1. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University CHAPTER 11 Pricing Products and Services 11 - 1

2. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University After reading this chapter you should be able to: Identify the elements that make up a price. Understand demand-oriented, cost-oriented, profit-oriented, and competition-oriented approaches to pricing and the major factors considered in arriving at a final list or quoted price. 11 - 2

3. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University After reading this chapter you should be able to: Explain what a demand curve is and what price elasticity of demand means. Explain the role of revenues (sales) and costs in pricing decisions. Understand the value of break-even analysis. 11 - 3

4. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University After reading this chapter you should be able to: Recognise the objectives a firm has in setting prices and the constraints on the range of prices a firm can charge. Describe the special adjustments made to the approximate price level on the basis of geography, discounts, and allowances. 11 - 4

5. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Nature and Importance of Price The price paid for goods and services goes by many names. You pay rent for an apartment, interest on a bank credit card and a premium for car insurance. Your dentist or doctor charges you a fee, a professional or social organisation charges dues, and airlines charge a fare. And what you pay for clothes or a haircut is termed a price. Price is the only variable in marketing, and in fact in business, that generates the majority of revenue for all business and most non-profit organisations. Without price, or revenue, no organisation would exist in a modern economy. 11 - 5

6. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University What Is a Price? These examples highlight the many varied ways that price plays a part in our daily lives. From a marketing viewpoint, price is the money or other considerations, including other goods and services, exchanged for the ownership or use of a product. The practice of exchanging goods and services for other goods and services rather than for money is called barter. Price can vary due to many internal and external factors, and therefore price setting can vary. 11 - 6

7. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University The price of three different purchases 11 - 7

8. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Price As an Indicator of Value For some products, price influences consumers’ perception of overall quality. From a consumer’s standpoint, price is often used to indicate value when price is compared with benefits of the product. At a given price, as perceived benefits increase, value increases. If you’re used to paying $10.99 for a medium pizza, wouldn’t a large pizza at the same price be more valuable? Creative marketers, aware that consumers’ value assessments are often comparative, engage in value pricing. Value pricing is the practice of increasing a product’s benefits while maintaining or decreasing price. 11 - 8

9. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Price in the Marketing Mix Pricing is a critical decision made by a marketing executive because price has a direct effect on a firm’s profits. This is apparent from a firm’s profit equation: –Profit = Total revenue – Total cost –= (Unit price × Quantity sold) – Total cost What makes this relationship even more complicated is that price affects the quantity sold, as illustrated with demand curves. Since the quantity sold sometimes affects a firm’s costs because of efficiency of production, price also indirectly affects costs. Thus, pricing decisions influence both total revenue (sales) and total cost, which makes pricing one of the most important decisions marketing executives face. 11 - 9

10. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University General Pricing Approaches A key to a marketing manager’s setting a final price for a product is to find an ‘approximate price level’ to use as a reasonable starting point. Four common approaches to helping find this approximate price level are: 1.demand-oriented. 2.cost-oriented. 3.profit-oriented. 4.competition-oriented approaches. Some of these methods do overlap. 11 - 10

11. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Four approaches for selecting an approximate price level 11 - 11

12. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Demand-Oriented Approaches Demand-oriented approaches emphasise factors underlying expected customer tastes and preferences more than such factors as cost, profit and competition when selecting a price level. Plasma TV manufacturers used skimming pricing to enter the market 11 - 12

13. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Demand-Oriented Approaches Some of the demand oriented approaches used in pricing are: –Price Skimming –Penetration Pricing –Prestige Pricing –Odd-Even Pricing –Target Pricing –Bundle Pricing –Yield Management Pricing –Economic Value Pricing 11 - 13

14. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 1.What is the profit equation? 1. The profit equation is: Profit = Total Revenue - Total Cost = (Unit Price x Quantity Sold) - Total Cost 11 - 14

15. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 2.What is the difference between skimming and penetration pricing? A firm introducing a new product can use either skimming pricing to set the highest initial price that customers desiring the product are willing to pay or penetration pricing to set a low initial price to appeal immediately to the mass market. 11 - 15

16. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 3. What is odd-even pricing? 3.Odd-even pricing involves setting prices a few dollars or cents under an even number ($599.99 vs. $600.00). Psychologically, the $599.99 price feels lower than $600.00, even though the difference is 1 cent. 11 - 16

17. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Cost-Oriented Approaches With cost-oriented approaches a price setter stresses the cost side of the pricing problem, not the demand side. Price is set by looking at the production and marketing costs and then adding enough to cover direct expenses, overheads and profit. Some of the pricing methods used with this approach are: –Standard Markup Pricing –Cost-Plus Pricing 11 - 17

18. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Profit-Oriented Approaches A price setter may choose to balance both revenues and costs to set price using profit oriented approaches. These might involve either setting a target of a specific dollar volume of profit or expressing this target profit as a percentage of sales or investment. Some of the pricing methods used with this approach are: –Target Profit Pricing –Target Return-on-Sales Pricing –Target Return-on-Investment Pricing 11 - 18

19. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Competition-Oriented Approaches Rather than emphasise demand, cost or profit factors, a price setter can stress what competitors or ‘the market’ is doing. Some of the pricing methods used with this approach are: –Customary Pricing –Above-, At- or Below-Market Pricing –Loss-Leader Pricing 11 - 19

20. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Estimating Demand and Revenue Basic to setting a product’s price is the extent of customer demand for it. Marketing executives must also translate this estimate of customer demand into estimates of revenues the firm expects to receive. Ten years after it arrived in Australia, pay TV has penetrated only 26 per cent of Australian homes despite a $1.5 billion investment. If you don’t have pay TV ask yourself the reasons. For example, since price is only part of the value equation, how much is price a factor compared to content? At what price would you decide to subscribe? 11 - 20

21. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University The Demand Curve A demand curve shows the number of products that will be sold at a given price. But price is not the complete story in estimating demand. Economists emphasise three other key factors: –Consumer tastes. –Price and availability of similar products. –Consumer income. Movement along versus shift of a Demand Curve: –Different factors can cause either a shift or a movement in the demand curve for a product. 11 - 21

22. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Demand Curve in Practice 11 - 22

23. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Price Elasticity of Demand Marketing managers are especially interested in price elasticity—a key consideration related to the product’s demand curve. Price elasticity refers to how sensitive consumer demand and the firm’s revenues are to changes in the product’s price. A product with elastic demand is one in which a slight decrease in price results in a relatively large increase in demand, or units sold. The reverse is also true: with elastic demand, a slight increase in price results in a relatively large decrease in demand. A product with inelastic demand means that slight increases or decreases in price will not significantly affect the demand, or units sold, for the product. 11 - 23

24. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 1.What is loss-leader pricing? 1.For a special promotion, retail stores deliberately sell a product below its customary price to attract customers in hopes they will buy other products as well, particularly the discretionary items with large markups. 11 - 24

25. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 2.What are the four demand factors that determine consumers’ willingness and ability to pay for goods and services? 2.They are price, consumer tastes, price and availability of similar products, and consumer income. 11 - 25

26. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 3. What is the difference between movement along a demand curve and a shift in a demand curve? A movement along a demand curve occurs when the price is lowered and the quantity demanded increases (and vice versa), assuming that other factors remain unchanged. However, if these factors change, then the demand curve will shift. 11- 26

27. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Fundamental revenue concept 11 - 27

28. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Fundamentals of Estimating Revenue While economists may talk about ‘demand curves’, marketing executives are more likely to speak in terms of ‘revenues generated’. Demand curves lead directly to an essential revenue concept critical to pricing decisions: total revenue. As summarised in the previous slide total revenue (TR) equals the unit price (P) times the quantity sold (Q). 11 - 28

29. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Determining Cost, Volume and Profit Relationships While revenues are the moneys received by the firm from selling its products or services to customers, costs or expenses are the moneys the firm pays out to its employees and suppliers. Marketing managers often use break-even analysis to relate revenues and costs, topics covered in this section. 11 - 29

30. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University The Importance of Controlling Costs Understanding the role and behaviour of costs is critical for all marketing decisions, particularly pricing decisions. Many firms go bankrupt because their costs get out of control, causing their total costs to exceed their total revenues over an extended period of time. This is why sophisticated marketing managers make pricing decisions that balance both their revenues and their costs. Three cost concepts are important in pricing decisions: –total cost, –fixed cost, –variable cost. 11 - 30

31. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Fundamental cost concepts 11 - 31

32. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Break-Even Analysis Marketing managers often employ an approach that considers cost, volume and profit relationships, based on the profit equation. Break-even analysis is a technique that analyses the relationship between total revenue and total cost to determine profitability at various levels of output. The break-even point (BEP) is the quantity at which total revenue and total cost are equal. Profit comes from any units sold beyond the BEP. 11 - 32

33. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Calculating a Break-Even Point 11 - 33

34. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Break-even analysis graph for a picture frame store 11 - 34

35. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Applications of Break-Even Analysis Because of its simplicity, break-even analysis is used extensively in marketing, most frequently to study the impact on profit of changes in price, fixed cost and variable cost. The mechanics of break-even analysis are the basis of the widely used electronic spreadsheets offered by computer programs such as Microsoft Excel that permit managers to answer hypothetical ‘what if ’ questions about the effect of changes in price and cost on their profit. 11 - 35

36. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 1.What is the difference between fixed costs and variable costs? 1. Fixed cost is the sum of the expenses of the firm that are stable and do not change with the quantity of the product that is produced and sold. Variable cost is the sum of the expenses of the firm that vary directly with the quantity of the product that is produced and sold. 11 - 36

37. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 2. What is a break-even point? 2.A break-even point (BEP) is the quantity at which total revenue and total cost are equal. 11 - 37

38. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Pricing Objectives and Constraints With such a variety of alternative pricing strategies available, a marketing manager must consider the pricing objectives and constraints that will narrow the range of choices. While pricing objectives frequently reflect corporate goals, pricing constraints often relate to conditions existing in the marketplace. 11 - 38

39. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Identifying Pricing Objectives Pricing objectives specify the role of price in an organisation’s marketing and strategic plans. To the extent possible, these pricing objectives are carried to lower levels in the organisation, such as in setting objectives for marketing managers responsible for an individual brand. These objectives may change depending on the financial position of the company as a whole, the success of its products, or the segments in which it is doing business. 11 - 39

40. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Identifying Pricing Objectives Pricing objectives that are used in marketing are: –Profit –Sales –Market Share –Unit Volume –Survival –Social Responsibility These objectives can be used individually or in any combination that the organisation believes will help it achieve its overall marketing and corporate objectives. 11 - 40

41. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Identifying Pricing Constraints Factors that limit the range of price a firm may set are pricing constraints. Consumer demand for the product clearly affects the price that can be charged. Other constraints on price vary from factors within the organisation to competitive factors outside it. Pricing constraints include: –Demand for the Product Class, Product and Brand –Newness of the Product: Stage in the Product Life Cycle –Cost of Producing and Marketing the Product –Competitors’ Prices –Legal and Ethical Considerations 11 - 41

42. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 1.What is the difference between pricing objectives and pricing constraints? 1.Pricing objectives specify the role of price in an organisation’s marketing and strategic plans. Pricing constraints are factors that limit the range of price a firm may set. 11 - 42

43. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 2. Explain what bait and switch is and why it is an example of deceptive pricing. 2.This occurs when a firm offers a very low price on a product (the bait) to attract customers to a store, who then are persuaded to purchase a higher-priced item (the switch). Misleading consumers is both illegal and unethical. 11 - 43

44. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Setting A Final Price The final price set by the marketing manager serves many functions. It must be high enough to cover the cost of providing the product and meet the objectives of the company. Yet it must be low enough that customers are willing to pay it. But not too low, or customers may think they’re purchasing an inferior product. Dizzy yet? Setting price is one of the most difficult tasks the marketing manager faces, but three generalised steps are useful to follow. 11 - 44

45. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Step 1: Select an Approximate Price Level Before setting a final price, the marketing manager must understand the market environment, the features and customer benefits of the particular product, and the goals of the firm. A balance must be struck between factors that might drive a price higher (such as a profit-oriented approach) and other forces (such as increased competition from substitutes) that may drive a price down. Marketing managers consider pricing objectives and constraints first, then choose among the general pricing approaches— demand-, cost-, profit- or competition - oriented— to arrive at an approximate price level. This price is then analysed in terms of cost, volume and profit relationships. 11 - 45

46. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Step 2: Set the List or Quoted Price A seller must decide whether to follow a one-price or flexible-price policy. A one-price policy involves setting one price for all buyers of a product or service. In contrast, a flexible-price policy involves setting different prices for products and services depending on individual buyers and purchase situation in light of demand, cost and competitive factors. 11 - 46

47. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Step 3: Make Special Adjustments to the List or Quoted Price Three special adjustments to the list or quoted price are: 1.Discounts: –Discounts are reductions from list price that a seller gives a buyer as a reward for some activity of the buyer that is favourable to the seller. Four kinds of discounts are especially important in marketing strategy: (1) quantity, (2) seasonal, (3) trade (functional) and (4) cash 2.Allowances –Allowances—like discounts—are reductions from list or quoted prices to buyers for performing some activity. 3.Geographical adjustments. –Geographical adjustments are made by manufacturers or even wholesalers to list or quoted prices to reflect the cost of transportation of the products from seller to buyer. –The two general methods for quoting prices related to transportation costs are (1) FOB origin pricing and (2) uniform delivered pricing. 11 - 47

48. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Concept Check 1.Why would a seller choose a flexible-price policy over a one-price policy? 2.What is the purpose of (a) quantity discounts and (b) promotional allowances? 1.A flexible-price policy involves setting different prices for products and services depending on individual buyers and purchasing situations in light of demand, cost, and competitive factors instead of setting one price for all buyers. 2.Quantity discounts encourage customers to buy larger quantities of a product. (b) Promotional allowances are used to encourage sellers to undertake certain advertising or selling activities to promote a product. 11 - 48

49. Copyright  2008 McGraw-Hill Australia Pty Ltd PPTs t/a Marketing: The Core by Kerin et al Slides prepared by Andrew Hughes, Australian National University Finish Questions? 11 - 49