Chapter 11: Pricing Concepts & Strategies: Establishing ...
Chapter 11: Pricing Concepts & Strategies: Establishing Value
Price – the overall sacrifice a consumer is willing to make – money, time, energy – to acquire a specific P/S Consumers judge benef its of product against sacrifices to obtain it Key to successful pricing is matching the P/S with consumer’s value perceptions A low price may trigger thoughts of low quality, poor performance, or other negative attributes Consumers rank price as one of the most important factors in their purchase decisions
The 5 Cs of Pricing
Successful pricing strategies are built through five critical components:
Company Objectives
Each firm has different objectives & so has to choose a price that fits to be successful Profit Orientation o Target Profit Pricing when they have a particular profit goal as overriding concern; uses price to stimulate a certain level of sales at a certain profit per unit o Maximizing Profits Strategy mathematical model to determine price at which profits are maximized o Target Return Pricing more interested in rates at which profits are generated relative to investments Sales Orientation o Belief that increasing sales will help the firm more than will increasing profits; taking or holding onto larger market share is the perspective Competitor Orientation o Measure themselves mainly against their competition o Competitive Parity setting prices that are similar to those of major competitors Customer Orientation o Invokes concept of customer value & setting prices to match consumer expectations o No-haggle price structure to make purchase process easier and add value o High-priced, state-of-the-art products in anticipation of limited sales and makes a statement that the company is capable of producing high end products
Customers
Understanding consumers’ reactions to different prices Demand Curves & Pricing o Shows how many units of a P/S consumers will demand during period at specific prices o Usual demand curve illustrates that as price increases, demand decreases o Prestige P/S consumers purchase for status rather than functionality Higher price means more sold Price Elasticity of Demand o Marketers determine how consumers respond to actual changes in price so they can know whether changing the price makes sense o Price elasticity of demand measures how changes in price affect quantity demanded Necessities = less sensitive to price Substitutes = more sensitive to price o Elastic = Price sensitive = < -1 = relatively small changes in price generate fairly large changes in Q demanded o Inelastic = price insensitive = > -1 = relatively small changes in price will not generate large changes in Q demanded o Consumers more sensitive to price increases than to price decrease o Unless a straight line, price elasticity of demand changes at different points of the demand curve o Factors influencing P.E. of D. Income Effect = change in Q of product demanded due to change in income Substitution Effect = ability to sub other products for the focal brand; price elasticity increases for focal brand Cross-Price Elasticity = % change in demand for PA that occurs in response to a % change in price of PB Complimentary products – positive relationship Substitute products – negative relationship
Costs
Consumers use only the price they must pay & benefits they receive to judge value Consumers don’t care how much costs the firm faces to produce P/S Variable costs primarily labour & materials that vary with production volume; complex in service industry Fixed costs remain essentially at the same level regardless of any changes in production volume Total cost sum of variable and fixed costs Break-even Analysis & Decision Making o Break-even point point where # of units sold generates enough revenue so that profits equal 0 ( ) o o o
Contribution per unit price/unit – VC/unit Has limitations: Price used might represent an average price to account for variances Prices often get reduced as quantity increases Cannot indicate for sure how many products will sell at a given price
Competition
Four levels of competition: monopoly, oligopolistic, monopolistic, and pure Monopoly = only one firms provides the product or service in a particular industry o E.g. in the utility industry Hydro One supplies most of Ontario Oligopolistic = only a few firms dominate (e.g. banking, gasoline) o Price War firms compete by lowering their prices (e.g. airline industry) Monopolistic = many firms selling closely related (but not homogeneous) items o Most common form of competition o Substitutes but not perfect substitutes Pure = different companies sell commodity products that consumers perceive are substitutable (e.g. wheat) o Price is set according to the laws of supply and demand
Channel Members
Manufacturers, retailers, wholesalers have different perspectives on price strategies so it is important to choose channel members with the same position of moving products as you Grey Market employs irregular (not necessarily illegal) methods to sell goods at lower prices than intended by the manufacturer. o To discourage grey market distribution, some manufacturers have posted large disclaimers on their websites, packaging, and other communications to warn consumers that the manufacturer’s warranty becomes null and void unless the item has been purchased from an authorized dealer
Other Influences on Pricing The Internet
People buy more online and this has made them more price sensitive and opened new categories of products Stores now attempt to focus consumers’ attention on prepurchase advice, consulting, & after-sales help Search engines allow consumers to find best prices quickly Consumers know more about P/S, the firm, its competitors, etc eBay allows consumers to bid for products and make deals with others Recent trend affecting price includes the growth of online daily coupon promotions from companies such as Groupon or WagJag
