Download Economics 308 Handout 1 Professor Tom K

Economics 307
Handout 1
Professor Tom K. Lee
Section I: What is marketing economics?
Part 1: What is marketing?
(CH 1)
Marketing is the management of the process by which organizations create value for
customers and build strong customer relationships in order to capture value from
customers in return. It involves the delivery of price, quantity, quality, performance,
style and feature of existing and/or new products & services to current and/or new
customers of organizations for the purpose of achieving organizational objectives
through understanding of customers needs, creating customers’ value, communicating
information to customers, sorting customers, delivering customers’ satisfaction and
extracting customers’ value.
The economic foundation of marketing is lowering transaction costs. Information is costly.
People are imperfectly informed. It is differentially costly for people to differentiate brands,
to make decision, to coordinate their decisions and to monitor & enforce contracts.
Basic marketing questions:
-What are the customers’ needs and wants?
-How, when, how often and why do customers make decision to buy and to use?
-What group of customers to serve (market segmentation, target marketing & market
positioning)?
-How to design customer-driven & customer-driving marketing strategies?
-How to construct a marketing program to deliver superior value to customers?
-How to achieve long-term customer satisfaction and to build beneficial customer
relationships?
-How to capture value from customers and improve customer quality and equity?
-How to ensure an efficient and continual supply of superior products to customers?
Maslow’s hierarchy of needs:
1) Basic survival needs (physiological, e.g. food, clothing & transportation)
2) Safety needs (e.g. housing, banking, security & protection)
3) Social needs (sense of belonging & love, e.g. clubs, restaurants, churches)
4) Esteem needs (self-esteem, recognition & status, e.g. Lexus, diamonds, designer
jeans, cruise)
5) Self- actualization needs (self-development & realization, e.g. meditation, peace corp.)
Customer-driven marketing is to research customers’ needs and wants and provide the
right product &/or service mix to satisfy the customers’ needs. This works well if
customers know what they need and want, e.g. Panda Express.
Customer-driving marketing is to understand customers’ needs and wants better than
they do and creating products &/or services that will satisfy their latent needs. This
works well when customers don’t know what they need or want or even what is
possible, e.g. Apple’s iPod and iPhone.
Marketing strategy is the lay down of the reasoning behind & the method of execution
of a plan to achieve beneficial customers relationship.
Economics 307
Handout 2
Professor Tom K. Lee
There are three steps of marketing strategy:
1) Market segmentation is to divide profitably a heterogeneous market into segments of
more homogeneous customers according to geographic regions, demographic
differences (age, education, gender & race), income levels, psychographic (such as
social class, lifestyle, or personality characteristics), behavioral (attitude, why
purchase, when to buy, when to use) and benefits (what customers perceive to
receive) for differential channels of marketing communication & price discrimination.
2) Target marketing is to select which segments of customers to serve according to the
segment size, growth potential, and degree of competition & product differentiation in
relation to the organization objectives and resources. Hence we can have
undifferentiated marketing, differentiated marketing, concentrated (niche) marketing,
and micro-marketing ( local and individual marketing)
3) Market positioning is arranging for a product to occupy a clear, distinctive, and
desirable place relative to competing products in the minds of target customers. Hence
the key is to identify the organization’s comparative advantage and competitive
advantage against its competitors.
Demarketing (Downsizing) is to stop serving the less beneficial customers temporarily or
permanently by reducing products, services &/or organization units to serve customers.
Marketing mix is the set of controllable and tactical marketing tools (the four Ps:
product, price, place & promotion, or five Ps: if you add people, or seven Ps: if you add
physical evidence and process) that an organization blends to produce the response
it wants in the target market.
Customer relationship management (CRM) is the overall process of building and
maintaining beneficial customer relationships by delivering superior customer value
and satisfaction. Relationship varies from basic relationship to full partnership.
Customer lifetime value is the present value of the entire stream of purchases that the
customer would make less the perceived cost of obtaining the product or service over a
lifetime of patronage.
Customer satisfaction is the difference between what they perceive receiving and what
they perceive promised to receive.
Customer equity is the total combined customer lifetime values of all of the
organization’s customers.
Partnership management is working closely with partners within the organization and
partners outside of the organization to jointly bring greater value to customers.
Supply chain management is to ensure efficient and continual supply of products from
raw materials to components to final products to customers against competitors’ supply
chain. It requires the exchange of technical and managerial information between
upstream and downstream partners. It may also require coordination to achieve
just-in-time inventory control. Since 1990s, three examples standout out in the
successful application of the concept, namely Dell, Baxter and Proctor and Gamble.
