Chapter 17 Price Setting in the Business World Marketing 333 Chapter 17 Price Setting in the Business World

Key Factors That Influence Price Setting Instructor’s Note: This slide corresponds to Exhibit 17-1 on p. 394 and Transparency 113. Pricing objectives Discounts and allowances Legal environment Price flexibility Geographic pricing terms Demand Cost Price of other products in the line Competition Price setting Notes Many firms set a price by just adding a standard markup to the average cost of the products they sell. But this is changing. More managers are realizing that they should set prices by evaluating the effect of a price decision not only on profit margin for a given item but also on demand and therefore on sales volume, costs, and total profit. In Wal-Mart’s very competitive markets, this approach often leads to low prices that increase profits and at the same time reduce customers’ costs. For other firms in different market situations, careful price setting leads to a premium price for a marketing mix that offers customers unique benefits and value. But these firms commonly focus on setting prices that earn attractive profits--as part of an overall marketing strategy that satisfies customers’ needs. Markup chain in channels Exhibit 17-1 17-3

Markup An amount added to the cost of a product that results in the price May be calculated as a percentage on selling price or on cost Relationship between markup and turnover

Markup in the Channel of Distribution Manufacturer Cost $20.00 20% MU $ 5.00 Selling price $25.00 Wholesaler Cost $25.00 15% MU 4.41 Selling price $29.41 Retailer Cost $29.41 41% MU $20.59 Selling price $50.00

Six Types of Costs Total Cost Average Fixed Cost Total Variable Cost This slide relates to the material on pp. 399-400. See Overhead 189. Total Cost Average Fixed Cost Total Variable Cost Variable Cost Total Fixed Average Cost Summary Overview A problem with average-cost pricing is that it does not consider how the various costs incurred by a business change in different ways as output changes. This can lead to losses. For this reason it is important to understand six types of costs. Six Types of Costs Total Fixed Cost. This is the sum of those costs that are fixed in total, regardless of how much of something is produced. Things like rent, managers’ salaries, and insurance remain constant whether production goes up or down. Total Variable Cost. This is the sum of expenses that change with the level of output. This includes things like hourly wages but also the cost of materials, packaging, shipping, and sales commissions. Teaching Tip: Tell students to keep this in mind for when you discuss marginal analysis. Total Cost. This is the sum of total fixed and total variable costs. Average Cost. Average cost per unit is obtained by dividing total cost by the related quantity. Average Fixed Cost. Average fixed cost per unit is obtained by dividing total fixed cost by the related quantity. Average Variable Cost. Average variable cost per unit is obtained by dividing total variable cost by the related quantity. Teaching Tip: As covered in Chapter 16 and restated in Chapter 17, average-cost pricing may encourage managers to pay less attention to demand than they should. Good marketers never downplay the importance of demand! 17-5

Types of Costs Price Marginal cost Average cost Demand Marginal revenue Quantity

Marginal Analysis Method for determining the costs and revenues associated with the production and sale of each additional unit of product

Intersection of Marginal Cost and Marginal Revenue MR Marginal cost = marginal revenue MC Cost and revenue Cost less than revenue Cost greater than revenue Units produced and sold

Break Even Analysis Total Revenues Profit Loss Total Costs Break Revenue & cost Break even point Fixed Costs Loss Quantity units produced & sold

Demand Curve Relationship between various prices and the quantities of product demanded. Demand 8,000 13,000 18,000 23,000 28,000

Evaluating a Customer’s Price Sensitivity Are there substitute ways of meeting a need? Is it easy to compare prices? Who pays the bill? How great is the total expenditure? How significant is the end benefit? Is there already a sunk investment related to the purchase? 17-10

Price Elasticity Measures the effect of a change in price on the quantity demanded Price elasticity Price inelasticity Perfect price elasticity Perfect price inelasticity Cross elasticity

