Setting the Right Price Lamb, Hair, McDaniel Chapter 20 Setting the Right Price 2011-2012 CHAPTER 20 Setting the Right Price © BUENA VISTA IMAGES/THE IMAGE BANK/GETTY IMAGES All pricing objectives have trade-offs that managers must weigh.

Chapter 20 Setting the Right Price Learning Outcomes LO 1 Describe the procedure for setting the right price LO 2 Identify the legal and ethical constraints on pricing decisions LO 3 Explain how discounts, geographic pricing, and other special pricing tactics can be used to fine-tune the base price

Learning Outcomes LO 4 Discuss product line pricing Chapter 20 Setting the Right Price Learning Outcomes LO 4 Discuss product line pricing LO 5 Describe the role of pricing during periods of inflation and recession

How to Set a Price on a Product Chapter 20 Setting the Right Price How to Set a Price on a Product Describe the procedure for setting the right price LO1

Exhibit 20.1 New-Product Development Process Chapter 20 Setting the Right Price Exhibit 20.1 New-Product Development Process Fine-tune with pricing tactics Choose a price strategy Estimate demand, costs, and profits Establish pricing goals Results lead to the right price Notes: Setting the right price is a four-step process as shown in Exhibit 20.1. LO1

Establish Pricing Goals Chapter 20 Setting the Right Price Pricing objectives fall into three categories: Profit-Oriented Sales-Oriented Status Quo Notes: The first step in setting the right price is to establish pricing goals. In Chapter 19, we learned that pricing objectives fall into three categories—profit oriented, sales oriented, and status quo. These pricing goals are derived from the firm’s overall objectives. A good understanding of the marketplace and of the consumer can tell a manager if a goal is realistic. All pricing objectives have trade-offs. Reaching the desired market share often means sacrificing short-term profit, because without careful management, long-term profit goals may not be met. Meeting the competition is the easiest pricing goal to implement. But demands and costs, the life-cycle stage, and other considerations can not be ignored when creating pricing objectives. LO1

Choose a Price Strategy Chapter 20 Setting the Right Price Price Strategy A basic, long-term pricing framework that establishes the initial price for a product and the intended direction for price movements over the product life cycle. Notes: The price strategy sets a competitive price in a specific market segment. Consequently, changing a price strategy can require dramatic alterations in the marketing mix, including the product itself. Pricing a new product depends on the market conditions and the other elements of the marketing mix. For example, introducing a product resembling several others in the marketplace will have restricted pricing freedom. In contrast, introducing a product with no close substitutes will have considerable pricing freedom. Most companies do not do a good job of researching price strategies. LO1

Choose a Price Strategy Chapter 20 Setting the Right Price Status Quo Pricing Price Skimming Penetration Pricing Charging a price identical to or very close to the competition’s price. A firm charges a high introductory price, often coupled with heavy promotion. A firm charges a relatively low price for a product initially as a way to reach the mass market. Notes: Companies that plan for creating a price strategy can select from three basic approaches: price skimming, penetration pricing, and status quo pricing. A discussion of each type follows. LO1

Price Skimming LO1 Situations When Price Skimming Is Successful Chapter 20 Setting the Right Price Situations When Price Skimming Is Successful Unique Advantages/Superior Legal Protection of Product Blocked Entry to Competitors Technological Breakthrough Inelastic Demand Notes: Price skimming is a pricing policy whereby a firm charges a high introductory price, often coupled with heavy promotion. The term is derived from the phrase “skimming the cream off the top.” Companies often use price skimming for new products when the product is perceived as having unique advantages. Over time the price will be lowered. Additional situations when price skimming is successful are listed on this slide. Firms often feel it is better to test the market at high prices and then lower the price if sales are too slow. A price skimming strategy will encourage competitors to enter the market. Discussion/Team Activity: List companies and/or products that utilize a price skimming strategy. LO1

Penetration Pricing LO1 Advantages Disadvantages Chapter 20 Setting the Right Price Advantages Disadvantages Can lead to lower cost per unit as production expands Discourages or blocks competition from market entry Boosts sales and provides large profit increases Requires gear up for mass production Selling large volumes at low prices Strategy to gain market share may fail Notes: Penetration pricing is at the opposite end of the spectrum from price skimming. By charging a low price for a product, a larger share of the market is captured, resulting in lower production costs. It does, however, mean lower profit per unit, and a higher volume of sales is required to reach the break-even point. Penetration pricing does tend to discourage competition and is effective in a price-sensitive market. LO1