Value delivery network is made up of an organization, its suppliers & distributors, and
ultimate customers who are partners with one and other to improve performance of the
entire system to deliver superior value to customers. It emphasizes mutually beneficial
gains to partners.
Economics 307
Handout 3
Professor Tom K. Lee
Vertical marketing system (VMS) is a distribution channel structure in which
producers, wholesalers, and retailers cooperate, under proper incentives, to make a
product &/or service available to customers for use or consumption.
There are three different forms of vertical marketing system (VMS):
-corporate VMS combining production, distribution & sales, e.g. AIG
-contractual VMS such as franchise organization, e.g. MacDonald & its franchises
-administered VMS due to market power, e.g. Wal-Mart & its suppliers.
Horizontal marketing system is a distribution channel structure in which two or more
organizations at one level of delivery to join together temporarily or permanently to
follow a new marketing opportunity. Examples are Wells Fargo Banks in Ralph’s
supermarkets, Starbuck in Von’s and McDonald restaurants in Wal-Mart stores.
Multi-channel distribution system (hybrid marketing channel) is a distribution
channel structure in which one organization sets up two or more marketing channels to
reach one or more customer segments such as direct-mail catalogs, telemarketing,
internet, wholesalers & retailers, and own sales force, e.g. Avon Products.
There are three distribution strategies:
1) intensive distribution to maximize the number of outlets for the product or service,
for example, Kraft and Coca-Cola products.
2) exclusive distribution to limit the number of outlets for all of its products or services,
for example, Bentley dealership.
3) selective distribution to use a subset of willing outlets for its products or services,
for example, Kitchen Aid and General Electric.
Total quality management is a program designed to constantly improve the quality of
products, services and marketing processes. The demand for high quality is due to
rising income per capital, meaning increasing opportunity cost of time spent in repair
service, e.g. Toyota Motors. Six Sigma method attempts to reduce defect to less than
3.4 per million through Define, Measure, Analyze, Improve and Control.
Marketing management is the decision management and decision control of marketing
programs.
Decision management consists of initiation of alternatives and executions of a ratified
initiated alternative.
Decision control consists of ratification of an initiative, and monitoring, evaluating &
rewarding of ratified-initiative execution.
Decision management and decision control must be separated to avoid conflict of interest
with decision management done by lower level of hierarchy and decision control by
higher hierarchy of an organization.
There are three stages of marketing:
1) Entrepreneurial marketing is marketing by face-to-face contact and by word of mouth
of a start-up organization, e.g. Bear Naked yogurt bars.
2) Formulated marketing is marketing by mass media by a just-proved-to-be successful
organization, e.g. T-Mobile.
3) Intrepreneurial marketing is fine-tuning of mass media marketing for a well
established organization, e.g. Pepsi Cola.
Economics 307
Handout 4
Professor Tom K. Lee
Organizations form marketing alliances such as:
-product/ service alliances jointly market their complementary products & services, e.g. Dell & Intel.
-promotional alliances jointly promote one and other’s products or services, e.g. trade shows.
-logistics alliances offer distribution channels for one and other’s products/services, e.g. Shanghai
Airline teams up with other local airlines for cargo shipping to compete with UPS & FedEx.
-pricing alliances reciprocate the acceptance of one and other’s discount coupons, e.g. CVS &
Rite Aid.
Note that this is not price-fixing, which is illegal. However, businessman has the right to meet
competitors’ lower prices.
Part 2: What is marketing economics?
Basic marketing economic questions
-How to define a market?
-How do customers perceive value, make decision to buy and feel satisfied?
-What is the optimality condition of spending on different marketing tools?
-How to set pre- and post-sale service and product price and quality to capture value?
-How to motivate partners of an organization to achieve marketing objectives?
-How are the equilibrium marketing strategies among rivals determined?
-How would difference in market structures affect the equilibrium marketing strategies?
-What is a winning strategy of a business game?
A market is a set of actual & potential buyers, actual & potential sellers, and actual &
potential agents to facilitate their decisions to transact a product or service.
Cross-price demand elasticity and cross-price supply elasticity
Comparative advantage is the lower opportunity cost in pursuing a given marketing tool
relative to another.
Revenue possibility frontier is the combinations of revenues that can be efficiently
generated by different marketing tools.
Competitive advantage over competitors is the ability to offer customers greater value,
either through lower price, or by offering more benefits that justify higher price.
