pricing concepts for establishing value thirteen pricing concepts for establishing value Chapter 13 – Pricing Concepts for Establishing Value McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Pricing Concepts for Establishing Value LO1 List the four pricing orientations. LO2 Explain the relationship between price and quantity sold. LO3 Explain price elasticity. LO4 Describe how to calculate a product’s break-even point. LO5 Indicate the four types of price competitive levels. LO6 Describe the difference between an everyday low price strategy (EDLP) and a high/low strategy. LO7 Explain the difference between a price skimming and a market penetration pricing strategy. LO8 List pricing practices that have the potential to deceive customers. These are the learning objectives for this chapter. 13-2

The 5 C’s of Pricing The following slides discuss each C in detail; alternatively, you can use this graph as a basis for a shortened discussion. 13-3

1st C: Company Objectives Each firm has a specific orientation in the marketplace that dominates its pricing strategy. Profit-oriented firms do not use value as a consideration but rather focus on generating a set level of profit from each sale. 13-4

2nd C: Customers The following slides address different parts of this graph; this slide serves as an introduction to the topic of demand curves. 13-5

Demand Curves Not all are downward sloping Prestigious products or services have upward sloping curves Ask students to name a prestige product. Why do they think people are willing to pay a higher price. For example, why will someone pay a higher price for a BMW than a Saturn. They will mention product quality but also branding issues including the esteem offered to the owner from the BMW. 13-6

Price Elasticity of Demand Elastic (price sensitive) Inelastic (price insensitive) Consumers are less sensitive to price increases for necessities For pricing, elasticity is a crucial concept. ©PhotoLink/Getty Images 13-7

3rd C: Costs Variable Costs Fixed Costs Total Cost Vary with production volume Fixed Costs Unaffected by production volume Total Cost Sum of variable and fixed costs No discussion of price would be complete without a discussion of cost. The price must at least cover the cost of the item. However, as students may have learned in their finance courses, understanding costs is rarely easy. Michael Rosenfeld/Stone/Getty Images 13-8

Break Even Analysis and Decision Making Students might have discussed break-even in previous classes – ask them what it is. In many cases it is hard for students to define. 13-9

4th C: Competition Group activity: List a product or service market that demonstrates each type of competition. Monopoly: Microsoft software products. Oligopolistic: Cable TV firms. Pure: Most frequently purchased consumer goods such as soft drinks. This you tube ad is for a $5 foot long commercial for Subway (always check link before class). Students will be familiar with this promotion. Ask students if this price promotion has motivated them to visit subway? Subway Commercial 13-10

5th C: Channel Members Manufacturers, wholesalers and retailers can have different perspectives on pricing strategies Manufactures must protect against gray market transactions Ask students: have you ever bought books marked “Instructor Copy: Not for Resale,” or “International Student Edition”? Is the bookstore engaging in unethical behavior? Whom does this gray market benefit? Whom does it hurt? Answer: The purchase of gray market textbooks hurt the publisher and authors. These books do not help recover the costs of all the ancillary packages that are provided to instructors. 13-11

Macro Influences on Pricing The Internet Increased price sensitivity Growth of online auctions Ask students: How has online shopping affected firms’ pricing strategies? Answers: Internet shopping has provided people with more information so they have become more sensitive to prices, alternative product options and retailers Ryan McVay/Getty Images 13-12

Economic Factors Increasing disposable income Local economic conditions Increasing disposable income Cross- shopping Increasing status consciousness Increasing globalization Firms and consumers alike should constantly monitor the economic environment, because economic conditions have a direct impact on pricing. Ask students: How many people cross-shop? Do you believe this practice has influenced the way some firms price their merchandise? Answer: it has made prestige products more expensive and more moderately priced merchandise even less expensive. 13-13

Everyday Low Pricing vs.. High/Low Pricing Create value in different ways EDLP saves search costs of finding lowest overall prices High/low provides the thrill of the chase for the lowest price High/low pricing Everyday low pricing (EDLP) Group activity: Imagine you need an outfit for an upcoming party. You can visit TJMaxx, where you know you will find an EDLP pricing strategy. However, Nordstrom is having its semi-annual sale, during which it drastically marks down its usually high prices. Where do you think you will find a better price? Which offers better value? Why? vs.. Photodisc Collection/Getty Images ©Lars A Niki 13-14