Status Quo Pricing LO1 Advantages Disadvantages Simplicity Chapter 20 Setting the Right Price Advantages Disadvantages Simplicity Safest route to long- term survival for small firms Strategy may ignore demand and/or cost Notes: Status quo pricing means meeting the competition’s prices by charging an identical price or very close to the competition’s price. It is a simple method of pricing, but the strategy may ignore demand and/or cost. However, if the firm is small, meeting the competition’s prices may be the safest route to long-term survival. LO1

The Legality and Ethics of Price Strategy Chapter 20 Setting the Right Price The Legality and Ethics of Price Strategy Identify the legal and ethical constraints on pricing decisions Notes: Some pricing decisions are subject to government regulation. LO2

The Legality and Ethics of Price Strategy Chapter 20 Setting the Right Price The Legality and Ethics of Price Strategy Unfair Trade Practices Price Fixing Price Discrimination Notes: The issues that limit pricing decisions are unfair trade practices, price fixing, price discrimination, and predatory pricing. Predatory Pricing LO2

Unfair Trade Practices and Price Fixing Chapter 20 Setting the Right Price Unfair Trade Practices and Price Fixing Unfair Trade Practices Acts Laws that prohibit wholesalers and retailers from selling below cost. Price Fixing An agreement between two or more firms on the price they will charge for a product. Notes: In over half the states, unfair trade practice acts put a floor under wholesale and retail prices, and selling below cost is illegal. Wholesalers and retailers must take a certain minimum percentage markup on their combined merchandise cost and transportation cost. The most common markup figures are 6 percent at the retail level and 2 percent at the wholesale level. If a specific wholesaler or retailer can provide “conclusive proof” that operating costs are lower than the minimum required figure, lower prices may be allowed. The intent of unfair trade practice acts is to protect small firms from retail giants like Walmart and Target, which operate efficiently on razor-thin profit margins. State enforcement of unfair trade practice laws has generally been lax, because low prices benefit local consumers. ------------------------------------------------------ Price fixing is illegal under the Sherman Act and the Federal Trade Commission Act. Discussion Question/Team Activity Research examples of cases tried under the Sherman and Federal Trade Commission Acts. LO2

Predatory Pricing LO2 Predatory Pricing Chapter 20 Setting the Right Price Predatory Pricing Predatory Pricing The practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market. Notes: Predatory pricing is illegal under the Sherman Act and the Federal Trade Commission. However, proving the use of this practice is difficult and expensive. The Justice Department must show that the predator explicitly tried to ruin a competitor and that the predatory price was below the predator’s average variable cost. LO2

Tactics for Fine-Tuning the Base Price Chapter 20 Setting the Right Price Tactics for Fine-Tuning the Base Price Explain how discounts, geographic pricing, and other pricing tactics can be used to fine-tune the base price LO3

Tactics for Fine-Tuning the Base Price Chapter 20 Setting the Right Price Tactics for Fine-Tuning the Base Price Special pricing tactics Discounts Geographic pricing Notes: The base price is the general price level at which the company expects to sell a good or service. The general price level is correlated with the pricing policy: above the market, at the market, or below the market. The final step is to fine-tune the base price. Fine-tuning techniques include discounts, geographic pricing, and other pricing tactics. LO3

Discounts, Allowances, Rebates, and Value-Based Pricing Chapter 20 Setting the Right Price Discounts, Allowances, Rebates, and Value-Based Pricing Quantity Discounts Cash Discounts Functional Discounts Seasonal Discounts Promotional Allowances Rebates Zero Percent Financing Value-Based Pricing Notes: A base price can be lowered through the use of discounts and the related tactics of allowances, rebates, low or zero percent financing, and value-based pricing. Discounts are used to encourage customers to do what they would not ordinarily do, such as pay cash, take delivery out of season, or performing certain functions within a distribution channel. The most common tactics are: Quantity discounts with lower prices for buying in multiple units of above a specified dollar amount. Cash discounts offered for prompt payment of a bill Functional discounts (trade discounts) are offered when channel intermediaries perform a service for the manufacturer. Seasonal discounts are lower prices for buying merchandise out of season. Promotional allowances (or trade allowance) are payments to dealers for promoting the manufacturer’s products. Rebates are cash refunds given for purchasing a product within a specified period. Zero percent financing offers no interest charge to increase sales. However, it does cost the manufacturers. Value-based pricing sets the price at a level that seems to the customer to be a good price compared to other prices. LO3