Micro-environment consists of partners of an organization that affects it ability to serve
its customers, such as organizational architecture, suppliers, marketing intermediaries,
customer markets, competitors and publics (government publics, citizen-action publics,
local publics, general publics and internal publics).
There are three components to organization architecture:
1) Assignment of decision rights & the right info to the right person to make the right decision
2) Setting of incentive & risk sharing to motivate members of an organization
3) Monitor, evaluate and rewarding members of an organization
Marketing intermediaries help the organization to finance, promote, produce, store,
distribute and sell its products to customers, such as financial intermediaries, marketing
service agencies, physical distributors and resellers.
Macro-environment is the larger social forces that affect the microenvironment, such as
demographic, economic, natural, technological, political and cultural forces.
Economic 307
Handout 5
Professor Tom K. Lee
Political, Economic, Social, Technology Analysis
Notable demographic environment: The world population stands at 6.4 billion. The post –
World War II baby boom in US produced 78 million baby boomers, born between 1946
and 1964. Today baby boomers account for 28 % of the population but earn more than
50% of all personal income. They constitute a lucrative market for new housing and
home improvement, financial services, travel & entertainment, dining out, health and
fitness products & services, and luxuries. For example, baby boomers are spending $30
billion a year on anti-aging products and services. The 72 million babies of the baby
boomers are the generation Y, born between 1977 and 1994. They have an average
disposable income of $103 per week which amount to $175 billion spending per year
and they influence another $30 billion in family spending. They are impatient, tech
thirsty, independent and achievers. Other notable demographic changes are: changing
American family composition and style, female labor force participation, geographic
shifts in population, more better-educated white collar population, and increasing racial
diversity.
Notable economic environment: rising average income of households, continue
skewed income distribution, and “squeezed consumers”. Consumers at different income
levels have different spending patterns. For example, as family income rises, the
percentage of income spend on food, housing and transportation declines, percentage
spend on clothing remains constant, and percentage spend on insurance increases.
Notable natural environment: growing shortage of raw materials, rising pollution, and
increasing government intervention.
Notable technological environment: genetic engineering, nanotechnology, new
pharmaceutical drugs, internet, and electronic gadgets. Increasing number of specialty
channels in TV broadcasting and magazines reduce mass communication effectiveness.
Notable political environment: more deregulation, more legislatures & more capitalism.
Notable cultural environment: Baby boomers are adventurous, better educated, more
caring, and re-treading for early retirement to pursue alternative lifestyle. Generation Y
are highly motivated for economic well-being, in control, returning to traditional value,
active lifestyle, and balancing career, fun and family.
Strategic planning is the process of developing a strategic fit of an organization’s goals
and capabilities against changing environment & opportunities.
There are four marketing strategies for growth:
-Market penetration is a strategy for an organization to increase sales of existing
products &/or services to existing market segments, e.g. family-owned car dealership.
-Market development is a strategy for an organization to identify and develop new
markets segments for existing products &/or services, e.g. GM in China.
-Product development is a strategy for an organization to offer refined or new
products &/or services to existing market segments, e.g. Colgate toothpaste.
-Diversification is strategy of an organization to introduce refined or new products
&/or services to new market segments, e.g. Bank of America.
Economics 307
Handout 6
Professor Tom K. Lee
There are three implications of Economic Darwinism:
1) successful organizations under competition are not random, e.g. Apple.
2) organizations’ success is relative and not absolute, e.g. GM vs Ford.
3) to remain successful an organization must adapt to new technology (Kodak),
Competition (Walmart), or regulation change (United Airline).
Benchmarking is identifying the best organization under competition or the best
departmental unit in an organization & imitating it, e.g. Walmart vs Target.
Section II: Basic marketing economics
Part 3: Basic economic principles
Basic economic principles
-people are non-satiated (in quality, performance & features), self interest and smart.
-resources are limited.
-prices economize on the cost of transferring information to coordinate decisions.
-people do tradeoff, e.g. monetary and non-monetary rewards are both important.
-people react to incentive and do cost benefit analysis.
-opportunity cost is the relevant cost
-marginal analysis, e.g. MR=MC & MR=P[1+1/e]
-own- (cross-) price demand (supply) elasticity and inverse demand elasticity rule
-information is costly, imperfect & asymmetric: adverse selection & moral hazard
-people are risk averse & there is risk premium.
-diversify but don’t diversify for the sake of diversification
-transaction costs dictate marketing practices, strategies, communications and signaling
-voting with your feet: Tiebout location equilibrium for consumers & Producers
-there is time value of money.