Economic Factors
Increase in consumers’ disposable income & status consciousness High-priced items aimed at the elite are being bought by more & more consumers Other consumers are still conscious about the way they spend their money Cross-shopping pattern of buying both premium & low-priced merchandise or patronizing both expensive, status-oriented & price-oriented retailers Economic environment at local, regional, national, & global levels influences prices o By thinking globally, firms can offer most cost-efficient methods of providing P/S to customers
Pricing Strategies
The choice of pricing strategy is specific to the P/S and target market
Cost-Based Methods
Cost-based pricing method: determines the final price to charge by starting with the cost, without recognizing the role that consumers or competitors’ prices play in the marketplace Requires that all costs can be indentified and calculated on a per-unit basis Prices are usually set on the basis of estimates of average costs
Competitor-Based Methods
Competitor-based methods: Set prices to reflect way they want consumers to interpret their own prices relative to competitor’s offerings Premium pricing: price product deliberately above price set for competing products to capture consumers who shop for the best or for who price doesn’t matter
Value-Based Methods
Value-based methods: Focus on overall value of P/S as perceived by consumer, who determine value by comparing the benefits they expect the product to deliver with the sacrifice they will need to make to acquire the product Improvement Value Method: Estimate of how much more or less consumers are willing to pay for a P/S relative to other comparable P/S Cost of Ownership Method: Setting prices that determines the total cost of owning the product over its useful life Value-based pricing strategies necessitate a great deal of consumer research to be implemented successfully
New Product Pricing
One of the most challenging tasks, especially for new-to-world products
Price Skimming
Price Skimming: Selling new P/S at a high price that innovators and early adopters are willing to pay for & lowering price once market segment becomes saturated so that firm can capture next most price-sensitive segment o For this to work product or service must be groundbreaking by offering new benefits currently unavailable in alternative products o To signal high quality, to limit demand, to test consumers’ price sensitivity o To be successful, competitors must not be able to enter easily o Face potential drawback from high unit costs associated with producing small volumes of products o Can cause discontent for consumers who pay the initial high price, then realize a price drop
Market Penetration Pricing
Market Penetration: Set initial price low for the intro of the new P/S, with objective of building sales, market share, & profit more quickly o Profits flow through volume o Experience Curve Effect refers to drop in unit cost as volume sold increases; as sales continue to grow, the costs continue to drop, allowing even further reductions in the price Discourages competitors from entering the market b/c the profit margin is relatively low Drawbacks: firm must have the capacity to satisfy a rapid rise in demand, low price does not signal high quality, and firms can lose profit if there are some segments willing to pay more for the product
Psychological Factors Affecting Value-Based Strategies Consumers’ Use of Reference Prices
Reference Price price against which buyers compare actual selling price of P/S & that facilitates evaluation process External Reference Price a higher price to which the consumer can compare selling price to evaluate the deal Internal Reference Price price info stored in consumers’ memory that’s used to assess current price offering External reference prices influence internal reference prices
Everyday Low Pricing (EDLP) Versus High/Low Pricing
EDLP = emphasize continuity of their retail prices at a level somewhere between the regular, non-sale pricing & the deep-discount pricing their competitors offer High/low pricing = relies on the promotion of sales, during which prices are reduced to encourage purchases Some don’t want to put time/effort in and patronize EDLP stores Other consumers are price sensitive & will search out the lowest price every time Some consumers perceive EDLP store are less quality; high/low stores carry higher quality items
Odd Prices
Prices that end in odd numbers (usually 9) – e.g. $3.99 Firms fear rounding prices will have a negative effect Firms believe consumers truncate the actual price, making perceived price appear cheaper than it really is Odd prices signal to consumers that the price is low
The Price Quality Relationship
Not all consumers use price to judge quality If they know the brand, had experience with P/S price becomes less important Consumers also judge quality via brand name, store, warranties/guarantees, etc
Pricing Tactics
Offer short-term methods to focus on certain components of 5 Cs Represents short-term response to competitive threat OR broadly accepted method of calculating final price
B2B
Customers
Seasonal Discounts – additional reduction as incentive to retailers to order much in advance of normal buying season; trade-off for dealers between cost savings and cost of carrying inventory for long period of time.
Price Lining = establish price floor & price ceiling fir entire line of similar product & setting price points in between to represent distinct differences in quality.
