Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Part 7: Pricing Decisions 18.Price Concepts and Approaches 19.Pricing Strategies

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Chapter 18 Price Concepts and Approaches

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Chapter Objectives 1.Outline the legal constraints on pricing. 2.Identify the major categories of pricing objectives. 3.Explain price elasticity and its determinants. 4.List the practical problems involved in applying price theory concepts to actual pricing decisions. 5.Explain the major cost-plus approaches to price setting. 6.List the chief advantages and shortcomings of using breakeven analysis in pricing decisions. 7.Explain the superiority of modified breakeven analysis over the basic breakeven model and the role of yield management in pricing decisions. 8.Identify the major pricing challenges facing online and international marketers.

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Pricing and the Law Price Price: the exchange value of a good or service Robinson-Patman Act Robinson-Patman Act Federal legislation prohibiting price discrimination that is not based on a cost differential Also prohibits selling at unreasonably low prices to eliminate competition

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Unfair Trade Laws Unfair Trade Laws Require sellers to maintain minimum prices for comparable merchandise. These laws were intended to protect small specialty shops. Designed to protect small stores and businesses from the predatory pricing practices of larger chain stores Fair Trade Laws Fair Trade Laws Allow manufacturers to stipulate minimum prices for their products and force retailers to adhere to them Enable companies to establish and maintain product images

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Pricing Objectives and the Marketing Mix Prices, and the resulting sales, determine how much revenue a company receives Prices thus influence a firm’s profits Prices also influence the firm’s employment of the factors of production: Natural resources Capital Human Resources Entrepreneurship

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved ObjectivePurposeExample Profitability Objectives Profit Maximization Target Return Low introductory interest rates on credit cards with high standard rates after 6 months. Volume Objectives Sales Maximization Market Share Dell’s low-priced PCs increase market share and sales of services Meeting Competition Objectives Value PricingPer-song charges for music downloads Prestige Objectives Lifestyle Image High-priced luxury autos such as BMW and watches by Piaget Not-for-Profit Objectives Profit Maximization Cost Recovery Market Incentives Market Suppression High prices for tobacco and alcohol to reduce consumption

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Profitability Objectives Profitability Objectives For-profit firms must set prices with profitability in mind Profit Maximization: point at which the additional revenue gained by increasing the price of a product equals the increase in total costs Target-Return Objectives: Short-run or long-run pricing objectives of achieving a specified return on either sales or investment

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Volume Objectives Volume Objectives Sales maximization: A minimum profit level is set and firms seek to maximizes sales Market-share objectives: the goal set for controlling a portion of the market for a firm’s good or service The Product Impact of Market Strategies (PIMS) Project: Research that discovered a strong positive relationship between a firm’s market share and product quality and its return on investment

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Meeting Competition: Meeting Competition: Seeks simply to meet competitor’s prices Value Pricing Value Pricing: Pricing strategy that emphasizes the benefits derived from a product in comparison to the price and quality levels of competing offerings

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Prestige Objectives Prestige Objectives: Prices are set at a relatively high level in order to develop and maintain an image of quality and exclusiveness that appeals to status- conscious consumers

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Pricing Objectives of Not-for-Profit Organizations Profit maximization Cost recovery Market incentives Market suppression

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Methods for Determining Prices Customary Prices: traditional prices that consumers expect to pay for a good or service

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Price Determination in Economic Theory Demand: schedule of the amounts of a firm’s good or service that consumers purchase at different prices during a specified period Supply: schedule of the amounts of a good or service that firms will offer for sale at different prices during a specified time period

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Four Market Structures Pure Competition: Market structure characterized by homogeneous products in which there are so many buyers and sellers that none has a significant influence on price Monopolistic Competition: Market structure involving a heterogeneous product and product differentiation among competing suppliers, allowing the marketer some degree of control over prices

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Oligopoly Oligopoly: Market structure involving relatively few sellers and barriers to new competitors due to high start-up costs Monopoly Monopoly: Market structure involving only one seller of a good or service for which no close substitutes exist