-three elements of decision theory (objective, information and control variables)
-five elements of game theory: # of players, objectives of the players, information sets
of the players (SWOT/PEST analyses), strategy sets of the players, and equilibrium
concept of the game; sub-game perfectness and first-mover advantage
-Free Rider Problem
-network effect, e.g. facebook
-fixed cost: economies of scale & economies of scope
-learning curve effect and cumulative output
Part 4: What is a firm, why it exists and why firms cluster?
Economic transactions involve transaction costs, including search, information,
bargaining, decision, monitoring & enforcement costs. The optimal method of
organizing an economic transaction is the one that minimizes transaction costs.
A firm is a focal point of a set of implicit and explicit contracts.
A contract is an agreement to facilitate deferred exchange.
Legal contracts are, but implicit contracts are not, enforceable in a court of law.
Economics 307
Handout 7
Professor Tom K. Lee
There are five reasons for a firm to exist:
1) to reduce transaction costs and to achieve information specialization, e.g. Dell.
2) to enjoy economies of scale and scope, GM & McDonald.
3) to diversify risk, e.g. GE.
4) to solve problems of specific assets, e.g. Alcoa.
5)to pose bond to trading partners through reputation, Sears.
Specific assets are assets that are worth more in their current use than in alternative uses.
There are seven reasons for firms to cluster:
1) sharing intermediate inputs, e.g. dressmakers cluster around a button-maker
2) sharing a labor pool to transfer labor from unsuccessful firms to successful firms
3) job-worker matching
4) knowledge spillovers such as many start-up firms cluster around research universities
5) economies of scale in local public goods (education, sports, utilities) and social opportunities
6) reduce transportation cost e.g. bauxite mine & smelting plant are close together.
7) to form network organization to enjoy (avoid) (dis)economies of scale & scope
Examples of firm clustering:
-information technology in San Jose, CA
-financial services in New York, New York
-hospitality and tourism in Las Vegas, Nevada
-analytical instruments in Boston, MA
There are three facts of a firm:
-There are many decision makers within a firm.
-The primary objective of most decision makers is not to maximize the value of a firm.
-Firms often use internal pricing and market to allocate internal resources.
Part 5: Consumer behavior
There are eleven factors that affect consumer behavior:
1) Income: Engel curve, opportunity cost of time and the demand for quality
2) Prices: first& second law of demand, cross-price demand elasticity (substitutes,
complements), and price/quality relation
3) Transaction costs: information cost, experience & reputation, search cost & location,
branding (packaging & labeling), co-branding (Ford Motors and Eddie
Bauer co-branded a sport utility vehicle) and decision cost & new products
4) Business cycle: cyclical industries versus non-cyclical industries
5) Age & interest rate: life-cycle theory of consumption, experience & learning
6) Occupation/education: standards (e.g. dress code) and customs (e.g. dining out)
7) Gender: difference in demand elasticity across gender differences
8) Family composition: single, married couple, living-together partners etc.
9) Culture: choice of product mix, holidays & celebration events, and working days per week
10) Personality is the unique psychological characteristics that lead to relatively consistent
and lasting responses to one’s own environment such as sociable persons go to Starbucks.
Economics 307
Handout 8
Professor Tom K. Lee
11) Lifestyle: AIO dimensions
-activities (work, hobbies, habits, and social & cultural events)
-interests (food, fashion, family, recreation)
-opinions (about themselves, social and political issues)
There are four types of buying decision behavior:
1) Complex buying behavior is when consumers are highly involved in a purchase
and perceive significant differences among brands, e.g. cars & houses.
2) Dissonance-reducing buying behavior is when consumers are highly involved
in a purchase but perceive little differences among brands, e.g. air travel.
3) Habitual buying behavior is when consumers are lowly involved in a purchase
and perceive little significant differences in brands, e.g. salt, pepper and sugar.
4) Variety-seeking buying behavior is when consumers are lowly involved in a
purchase but perceive significant differences among brands, e.g. cereals &
clothing. In this case, consumers tend to do a lot of brand switching to seek variety.
Price discount, coupons, free samples, and advertising are most useful in this situation.
Consumers are highly involved in a purchase because the purchase is expensive, e.g. a
car; infrequent, e.g. a house; or risky, e.g. medical services.
When consumers’ perceived brand differences are small, they tend to buy quickly and
respond to price differences or purchase convenience, e.g. banking services.
Part 6: New product adoption
There are six stages in a new product adoption process:
1) Awareness: consumers are informed of the new product availability.