Demand-Oriented Pricing This slide relates to the material on pp. 405-410. See also Overheads 198 and 200 and Transparencies 128-129. Prestige Value-in-Use Types of Demand-Oriented Pricing Reference Psychological Summary Overview Final consumers don’t consider costs the same way business buyers and marketers do. Consumers often have a reference price -- the price they expect to pay -- for many of the products they purchase. As marketers have learned, that reference price may be realistic or unrealistic -- but it is the basis for all other consumer evaluations of the marketing offer. Many demand-oriented price policies are designed to affect consumers subjective reactions to price. Demand-Oriented Pricing Value-In-Use Pricing. For business markets, this pricing policy sets prices at something less than the total savings the customer will receive for switching to the new product. Reference Pricing. The price a consumer expects to pay for a product. Leader Pricing. This prices some products very low to get customers into the retail store. Bait Pricing. This sets some prices very low but those products are strongly “de-marketed” once the customer is in the store. Here the salesperson tries to steer customers to more expensive items. In some cases, bait pricing practices are illegal. Psychological Pricing. This attempts to discover the price range a customer prefers for a given product. Price cuts within the range don’t affect demand much. Odd-Even Pricing. This set prices to end in certain numbers: $49 (not $50), $24.95 (not $25), $99 (not $100). Price Lining. This sets a few price levels for a product line and then marks all items at these prices (e.g., neckties at $10, $15, or $20 each). Demand-Backward Pricing. This involves setting an acceptable final consumer price and working backward to what a producer can charge. Prestige Pricing. This sets a rather high price to suggest high quality or high status. Leader Odd-Even 17-11

????? Full-Line Pricing Market- or Firm Oriented? Complementary This slide relates to the material on p. 411. Full-Line Pricing Market- or Firm Oriented? ????? Summary Overview Because most marketing managers are responsible for more than one product, it is important to understand how a full line of products is priced as part of the firm’s overall competitive strategy plan. Full Line Pricing: Key Concepts Full-Line Pricing. Full-line pricing is setting prices for a whole line of products. How marketing managers do this depends on which of the two basic situations a firm is facing: Market-oriented. Here the firm makes a line of products that are all aimed at the same general target market. The differences in price should reasonably reflect the differences in the features for each version of the product. Firm-oriented. Here the firm makes a line of products where each product serves an entirely different target market. So there doesn’t have to be any relation between the various prices. Complementary Product Pricing. Complementary pricing means setting prices on several products as a group. The overall objective is to increase sales for the group as a whole. One product may be priced very low so that profits from another product will increase. Product-Bundling Pricing. This involves setting one price for a set of products. It’s cheaper for the customer to buy the products at the same time than separately. This strategy may help stimulate demand for some products that are not as attractive to the consumer in isolation but offer a reasonable increase in benefits when bundled with the other items. Teaching Tip: Many hair care product makers bundle shampoo and conditioner together for less than each priced alone. The trick is that the products are in different sizes, eventually requiring a new purchase of one of the products to replace the one that has been used up. Complementary Pricing? Product-Bundling Pricing? 17-12

Bid and Negotiated Pricing This slide relates to the material on pp. 412-413. Bid pricing means offering a specific price for each possible job. Determining costs is a complicated process. Summary Overview Bid pricing means offering a specific price for each possible job rather than setting a price that applies for all customers. For large jobs, such as building construction, this is a very complicated process, since the cost of each component may change over the course of the project’s completion. Teaching Tip: Fluor Corporation is an international company that excels at bid pricing of large projects such as water desalinization plants for developing countries. Their success benefits countries that could not otherwise afford to build much-needed infrastructure as well as earning strong(and fair) profits for the company. Negotiated pricing involves setting a price as the result of a bargaining process between the buyer and seller. Negotiated pricing is most common in situations where the marketing mix is adjusted for each customer--so bargaining may involve the whole marketing mix, not just the price level. Sellers must know their costs to negotiate prices effectively. Negotiated pricing involves setting a price as the result of a bargaining process between the buyer and seller. 17-13

Pricing and Social Responsibility Some legal pricing strategies create ethical dilemmas Corporate profit goals SR often increases price Business self-interest versus society’s best interest