers • Offer a larger profit margin or trade allowance Wholesalers/Retailers Sell against the brand Buy gray-market goods • Use exclusive distribution • Franchising • Avoid business with pricecutting discounters • Develop brand loyalty Copyright 2010 by Cengage Learning Inc. All Rights Reserved 50 Distribution Strategy Selling Against the Brand- Stocking well-known branded items at high prices in order to sell store brands at discounted prices. Copyright 2010 by Cengage Learning Inc. All Rights Reserved 51 The Impact of the Internet Product selection Second opinions from expert sites Shopping bots Internet auctions Copyright 2010 by Cengage Learning Inc. All Rights Reserved 52 Promotion Strategy/Price Guarantee Promotion Strategy • Price used as promotional tool • Pricing can also be a tool for trade promotions Price Guarantee • Match any competitor’s price • Signals to target market it is positioned as a lowprice dealer 53 Copyright 2010 by Cengage Learning Inc. All Rights Reserved The Relationship of Price to Quality Prestige Pricing - Charging a high price to help promote a highquality image. http://www.vivre.com http://www.ashford.com Copyright 2010 by Cengage Learning Inc. All Rights Reserved Online 54 Dimensions of Quality 1. Ease of use 2. Versatility 3. Durability 4. Serviceability 5. Performance 6. Prestige Copyright 2010 by Cengage Learning Inc. All Rights Reserved 55 LO6 Review Learning Outcome Factors Affecting Price Copyright 2010 by Cengage Learning Inc. All Rights Reserved 56