Value-Based Pricing Value-Based Pricing is… LO3 Chapter 20 Setting the Right Price Value-Based Pricing is… setting the price at a level that seems to the customer to be a good price compared to the prices of other options. Notes: The basic assumption with value-based pricing is that the firm is customer driven, seeking to understand the attributes customers want in the goods and services they buy and the value of that bundle of attributes to customers. LO3

Pricing Products Too Low Chapter 20 Setting the Right Price Pricing Products Too Low Managers attempt to buy market share through aggressive pricing. Managers have a natural tendency to want to make decisions that can be justified objectively. Notes: Pricing products too low reduces company profits. This happens for two reasons: The company is attempting to buy market share through aggressive pricing. Managers have a tendency to make decisions that can be justified objectively. As a result, pricing decisions are made based on current costs, projected short-term share gains, or current competitive prices rather than on long-term profitability. LO3

Geographic Pricing LO3 FOB Origin Pricing Uniform Delivered Chapter 20 Setting the Right Price FOB Origin Pricing Uniform Delivered Zone Pricing Freight Absorption Basing-Point The buyer absorbs the freight costs from the shipping point (“free on board”). The seller pays the freight charges and bills the purchaser an identical, flat freight charge. The U.S. is divided into zones, and a flat freight rate is charged to customers in a given zone. The seller pays for all or part of the freight charges and does not pass them on to the buyer. The seller charges freight from a basing point, regardless of the city from which the goods are shipped. Notes: The most common methods of geographic pricing are described on this slide.

Other Pricing Tactics LO3 Single-Price Tactic Chapter 20 Setting the Right Price Single-Price Tactic All goods offered at the same price Flexible Pricing Different customers pay different price Professional Services Pricing Used by professionals with experience, training or certification Price Lining Several line items at specific price points Leader Pricing Sell product at near or below cost Bait Pricing Lure customers through false or misleading price advertising Odd-Even Pricing Odd-number prices imply bargain Even-number prices imply quality Price Bundling Combining two or more products in a single package Two-Part Pricing Two separate charges to consume a single good Notes: Other pricing tactics are unique and defy neat categorization. Managers use these tactics to stimulate demand for specific products, to increase store patronage, and to offer a wider variety of merchandise at a specific price point. These pricing tactics are described on this slide. Discussion/Team Activity: Discuss products and/or businesses that utilize these pricing tactics.

Product Line Pricing LO4 Discuss product line pricing Chapter 20 Setting the Right Price Product Line Pricing Discuss product line pricing LO4

Product Line Pricing Product Line Pricing is… LO4 Chapter 20 Setting the Right Price Product Line Pricing Product Line Pricing is… setting prices for an entire line of products. Online Beauty.com Does Beauty.com use a product line pricing strategy? Choose a brand and view the product list and pricing sheet. What evidence do you see of product line pricing? Of other pricing strategies? Notes: In product line pricing, the manager tries to achieve maximum profits for the entire line rather than for a single component of the line. LO4

Relationships among Products Chapter 20 Setting the Right Price Relationships among Products Complementary Substitutes Neutral Notes: In setting product line prices, the manager first determines the relationship among the products in the line: Complementary: An increase in the sale of one good causes an increase in demand for the complementary product. Substitutes: Two products in a line can be substitutes for each other. If buyers buy one item in the line, they are less likely to buy a second item in the line. Neutral: A neutral relationship can exist between two products. Demand for one of the products is unrelated to demand for the other. LO4

Chapter 20 Setting the Right Price Joint Costs Joint Costs Costs that are shared in the manufacturing and marketing of several products in a product line. Notes: If costs are shared in the manufacturing and marketing of several products in the product line, product pricing is more difficult. Some common assignments of joint costs include a weight basis, market value, or quantity sold. Discussion/Team Activity: Name products that may require joint cost pricing. LO4

Pricing during Difficult Economic Times Chapter 20 Setting the Right Price Pricing during Difficult Economic Times Describe the role of pricing during periods of inflation and recession LO5

Cost-Oriented Tactics Demand-Oriented Tactics Inflation Chapter 20 Setting the Right Price Cost-Oriented Tactics High Inflation Demand-Oriented Tactics Notes: When the economy is characterized by high inflation, special pricing tactics are often necessary. LO5