2) Interest: consumers show interest by acquiring more information of the new product.
3) Evaluation: consumers do cost benefit analysis of trying the new product.
4) Trial: consumers try a small amount of the new product.
5) Adoption: consumers decide to make full scale and regular purchase of the new product.
6) Confirmation: Consumers remain loyal to the product.
Consumers’ tendency to adopt a new product is positively related to younger age, better education,
and higher income.
There are five product characteristics that determine new product adoption rate:
1) Relative advantage is the degree to which the new product appears superior to
existing products in price, quality, performance or feature.
2) Compatibility is the degree the new product fits the values & experience of consumers.
3) Complexity is the degree to which the new product is difficult to understand or use.
4) Divisibility is the degree to which the new product may be tried on small scale.
5) Communicability is the degree to which the results of using the new product can be
observed by or transmitted to others.
A successful new product must be able to satisfy some levels of consumers’ needs, e.g. in the
factory you manufacture cosmetics but at the store you sell hope of rejuvenation.
Economics 307
Handout 9
Professor Tom K. Lee
Part 7: Product branding and product line
A brand is a name, term, sign, symbol, design, or a combination of these that identifies the
maker or seller of a product or service. Brand names help consumers to reduce information
costs or to added value through economic signaling.
Brand equity is the extent customers are willing to pay extra for the brand, e.g. Coca-Cola’
brand name is worth $67 billion, Microsoft $61 billion, and IBM $54 billion.
Packaging and labeling help the identification of a product or brand.
There are four major marketing strategic decisions for brand:
1) Brand positioning is to impact customers of the brand’s product attributes, desirable
benefits, and strong beliefs & values, e.g. Wal-Mart vs Nordstrom & Timex vs Rolex.
2) Brand name selection is to find a brand name that suggest product’s benefits and
qualities, e.g. Beautycrest, Kleenex, Craftsman, OFF bug spray; is easy to pronounce,
recognize, and remember, e.g. Tide, Crest; is distinctive, e.g. Lexus, Kodak; is
extendable, e.g. amazon.com expand from bookselling to selling other products; is easy
to translate into foreign languages without bad connotation, e.g. Exxon doesn’t want to be
called Enco which means stalled engine in Japanese; and is capable of registration and
legal protection.
3) Brand sponsorship is to sell a product as manufacturer’s brand, e.g. PG’s Tide; private
brand, e.g. Kirkland Signature of Costco and Sam’s Choice of Wal-Mart; licensed brand
for royalty, e.g. Calvin Klein and Gucci; and co-brand, e.g. Ford Explorer, Eddie Bauer
Edition and Kellogg co-brand with ConAgra to develop Healthy Choice breakfast cereal.
4) Brand development is to add new items to the brand through line extensions (existing
brand names extended to new forms, sizes, and flavor of an existing product line, e.g.
Dannon added seven new yogurt flavor, a fat-free yogurt, and a large, economy-size
yogurt), brand extensions (existing brand names extended to new product lines, e.g.
Disney Cruise Lines), multi-brands (new brand names introduced in the same product
line, e.g. P&G’s Tide family and Crest family) and new brands (new brand names in new
product lines, e.g. Toyota’s Scion).
There are three types of cobranding:
1) Ingredient cobranding: identifies the brand of a part that makes up a product, e.g. Intel
processor in a Dell computer,
2) Cooperative cobranding: pooling two or more brand equities in a joint promotion, e.g.
guests in Ramada Inns who paid with an America Express card were automatically
entered in a contest to win a vacation for two from Continental Airline.
3) Complementary cobranding: two or more brand products are marketed for joint use,
e.g. Seagram’s spirits in joint use with 7 up.
The Federal Trade Commission Act of 1914 holds false, misleading, or deceptive labels or
packages illegal.
The Fair Packaging and Labeling Act of 1966 set mandatory labeling requirements such as:
unit price stating the price per unit of standard measure, open dating stating the expected shelf
life of the product, and nutritional labeling stating the nutritional value of the product.
The Nutritional Labeling and Educational Act of 1990 requires all sellers to provide detailed
nutritional information on food product.
Economics 307
Handout 10
Professor Tom K. Lee
A product line is a group of products that are closely related because they function in a similar
manner, are sold to the same group of customer groups, and are marketed through the same
types of outlets, or fall within the same price ranges.
There are three objectives of the choice of product line length:
1) To up-selling, e.g. BMW’s 3-, 5-, and 7- series models.
2) To cross-selling, e.g. HP sells printer and cartridges.
