Formulating Strategic Marketing Programs Pricing Management

Pricing... Converts the underlying value of a product offering or service into revenues and profits. Is a fundamentally important activity to the firm--pricing power. Is not a simple process.

Basic Concepts & Jargon Marginal costs--the unit costs of production  In a competitive market, establishes the lowest feasible price a firm can set. Value price--the highest price the market will bear  Establishes an upper bound on prices, though competition usually prevents value prices from being realized.

The Pricing Range Downward price pressure From competitive substitutes Upward price pressure through marketing efforts Value Price Our Price Marginal Cost 0 Feasible Price Range Our Premium

Price Sensitivity How customers respond to price changes Price elasticity of demand  Demand is less elastic when: Few or no substitutes or competitors Buyers do not notice the higher price Buyers are slow to change their buying habits Buyers think the higher prices are justified

Pricing Methods Mark-up pricing  Add a standard mark-up to the product’s costs unit cost (1-desired return on sales) Mark-up price =

Target-return pricing  The firm determines price based on desired target rate of return on investment (ROI) desired return x invested capital unit sales Unit cost + Target-return price =

Perceived value pricing  Base price on customers’ perceived value  Have to deliver more value than the competitor and demonstrate this to prospective buyers Value pricing  Based on firm becoming a low-cost producer while maintaining quality  Targets value-conscious consumers  Everyday low pricing

Going-rate pricing  Base prices primarily on competitors’ prices  The same, more, or less than major competitor Auction-type pricing Group pricing

Pricing Goals Determining pricing tactics depends on what goals are to be accomplished

Effective Pricing Management Discriminate between customers according to market segments. Coordinate incentives across intermediaries and consumers. Effectively deal with competition. Integrate with the firm’s other marketing efforts. Understand consumers’ willingness to pay. Understand pricing effects throughout product line.

Customer Discrimination Different segments of customers often have different value prices for the same product. Ideally, firms would like to charge each customer his/her value price. Discrimination, in the sense of charging different prices for the same good to reasonably identical customers is generally considered illegal.

Discrimination (continued) There are legal exceptions to discrimination:  Price-customization opportunities Business-to-business, service relations  Customers self-select into appropriate price tiers Choose between differently priced options  Quantity discounts  Loyalty programs Proactively shape customers into what is desired

Incentive Coordination Directly link incentives to desired behavior Three areas of incentive coordination:  Salesperson incentives and price flexibility  Intermediary margins and push  End-user incentives and service pricing

Salesperson Incentives The degree of pricing flexibility allocated to the salesperson directly affects selling behavior. Direct link between incentives and salesperson’s compensation plan.  If commission is tied to volume, the salesperson will discount heavily and frequently in order to maximize quantity sold.  If commission is tied to profitability, the salesperson will try to hold prices high in order to maximize margins, but low sales volume may result.

Intermediary Incentives The margin built into a price provides resellers with incentives to push the product. Trade promotions are another type of incentive:  Quantity discounts  Compensate marketing efforts

End-User Incentives Salient to services. To avoid over-utilization of services (e.g., health care), link cost savings to consumption to encourage judicious consumption behavior.

Dealing with Competition In a competitive environment, have to set prices with competitor actions in mind.  Commodity market: often use fluctuating prices  Mature products: high use of discounts and promotions Promotions can result in forward buying Take price out of the equation  Automatic Price Protection Loyalty programs  Useful in product categories marked by low differentiation

Integration With Other Marketing Efforts Price should reflect the value of the product or service. High prices--skimming  Obtain low market share with high margins.  Marketing program needs to communicate product benefits.  Intensive selling.  Maximize intermediary push.

Integration (continued) Low prices—penetration  Obtain high market share with low margins.  Marketing program should focus on generating general awareness.  Focus on productive capacity. Price differentiation

Consumers’ Willingness to Pay What is the impact of consumers’ willingness to pay on demand and a firm’s net income?  At various price levels  When price is changed Behavioral price vs. objective price  “How fair of a deal am I getting?” vs. “How good of a deal am I getting?”

Psychological Update #1 Willingness to pay is impacted by relative incentives. In determining willingness to pay, a consumer will consider both absolute “economic utility” from the transaction [i.e., perceived value - actual price] and relative incentive to enter the transaction [i.e., (perceived value - actual price)/actual price].

Psychological Update #2 Willingness to pay is impacted by a salient reference price. In determining willingness to pay, a consumer will consider economic utility from the transaction [i.e., perceived value - actual price] and the consistency between the actual price and a salient reference price [i.e., actual price - reference price]. The most common basis for a reference price is the previous price paid for a product.

Psychological Update #3 Willingness to pay is impacted by cost of goods sold. In determining willingness to pay, a consumer will consider his/her economic utility from the transaction [i.e., perceived value - actual price] and the economic utility of the firm [i.e., actual price - cost of goods sold]. Consumers do not want to be taken advantage of.

Psychological Update #4 Perceptions of fairness vary across product categories.  In determining willingness to pay, the degree to which a consumer will rely upon economic utility from the transaction [i.e., perceived value - actual price] will vary across product categories. Necessary vs. discretionary purchases. Luxury vs. utilitarian products.

Managing Perceptions of Transaction Fairness Strategy #1: Actively manage price expectations.  Establish credible reference prices. Customary prices Odd prices  Manage product price trends.  Encourage favorable comparisons.  Avoid unfavorable comparison through product differentiation.

Managing Perceptions... Strategy #2: Actively manage perceptions of cost of goods sold.  Focus attention of fully-loaded cost of goods sold.  Bundle products to obscure cost of goods sold.  Focus attention of consumer value.

Product Line Pricing The pricing of one product in product line may affect sales of other products in product line. Price elasticity of demand  The degree of responsiveness of demand to a price change. Cross-elasticity of demand  The degree to which changing the price of one product affects demand for another product.

Cross-elasticity of Demand Products with positive cross-elasticity are substitutes.  Lowering the price of Product A decreases demand for Product B without any change in the price of Product B. Products with negative cross-elasticity are complementary products.  Lowering the price of Product A increases demand for both Product A and Product B without any change in the price of Product B.