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Distinguishing features of the Four Market Structures Characteristics Pure Competition Monopolistic CompetitionOligopolyMonopoly Number of competitorsManyFew to manyFewNo direct competitors Ease of entry into industry by new firms EasySomewhat Difficult DifficultRegulated by government Similarity of goods or services offered by competing firms SimilarDifferentCan be either similar or different No directly competing goods or service Control over prices by individual firms NoneSome Considerable Demand curves facing individual firms Totally elasticCan be either elastic or inelastic Kinked; inelastic below kink; more elastic above Can be either elastic or inelastic Examples2000-acre ranch Banana Republic BPCommonwealth Edison

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Cost and Revenue Curves Cost and Revenue Curves Price is often determined by analyzing the cost and revenue curves Average total cost is calculated by dividing the total costs by the number of units produced Marginal cost is the change in total cost that results from producing an additional unit of output Average revenue is calculated by dividing total revenue by the quantity of goods or services sold Marginal revenue is the change in total revenue that results from selling an additional unit of output

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Determining Price by Relating Marginal Revenue to Marginal Cost

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Price Determination using Marginal Analysis Price Number Sold Total Revenue Marginal Revenue Total Costs Marginal Costs Profits (Total Revenue – Total Costs) ($50) $ $7(23) (2)

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved The Concept Of Elasticity In Pricing Strategy The Concept Of Elasticity In Pricing Strategy Elasticity: measure of responsiveness of purchasers and suppliers to changes in price Determinants Of Elasticity Determinants Of Elasticity  Availability of Substitutes or complements  Luxury or Necessity  Portion of Budget  Time Perspective

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Elasticity and Revenue Elasticity and Revenue Elasticity of demand exerts an important influence on total revenue as a result in the changes in the price of a good or service For example, should a city’s transit authority raise or lower price for public transportation? The answer, of course, lies in the elasticity of demand for public transportation

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Practical Problems of Price Theory Practical Problems of Price Theory Marketers may thoroughly understand price theory concepts but still encounter difficulty in applying them in practice. Practical limitations interfering with price setting include the facts that:  Many firms don’t attempt to maximize profits  Estimating demand curves is a difficult process

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Price Determination in Practice Cost-plus pricing: practice of adding a percentage of a specified dollar amount (markup) to the base cost of a product to cover unassigned costs and provide a profit

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Alternative Pricing Procedures Alternative Pricing Procedures Full-cost pricing uses all relevant variable costs and allocates fixed costs that cannot be directly attributed to the production of the specific item in setting a product’s price. Incremental-cost pricing attempts to overcome arbitrary allocation of fixed costs by only considering costs directly attributable to the product itself when setting prices

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Breakeven analysis Breakeven analysis: pricing technique used to determine the number of products that must be sold at a specified price in order to generate sufficient revenue to cover total cost Target Returns  A desired dollar return  A percentage of sales Evaluation of Breakeven Analysis

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Toward Realistic Pricing In actual practice, most pricing approaches are largely cost oriented They thus violate the marketing concept New approaches being developed are incorporating the element of consumer demand

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved The Modified Breakeven Concept The Modified Breakeven Concept Pricing technique used to evaluate consumer demand by comparing the number of products that must be sold at a variety of prices in order to cover total cost with estimates of expected sales at the various prices

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Modified Breakeven Chart

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Revenue and Cost data for Modified Breakeven Analysis Revenues Costs Price Quantity Demanded Total Revenue Total Fixed Cost Total Variable Cost Total Cost Breakeven Point -No. of Sales Required to Break Even Total Profit (or Loss) $152,500$37,500$40,000$12,500$52,5004,000$(15,000) 1010,000100,00040,00050,00090,0008,00010, ,000117,00040,00065,000105,000110,00012, ,000112,00040,00070,000110,00013,3342, ,000105,00040,00075,000115,00020,000(10,000)

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Yield Management Yield Management: pricing strategy that allows marketers to vary prices based on such factors as demand, even though the cost of providing those goods or services remains the same Designed to maximize sales in situations such as airfares, lodging, auto rentals, and theater tickets where costs are fixed

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved Global Issues in Price Determination Global Prices must support the firm’s broader goals including: Product development Advertising and sales Customer support Competitive plans Financial objectives

Copyright © 2006 by South-Western, a division of Thomson Learning, Inc. All rights reserved In General, there are five pricing objectives that firms can use to set prices in global marketing Profitability, volume, meeting competition, and prestige, are the same as those discussed earlier In addition international marketers work to achieve price stability Price stability is the ability to maintain consistent prices during major economic fluctuations and periods of political change