3) To diversify, Gap has several clothing-store chains to cover different price range such as
Gap, Old Navy, and Banana Republic.
There are two ways to lengthen a company’s product line:
1) Product line stretching is to lengthen a product line beyond its current range, e.g.
Daimler-Chrysler introduces its Mercedes C-class; Toyota introduces Lexus; and Marriott
hotels introduces Renaissance to attract and pleases top executives, Marriott for upper
and middle managers, Courtyards for salespeople, and Fairfield Inns for vacationers and
tight budget business travelers.
2) Product line filling is to add more items within the same range of a product line, e.g.
Sony filled its Walkman line by adding solar-powered and waterproof Walkmans, ultralight models for exercisers, the CD Walkman, and the Memory Stick Walkmans to
download tracks straight from the internet.
Product mix consists of all the product lines and items that a seller offers for sale, e.g.
Avon has ten major product lines: make-up, skin care, bath & body, fragrance, hair
care, wellness, gifts, fashion, children and men. Each product line consists of several
sub-lines, e.g. the make-up line breaks down to lips, eyes, nails, face, beauty tools &
beauty gift sets.
There are four ways to increase a company business by increasing:
1) Product mix width is the number of different product lines that a company
carries.
2) Product mix length is the total number of items a company carries within its
product lines, e.g. Avon product mix carries 1,300 items.
3) Product line depth is the number of versions offered for each product in a
product line, e.g. P&G Crest toothpaste comes in 16 varieties.
4) Product line consistency is how closely related the various product lines are in
end use, production requirements, distribution channels etc.
Part 8: Product pricing
There are two types of pricing:
1) Fixed pricing is setting one price for all customers.
2) Dynamic pricing is charging different prices to different customers (e.g. age,
gender, occupation, association, degree of patronage) at different situations (e.g.,
time or geographic markets).
Economics 307
Handout 11
Professor Tom K. Lee
There are four internal factors of pricing:
1) Marketing objectives: survival, profit maximization, market share leadership,
product quality leadership, limit pricing, and promotional pricing.
2) Marketing mix strategy: pricing is one of the four P’s in marketing mix strategy.
Target costing sets an ideal price then controls cost to make it possible to make profit
at that price, e.g. P&G’s Crest SpinBrush electric toothbrush. An alternative will be
to price according to the product quality.
3) Cost: Marginal cost pricing is efficient and profit maximizing in unregulated
industries. Average cost pricing is used in regulated industries.
4) Organizational considerations: In small companies, prices are often set by top
management. In large companies, price is set by divisional or product line
managers. Salespersons usually have flexibility to negotiate within a price range.
Limit pricing is to set price just low enough to make rivals unprofitable but itself still
profitable.
Predatory pricing is to set price below cost to drive out rivals & then raise price later
to recoup losses. This is illegal.
There are three external factors of pricing:
1) Market demand: Own-price demand elasticity and cross-price demand elasticity.
2) Competition: perfect competition, pure monopoly, monopolistic competition,
oligopoly, and dominant firm price leadership.
3) Other environmental factors: Economic conditions such as business cycle, inflation,
and interest rate, government regulation such as antitrust policies, regulatory price
hearings, patent and copyright policies, and fair pricing.
There are four general pricing approaches:
1) Mark-up pricing is to have a fixed mark-up on the cost of the product to set the
price, e.g. retail stores.
2) Value-based pricing (demand-based pricing) is setting price based on buyers’
perceptions of value independent of cost, e.g. Louis Vuitton and Rolex
3) Value pricing is offering the right combination of quality and good service at a fair
price, e.g. value meal menu.
4) Competition-based pricing is to set price following that of the industry leader, e.g.
breakfast cereal.
There are four product-quality pricing strategies:
1) Market-skimming pricing sets a high price at low quality to reap maximum
revenues step by step from the market segments, e.g. new high tech products.
2) Market-penetration pricing sets a low price at high quality to attract a large number
of customers and a large market share to enjoy network effect, PC operating system.
3) Economy pricing is to set low price at low quality to maximize sale volume, e.g. 99
cents Store.
4) Premium pricing (prestige pricing) is to set high price at high quality, e.g. Cunard
cruises. Goldilocks pricing is to provide a “gold-plated” version of a product in
order to make the next-lower priced option look more reasonably priced, e.g. comic
books and sport collectible cards.
Economics 307
Handout 12
Professor Tom K. Lee
There are five product-mix pricing strategies:
1) Product line pricing is to set price steps between various products in a product line
based on cost differences between products, customer evaluations of different
features, and competitors’ prices, e.g. Sony TVs.