Cash Discounts – additional discount that reduces invoice cost if buyer pays prior to end of discount period (2/10 n30). This allows firms to take advantage of the time value of money.
Price Bundling = pricing of more than 1 product for single, lower price than what the items would cost separately
Allowances: Advertising = offered to retailers if they agree to feature manufacturer’s product in their advertising/promotions Listing = offered to get new product into store &/or gain better shelf space
Leader Pricing = building store traffic by aggressively pricing & advertising a regularly purchased item, often priced at or just above the store’s cost. The store prices other items at higher price to make up for the markdown on the product. (e.g. milk)
Quantity Discounts = providing a reduced price according to amount purchased. The more the buyer purchases the higher the discount and the higher the value. Cumulative quantity discount = discount on the amount purchased over a specified period of time, involving several transactions. Vs. Noncumulative quantity discount = discount based on only the amount purchased in a single order
Markdowns are reductions retailers take on the initial selling price of the product or service. Allows retailers to move slow moving or obsolete items or increase sales. Size Discount – the larger the quantity bought the less the cost per unit Seasonal Discounts – price reductions on products to stimulate demand during off-peak seasons.
Uniform Delivered Pricing – the shipper charges one rate, no matter where the buyer is located Geographic Pricing – the setting of different prices depending on a geographical division of the delivery areas.
Coupons – provide a stated discount to consumers on the final selling prices of a specific item. Rebates – consumer discount in which a portion of the purchase price is returned to the buyer in cash.
Legal Aspects and Ethics of Pricing Deceptive or Illegal Price Advertising
Deceptive reference prices – external reference prices cannot be inflated (e.g. regular price) Loss leader pricing – takes the tactic of leader pricing one step further by lowering the price below the store’s cost. Bait and switch – practice of luring customers into the store with a very low advertised price on an item (the bait), only to aggressively pressure them into purchasing a higher-priced item (the switch) by disparaging the
low-priced item, comparing it unfavourably with the higher priced model, or professing an inadequate supply of the lower-priced item.
Predatory Pricing
Practice of setting a very low price for one or more of its products with the intent to drive its competition out of business Illegal under the Competition Act b/c it constrains free trade and represents a form of unfair competition
Price Discrimination
Selling the same product to different resellers or to the ultimate consumer at different prices; some but not all forms of price discrimination are illegal.
Price Fixing
The practice of colluding with other firms to control prices. 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. Vertical price fixing: occurs when parties at different levels of the same marketing channel collude to control the prices on to customers (e.g. manufacturers and retailers).
Price – the overall sacrifice a consumer is willing to make – money, time, energy – to acquire a specific P/S Consumers judge benef its of product against sacrifices to obtain it Key to successful pricing is matching the P/S with consumer’s value perceptions A low price may trigger thoughts of low quality, poor performance, or other negative attributes Consumers rank price as one of the most important factors in their purchase decisions
The 5 Cs of Pricing
Successful pricing strategies are built through five critical components:
Company Objectives
Each firm has different objectives & so has to choose a price that fits to be successful Profit Orientation o Target Profit Pricing when they have a particular profit goal as overriding concern; uses price to stimulate a certain level of sales at a certain profit per unit o Maximizing Profits Strategy mathematical model to determine price at which profits are maximized o Target Return Pricing more interested in rates at which profits are generated relative to investments Sales Orientation o Belief that increasing sales will help the firm more than will increasing profits; taking or holding onto larger market share is the perspective Competitor Orientation o Measure themselves mainly against their competition o Competitive Parity setting prices that are similar to those of major competitors Customer Orientation o Invokes concept of customer value & setting prices to match consumer expectations o No-haggle price structure to make purchase process easier and add value o High-priced, state-of-the-art products in anticipation of limited sales and makes a statement that the company is capable of producing high end products
Customers
Understanding consumers’ reactions to different prices Demand Curves & Pricing o Shows how many units of a P/S consumers will demand during period at specific prices o Usual demand curve illustrates that as price increases, demand decreases o Prestige P/S consumers purchase for status rather than functionality Higher price means more sold Price Elasticity of Demand o Marketers determine how consumers respond to actual changes in price so they can know whether changing the price makes sense o Price elasticity of demand measures how changes in price affect quantity demanded Necessities = less sensitive to price Substitutes = more sensitive to price o Elastic = Price sensitive = < -1 = relatively small changes in price generate fairly large changes in Q demanded o Inelastic = price insensitive = > -1 = relatively small changes in price will not generate large changes in Q demanded o Consumers more sensitive to price increases than to price decrease o Unless a straight line, price elasticity of demand changes at different points of the demand curve o Factors influencing P.E. of D. Income Effect = change in Q of product demanded due to change in income Substitution Effect = ability to sub other products for the focal brand; price elasticity increases for focal brand Cross-Price Elasticity = % change in demand for PA that occurs in response to a % change in price of PB Complimentary products – positive relationship Substitute products – negative relationship