Cost-Oriented Tactics Chapter 20 Setting the Right Price Problems with Cost-Oriented Tactics A high volume of sales on an item with a low profit margin may still make the item highly profitable. Eliminating a product may reduce economies of scale. Eliminating a product may affect the price-quality image of the entire line. Notes: One common cost-oriented tactic is culling products with a low profit margin. However this tactic may backfire for the three reasons listed on this slide. LO5

Cost-Oriented Tactics Chapter 20 Setting the Right Price Delayed-quotation pricing – used for industrial installations and many accessory items; firm price is not set until the item is finished or delivered Escalator pricing – final selling price reflects cost increases incurred between the order time and the delivery time Hold prices constant, but add new fees Notes: Cost-oriented tactics include delayed-quotation pricing, which is used for industrial installations and accessory items. Price is not set until the item is either finished or delivered. Examples: Builders of nuclear power plants, ships, airports, and office towers. Escalator pricing is similar to delayed-quotation pricing in that the final selling price reflects costs increases incurred between the time an order is placed and the time delivery is made. Another tactic is to hold prices constant but add new fees. LO5

Cost-Oriented Tactics Chapter 20 Setting the Right Price Increased Production Costs Decreased Demand Price Increase Maintaining a Fixed Gross Margin Notes: Any cost-oriented pricing policy that tries to maintain a fixed gross margin under all conditions can lead to a vicious circle, as shown in the diagram on this slide. A price increase will result in decreased demand, which in turn increases production costs because of lost economies of scale. Increased production costs require a further price increase, etc. LO5

Demand-Oriented Tactics Chapter 20 Setting the Right Price Price Shading The use of discounts by salespeople to increase demand for one or more products in a line. Notes: Demand-oriented tactics use price to reflect changing patterns of demand caused by inflation or high interest rates. Often price shading becomes habitual and is done routinely without much forethought. LO5

Demand-Oriented Tactics Chapter 20 Setting the Right Price Strategies to Make Demand More Inelastic Cultivate selected demand Create unique offerings Change the package design Heighten buyer dependence Notes: To make the demand for a good or service more inelastic and to create buyer dependency, a company can use the strategies as shown on this slide: Cultivate selected demand: Target prosperous customers who will pay extra for convenience or service. Create unique offerings: By studying buyers’ needs, the seller can design distinctive products to fit a buyers’ needs and establish a beneficial relationship. Change the package design: Companies pass on higher costs by shrinking the product sizes but keep prices the same. Heighten buyer dependence: Provide additional value-added services and training with product offerings to freeze out competition and support higher prices. LO5

Bundling or Unbundling Recession Chapter 20 Setting the Right Price Value-Based Pricing Bundling or Unbundling Notes: Effective pricing tactics during recession are value-based pricing and bundling. Value-based pricing stresses to customers that they are getting a good value for their money. Bundling or unbundling of features or services gives a perception of higher value. Bundling can be demonstrated in vacation packages that include lodging, meals, massages, etc. LO5

Renegotiating contracts Keeping the pressure on Supplier Strategies during Recession Chapter 20 Setting the Right Price Renegotiating contracts Offering help Keeping the pressure on Paring down suppliers Notes: In a recession, prices often fall so that companies can maintain demand for their products. Falling prices are an incentive to lower costs since falling prices mean lower profits or no profits. Suppliers can be excellent sources of cost savings. Some ways companies can use cost-saving strategies with suppliers are listed on this slide. Renegotiating contracts: Demanding lower prices or rebidding the contracts. Offering help: Help suppliers’ plants reorganize and increase productivity. Keeping the pressure on: Set annual, across-the-board cost-reduction targets. Paring down suppliers: Reduce the number of suppliers and boost purchases from those that remain. LO5

Setting the Right Price Chapter 20 Setting the Right Price Chapter 20 Videos Setting the Right Price Compare the pricing strategies of method, ReadyMadeMag, and Acid+All. Do all of these relatively new brands use the same strategy? Explain. http://www.cengage.com/marketing/book_content/1439039429_lamb/company_clips/ch20.html Beyond the Book

Part 6 Videos Beyond the Book Pricing Decisions Chapter 20 Setting the Right Price Part 6 Videos Pricing Decisions http://www.cengage.com/marketing/book_content/1439039429_lamb/part_videos/part06.html Beyond the Book