2) Optional product pricing is pricing optional or accessory products along with a
main product, e.g. Toyota cars.
3) Captive-product pricing is to set a price for products that must be used along with a
main product, e.g. blades for a razor and film for a camera.
4) By-product pricing is to set a price for by-products in order to make the main
product’s price more competitive, e.g. cocoa bean shells from chocolate candy
making are sold as mulch for gardening.
5) Product bundle pricing is to set a price of a group of products and/or services that is
less than the sum of the individual product/service prices, e.g. two-movie package,
value meal in fast food restaurant, and season tickets.
First (auctions), second (volume discount), third and fourth degree price discrimination,
inverse demand elasticity rule, two part-tariff pricing, and all-or-nothing contracts
There are five forms of pricing:
1) Discount pricing is a straight reduction in price on purchase in a specified period of time, e.g.
cash discount, quantity discount, cumulative quantity discount, functional discount (trade
discount, e.g. airfare special for travel agents) and seasonal discount, e.g. cruises. Allowance
pricing is giving promotional money by manufacturers to retailers in return for an agreement
to feature the manufacturer’s products in some way. The effective price is the price a seller
receives after accounting for discounts, promotions, and other incentives.
2) Segmented pricing is selling a product or service at two or more prices, where the difference in
prices is independent in costs, e.g. customer-segment pricing e.g. textbook & movie ticket prices,
location pricing e.g. airport fast food prices, and yield management. Yield management (revenue
management) is the process of understanding, anticipating and reacting to customer behavior in
order to maximize profits, e.g. Las Vegas hotel room rates & airline ticket prices
3) Psychological pricing is to price a product according to the beliefs of customers, e.g. higher
price means higher quality. Reference prices are prices that buyers carry in their minds and
compare to when they look at a given product.
4) Promotional pricing is temporarily set the price of a product below the list price, and
sometimes even below cost (loss leader), or low-interest financing and extended warranties to
increase short-run sale to clear inventory or to attract customers, e.g. GM employee discount
and white sale after Christmas.
5) Geographical pricing: FOB-origin pricing is pricing a product at the point of sale and customers
have to pay the freight from the point of sale to the destination of the customers, hence free on
board. Uniform- delivered pricing (freight absorption pricing) to set the same price including
freight to all customers irrespective of distance to destination of customers. Zone pricing is for
the seller to set up two or more zones with all customers pay the same price within a zone, but
the more distant the zone, the higher the price. Basing-point pricing is for a seller to designate a
city (where demand is most elastic) as a basing point and charges all customers the freight cost
from that city to the customers.
Economics 307
Handout 13
Professor Tom K. Lee
There are seven steps to develop new product pricing:
1) Develop marketing strategy: reasoning & plan for CRM
2) Make marketing mix decision: 4Ps
3) Demand analysis
4) Cost analysis: fixed, variable and marginal costs
5) Understand environmental factors: PEST (political, economic, social & technological) analysis
6) Setting pricing objectives: short-run vs long-run profit maximizing
7) Determine pricing
Part 9: Promotional Mix
There are five promotional tools:
1) Advertising is any paid form of non-personal presentation and promotion of ideas,
goods, or services by an identified sponsor.
2) Personal selling is personal presentation by an organization’s personnel for the
purpose of making sales and building customer relationships.
3) Sales promotion is short-term incentives to encourage the purchase or sale of a product/ service.
4) Public relations is improve relations with an organization’s various publics by
receiving favorable publicity, building a good organization image, and handling or
heading off unfavorable rumors, stories, and events. Public relations can promote
products, people, places, ideas, activities, organizations, and even nations.
5) Direct marketing is direct connections with carefully targeted individual customers
to both obtain an immediate response and cultivating lasting customer relationships
through telephone, mail, fax, email, and the internet etc.
There are two promotion mix strategies:
1) Push strategy uses the sales force and trade promotion to push the product from manufacturer
to wholesalers, to retailers and to customers. It is supply driven e.g. existing products with rival
substitutes.
2) Pull strategy is to promote a product to customers to build up demand so that retailers,
wholesalers and manufacturers will respond accordingly. It is demand driven e.g. new products.
There are four methods to set promotion budget:
1) Affordable method is to set the promotion budget based on the financial ability of
the organization.
2) Percentage-of-sales method is to set the promotion budget as a certain percentage
of current or forecasted sales or as a percentage of the unit sales price. The
percentage should be equal the demand-price promotion-spending elasticity.
