1. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Introduction to Marketing

2. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Chapter 15 Objectives 1.Define price and explain why cost- based pricing methods are used so widely, and understand the drawbacks of these methods. 2.Incorporate demand considerations into pricing and determine short- term profit maximizing price.

3. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Chapter 15 Objectives 3.Identify and explain strategic drivers of prices. 4.Explain and evaluate reasons why base prices change over time in both business and consumer markets. 5.Explain basic legal and ethical constraints on pricing behavior.

4. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Pricing Strategies and Determination Pricing decisions are complex and driven by many different factors including: –Cost –Competitors –Customer price-sensitivity or elasticity

5. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Defining Price and Determining Base Prices Price is a monetary value charged by an organization for the sales of its products. Market prices are determined by both the buyer’s choice behavior and the seller’s willingness to supply the product. Objective 1

6. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Defining Price and Determining Base Prices Studies of managerial pricing have found cost to be a dominant consideration in pricing decisions. Objective 1

7. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Cost-Plus Pricing Fixed costs- costs that have no relationship to volume. Variable costs- costs that are incurred for each customer. Objective 1

8. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Average Total Cost Average total cost = Variable cost + Fixed Cost Unit Sales Objective 1

9. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Cost-Based Pricing Approaches Two common approaches to setting prices based upon cost: 1.To use a standard rule-of-thumb mark-up. 2.To build up the price by adding together both cost per unit and desired profit. Objective 1

10. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Standard Mark-Up Unit Cost = Unit Cost Selling Price(1 – Markup %) Objective 1

11. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Target Return Pricing Selling Price = Unit Cost + Desired Profit per Unit Objective 1

12. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Drawbacks of Cost-plus Pricing The fundamental flaw of this approach to pricing is that it ignores demand. –Price determines demand, not the other way around. In addition, a cost-plus pricing rule fails to account for competition. Objective 1

13. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Drawbacks of Cost-plus Pricing Cost-plus pricing generally involves allocating fixed costs on a per-unit basis even though fixed costs do not change with the number of units sold. Objective 1

14. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Demand Considerations: The Relationship between Price and Sales If your price is lower, demand is usually higher, and vice versa. Elasticity of demand helps us better understand the relationship between changes in price and quantity sold. Objective 2

15. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Break-even Analysis Break even analysis tells what sales level you need for a particular price to be profitable. Break-even sales = Fixed Costs Selling Price – Variable Costs Objective 2

16. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. The Demand Schedule Demand schedules provide a systematic look at the relationship between price and quantity sold. Objective 2

17. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Elasticity of Demand Economists quantify the relationship between price and quantity sold using a concept called elasticity. Elasticity coefficient E = Percentage change in Q Percentage change in P Objective 2

18. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Elasticity of Demand Inelastic demand is reflected by an elasticity coefficient of less than 1. Elastic demand is reflected by an elasticity coefficient of greater than 1. Unitary elasticity means that the coefficient is exactly equal to 1. Objective 2

19. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Profit Maximization Given the information contained in a demand curve, the firm can determine the profit-maximizing price by simply calculating the profit at each point and determining which price produces the highest profit. Objective 2

20. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Profit Maximization Marginal revenues- the change in a firm’s total revenue per-unit change in its sales level. Marginal costs- the change in a firm’s total costs per-unit in its output level. Objective 2

21. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Profit Maximization Isolating the effect of price can be done several ways: 1.Analytic modeling 2.Experiments 3.Customer surveys 4.Managerial judgment Objective 2

22. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Strategic Drivers of Price Important strategic factors that will play a role in setting a base price are positioning strategy, objectives, specific new product pricing strategies, and price-quality inferences. Objective 3

23. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Positioning Strategy/Competition A competitive strategy positioning continuum is anchored by “low cost leadership” on one end and “differentiation” on the other. Competitive positioning strategy is an important determinant of base price level. Objective 3

24. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Pricing to Meet Objectives Goal-setting is an important part of a firm’s strategic planning process. Objectives in pricing: –Achieve a target return on investment –Create stabilization of price and margin –Reach a market share target –Meet or prevent competition –Profit maximization –Survival Objective 3

25. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Pricing to Meet Objectives Pricing to achieve a target ROI- assuming a standard volume, firms add a particular margin to standard cost, which is expected to produce a target profit rate on investment. Objective 3

26. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Pricing to Meet Objectives Pricing to create stabilization of price and margin- this approach reflects the goal of avoiding the fluctuations in prices that are characteristic of a commodity market. The theory of dual entitlement argues that concerns about fairness may constrain price increases. Objective 3

27. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Pricing to Meet Objectives Pricing to reach a market share target- Particularly when there is no patent protection on a product, firms may pursue a market share target. Pricing to meet or prevent competition- Meeting price cuts will eliminate a competitive disadvantage, while meeting price increases can fatten margins. Objective 3

28. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Pricing to Meet Objectives Pricing for profit maximization- The pursuit of this objective requires substantial cost and demand information. It has rarely been articulated as a goal by executives being interviewed about their pricing. Objective 3

29. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Pricing to Meet Objectives Pricing for survival- A company experiencing trouble may seek to produce an acceptable cash flow, to cover margin costs, and simply survive. This may result when competition is especially intense, when consumer needs are changing, and/or when there exists substantial excess capacity. Objective 3

30. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. New Product Pricing Two classic pricing strategies are commonly discussed for new products: –Skimming –Penetration Objective 3

31. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Price Skimming Market (price) skimming is a strategy of pricing the new product as a relatively high level and then gradually reducing it over time. Objective 3

32. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Price Penetration A penetration strategy requires that a firm enter the market at a relatively low price in an attempt to obtain market share and expand demand for its product. Objective 3

33. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Price-quality Inferences Customers may infer low quality from low price under the following circumstances: 1.When customers are uncertain about brand quality prior to purchase. 2.When the risk to customers of a bad decision is high. Objective 3

34. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Price-quality Inferences Although there continues to be a debate about how frequently customers use price as a signal of quality, it is fairly safe to assume that customer uncertainty about quality for a new brand is often very high, so that price-quality inference is a concern. Objective 3

35. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Explaining Adjustments to Base Price Over Time Most of the pricing decisions that are made for a product in its lifetime are price change decisions. Base price may change because of: –Variation in objectives over the product life cycle –Competitive price moves –Price Flexing Objective 4

36. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Variations in Objectives over the Product Life Cycle The firm’s objectives in pricing and other elements of the marketing mix will vary over the product life cycle. Predicting when and how much to cut prices is an important task. Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

37. Competitive Price Moves Very often, one firm’s price change prompts a reaction from the other. When competitors enter and improve products as an industry moves into the growth phase of its life cycle, the incumbent almost always has to respond with price and/or innovation. Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

38. Price Flexing Prices are not static—they may change in response to changes in the firm’s objectives over the product life cycle and in response to competitive price moves. Even more variation in prices is introduced by both established promotion and discount practices, and innovative pricing practices related primarily to new information technology. Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

39. Price Flexing to Business Customers Traditional approaches that result in flexible prices include: –Price Shading –Cash or payment discounts –Volume discounting –Geographic pricing –Sales promotion allowances –Creative alternatives to discounting –Price customization Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

40. Price Flexing to Business Customers Price Shading- Occurs when, during negotiation, a salesperson reduces the base price of a product. Cash Payment or Discounts- These are discounts the buyer receives for either paying in cash or paying promptly. –“Two-ten, net thirty” Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

41. Price Flexing to Business Customers Volume Discounting- Customers who buy in larger volumes are often given more favorable terms. Geographic Pricing- It is common for business customers in different regions to receive different prices since transportation costs may be accounted for in pricing. –Free on board (FOB) pricing –Uniform delivered pricing Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

42. Price Flexing to Business Customers Sales Promotion Allowances- These are discounts that business customers receive for putting the manufacturer’s product on sale to consumers for a particular period of time. Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

43. Price Flexing to Business Customers Creative Alternatives to Discounting- 1.Some manufacturers provide generous financing for buyers. 2.Some customers are requiring long-term contracts with suppliers that guarantee no price increases for the life of the deal. 3.Suppliers may provide services at no cost. 4.An increasing number of customers are demanding promises of quality improvement over the course of a contract at the same or lower price. Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

44. Price Flexing to Business Customers Price Customization- New technology may make it possible for prices to be literally customized on a transaction-by-transaction basis, depending upon the conditions of supply and demand at the moment. Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

45. Price Flexing to Consumers There is more price-flexing taking place in consumer markets than meets the eye: –Price promotion –Couponing –Pricing for different segments –Customization Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

46. Price Flexing to Consumers Price promotion is a ubiquitous and effective practice in many situations, particularly early in a product’s life, where the objective would be to encourage trial and to allow the seller to maintain a higher list price. –Prisoner’s dilemma Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

47. Price Flexing to Consumers Couponing provides another means of price discrimination in that it gives some consumers— those who wish to take the time and effort to clip coupons—the capability of paying lower prices. Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

48. Price Flexing to Consumers Pricing for different segments- Marketers very often have different marketing programs for different consumer segments. –Geographic segments –Usage segments –Demographic segments –Time segments Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

49. Price Flexing to Consumers Customization- new technology may have a significant effect on the prices consumers pay for products and may lead to significant variation in the prices that consumers pay for the same item. Objective 4 Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.

50. Legal and Ethical Issues in Pricing Prudent marketers must be attentive to legal and ethical concerns in pricing. –Price Fixing –Price Discrimination –Resale Price Maintenance –Predatory Pricing –Exaggerated Comparative Price Advertising Objective 5

51. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Ethical Concerns There are many questions raised by customers and public policy groups about pricing practices, primarily concerning what often appears to be exorbitant prices charged by firms. Objective 5

52. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Ethical Concerns Regarding ethical standards, the law defines minimally acceptable behavior. Business common sense defines another standard: –One does not want to alienate customers and lose them. There are also personal standards of ethics, which each of us needs to think about and develop. Objective 5