New Product Pricing Strategies Market Penetration Pricing Price skimming Group activity: Develop a list of products that might use price skimming versus penetration pricing. What qualities should a product possess to use a price skimming strategy? For example, Godiva introduced its hot chocolate mix at a price point that was double that of other hot cocoa mixes. How was it able to achieve success with this product? Penetration pricing helps firms build market share for their new products quickly, but consumers must be price elastic for this strategy to work. 13-15

Legal Aspects and Ethics of Pricing Deceptive or illegal price advertising Predatory pricing Price discrimination fixing A host of laws and regulations at both the federal and state levels attempt to prevent unfair pricing practices, but some are poorly enforced, and others are difficult to prove. 13-16

Glossary Break-even analysis enables managers to examine the relationships among cost, price, revenue, and profit over different levels of production and sales. Break-even analysis enables managers to examine the relationships among cost, price, revenue, and profit over different levels of production and sales. 13-17

Glossary Cross-price elasticity is the percentage change in the quantity of Product A demanded compared with the percentage change in price in Product B. Cross-price elasticity is the percentage change in the quantity of Product A demanded compared with the percentage change in price in Product B. 13-18

Glossary Fixed costs are those costs that remain essentially at the same level, regardless of any changes in the volume of production. Fixed costs are those costs that remain essentially at the same level, regardless of any changes in the volume of production. 13-19

Glossary Income effect is the change in the quantity of a product demanded by consumers due to a change in their income. Income effect is the change in the quantity of a product demanded by consumers due to a change in their income. 13-20

Glossary The maximizing profits strategy assumes that if a firm can accurately specify a mathematical model that captures all the factors required to explain and predict sales and profits, it should be able to identify the price at which its profits are maximized. The maximizing profits strategy assumes that if a firm can accurately specify a mathematical model that captures all the factors required to explain and predict sales and profits, it should be able to identify the price at which its profits are maximized. 13-21

Glossary Price is the overall sacrifice a consumer is willing to make to acquire a specific product or service. Price is the overall sacrifice a consumer is willing to make to acquire a specific product or service. 13-22

Glossary The substitution effect refers to consumers’ ability to substitute other products for the focal brand. The substitution effect refers to consumers’ ability to substitute other products for the focal brand. 13-23

Glossary Target profit pricing is implemented by firms to meet a targeted profit objective. The firms use price to stimulate a certain level of sales at a certain profit per unit. Target profit pricing is implemented by firms to meet a targeted profit objective. The firms use price to stimulate a certain level of sales at a certain profit per unit. 13-24

Glossary Target return pricing occurs when firms employ pricing strategies designed to produce a specific return on their investment, usually expressed as a percentage of sales. Target return pricing occurs when firms employ pricing strategies designed to produce a specific return on their investment, usually expressed as a percentage of sales. 13-25

Glossary The total cost is the sum of the variable and fixed costs. 13-26

Glossary Variable costs are the costs that vary with production value. 13-27

Glossary A cumulative quantity discount uses the amount purchased over a specified time period and usually involves several transactions. A cumulative quantity discount uses the amount purchased over a specified time period and usually involves several transactions. 13-28

Glossary Horizontal price fixing occurs when competitors that produce and sell competing products collude, or work together, to control prices, effectively taking price out of the decision process for consumers. Horizontal price fixing occurs when competitors that produce and sell competing products collude, or work together, to control prices, effectively taking price out of the decision process for consumers. 13-29

Glossary Price skimming is a strategy that occurs in many markets, and particularly for new and innovative products or services, and involves consumers being willing to pay a higher price to obtain the new product or service. Price skimming is a strategy that occurs in many markets, and particularly for new and innovative products or services, and involves consumers being willing to pay a higher price to obtain the new product or service. 13-30

Glossary A reference price is the price against which buyers compare the actual selling price of the product and that facilitates their evaluation process. A reference price is the price against which buyers compare the actual selling price of the product and that facilitates their evaluation process. 13-31

Glossary With a uniform delivered pricing tactic, the shipper charges one rate, no matter where the buyer is located. With a uniform delivered pricing tactic, the shipper charges one rate, no matter where the buyer is located. 13-32

Glossary Vertical price fixing occurs when parties at different levels of the same marketing channel collude to control the prices passed on to consumers. Vertical price fixing occurs when parties at different levels of the same marketing channel collude to control the prices passed on to consumers. 13-33