3) Competitive-parity method is to set the promotion budget to match competitors’
promotion spending.
4) Objective-and-task method is to set the promotion budget according to the
objectives of the promotion, the tasks that are needed to achieve the objectives of
the promotion, and the costs of performing the tasks. In other words, it is choosing a
profit maximizing promotional budget.
Incremental sale revenue due to the last dollar spent on each promotional tool should be
the same across all promotional tools.
Economics 307
Handout 14
Professor Tom K. Lee
Part 10: Advertising
There are five major advertising decisions:
1) Setting advertising objective: informative advertising (price, quality, features,
appeal, availability and location) to build primary demand, persuasive advertising
to build selective demand under competition, and reminder advertising for mature
products
2) Decide advertising budget at various stages of the product life cycle
3) Creating advertising message: message strategy is to decide what general message
to communicate to customers, followed by the development of a compelling
creative concept to transform a simple message idea to a great advertising
campaign. Advertising appeal must have three characteristics: meaningful for
product appeal, believable for customers’ confidence of promised benefits and
distinctive for ease of customers to see the difference of this product from its
competing alternatives. Advertising message must be able to reduce transaction cost
to customers or to let customers to see the value of economic signaling by using the
product or service.
4) Select advertising media choice
5) Monitor, evaluate and feedback: communication effectiveness and sales
effectiveness
Advertising strategy consists of creating advertising message and selecting advertising
media.
There are five stages of product life cycle:
1) Development stage has zero sales and heavy investment in developing a product.
2) Introduction stage has slow sales growth but heavy test marketing followed by
commercialization. Profits are low or negative with high distribution and
promotion expenses. Advertising is mostly informative.
3) Growth stage has rapid sales and profit growth. New competitors will enter the
market. Price remains steady or slightly declines, while promotion spending
remains steady or slightly increases. Product quality improves with new features
and models. Advertising is shifted to persuasive.
4) Maturity stage has declining sales growth. Competition is keen. Weaker
competitors drop out. New customers and new markets are explored. Price is
lowered. Service is emphasized. Advertising and sales promotions increase.
Advertising is mostly persuasive and reminder. Mass merchandizing is used.
R&D spending increases to improve the product. Organization has to tradeoff
current profit versus market share.
5) Decline stage has sales declining. Price decline further. More competitors leave
the market. A final decision has to be made whether to continue to drain
management resources and advertising and promotions spending or to drop the
product to release resources for a new product development.
Economics 307
Handout 15
Professor Tom K. Lee
There are four steps in advertising media choice:
1) choosing to reach which target group of customers, frequency in touch with the
target group of customers, and impact (effectiveness) of different advertising media
2) identifying major media types with different effectiveness and costs: newspaper,
TV, mail, email, radio, magazines, billboards, and internet
3) selecting specific media vehicles based on profitability
4) deciding on media timing whether to achieve continuity, e.g. breakfast cereal every
Saturday; or pulsing, e.g. cruises for spring break, and shopping for Christmas
Part 11: Sales promotion and public relations
There are three sets of sales promotion tools:
1) Consumer promotion tools such as sample, coupon, rebate, price mark-down,
premium, advertised specials, patronage reward, point-of-purchase promotion,
contests, sweepstakes, and games
2) Trade promotion tools such as discount, allowance (advertising allowance and
display allowance), and specialty advertising items, e.g. pens and calendars
3) Business promotion tools such as convention and trade shows, and sales contest
There are six public relations functions:
1) Press relations to release news information to attract attention to favorable events,
or to distract attention to unfavorable events
2) Product publicity to launch or re-launch a product
3) Public affairs build relationships with the publics.
4) Lobbying of federal, state and local government representatives
5) Investor relations are present in major corporate headquarters and web sites.
6) Business development
There are ten public relations tools:
1) Timely news release
2) Public speeches from executives, or invited scholars and/or celebrities
3) Special events such as grand openings, firework display, laser shows, hot air
balloon, multimedia presentations, and star-studded spectaculars
4) Buzz marketing to generate excitement and favorable word-of-mouth
communication
5) Mobile marketing such as traveling promotional tours
6) Written materials such as annual reports, brochures, newsletters and magazines
7) Audiovisual materials such as CD and DVD
8) Organization identity materials such as logos, stationery, signs, business cards,
building, uniforms, and vehicles
9) Organization web site, e.g. Butterball’s website features cooking and carving tips.
10) Contribution to community, e.g. 10K walk, tree planting, and giving free bottles
of water after an earthquake by Arrowhead.