Costs
Consumers use only the price they must pay & benefits they receive to judge value Consumers don’t care how much costs the firm faces to produce P/S Variable costs primarily labour & materials that vary with production volume; complex in service industry Fixed costs remain essentially at the same level regardless of any changes in production volume Total cost sum of variable and fixed costs Break-even Analysis & Decision Making o Break-even point point where # of units sold generates enough revenue so that profits equal 0 ( ) o o o
Contribution per unit price/unit – VC/unit Has limitations: Price used might represent an average price to account for variances Prices often get reduced as quantity increases Cannot indicate for sure how many products will sell at a given price
Competition
Four levels of competition: monopoly, oligopolistic, monopolistic, and pure Monopoly = only one firms provides the product or service in a particular industry o E.g. in the utility industry Hydro One supplies most of Ontario Oligopolistic = only a few firms dominate (e.g. banking, gasoline) o Price War firms compete by lowering their prices (e.g. airline industry) Monopolistic = many firms selling closely related (but not homogeneous) items o Most common form of competition o Substitutes but not perfect substitutes Pure = different companies sell commodity products that consumers perceive are substitutable (e.g. wheat) o Price is set according to the laws of supply and demand
Channel Members
Manufacturers, retailers, wholesalers have different perspectives on price strategies so it is important to choose channel members with the same position of moving products as you Grey Market employs irregular (not necessarily illegal) methods to sell goods at lower prices than intended by the manufacturer. o To discourage grey market distribution, some manufacturers have posted large disclaimers on their websites, packaging, and other communications to warn consumers that the manufacturer’s warranty becomes null and void unless the item has been purchased from an authorized dealer
Other Influences on Pricing The Internet
People buy more online and this has made them more price sensitive and opened new categories of products Stores now attempt to focus consumers’ attention on prepurchase advice, consulting, & after-sales help Search engines allow consumers to find best prices quickly Consumers know more about P/S, the firm, its competitors, etc eBay allows consumers to bid for products and make deals with others Recent trend affecting price includes the growth of online daily coupon promotions from companies such as Groupon or WagJag
Economic Factors
Increase in consumers’ disposable income & status consciousness High-priced items aimed at the elite are being bought by more & more consumers Other consumers are still conscious about the way they spend their money Cross-shopping pattern of buying both premium & low-priced merchandise or patronizing both expensive, status-oriented & price-oriented retailers Economic environment at local, regional, national, & global levels influences prices o By thinking globally, firms can offer most cost-efficient methods of providing P/S to customers
Pricing Strategies
The choice of pricing strategy is specific to the P/S and target market
Cost-Based Methods
Cost-based pricing method: determines the final price to charge by starting with the cost, without recognizing the role that consumers or competitors’ prices play in the marketplace Requires that all costs can be indentified and calculated on a per-unit basis Prices are usually set on the basis of estimates of average costs
Competitor-Based Methods
Competitor-based methods: Set prices to reflect way they want consumers to interpret their own prices relative to competitor’s offerings Premium pricing: price product deliberately above price set for competing products to capture consumers who shop for the best or for who price doesn’t matter
Value-Based Methods
Value-based methods: Focus on overall value of P/S as perceived by consumer, who determine value by comparing the benefits they expect the product to deliver with the sacrifice they will need to make to acquire the product Improvement Value Method: Estimate of how much more or less consumers are willing to pay for a P/S relative to other comparable P/S Cost of Ownership Method: Setting prices that determines the total cost of owning the product over its useful life Value-based pricing strategies necessitate a great deal of consumer research to be implemented successfully
New Product Pricing
One of the most challenging tasks, especially for new-to-world products
Price Skimming
Price Skimming: Selling new P/S at a high price that innovators and early adopters are willing to pay for & lowering price once market segment becomes saturated so that firm can capture next most price-sensitive segment o For this to work product or service must be groundbreaking by offering new benefits currently unavailable in alternative products o To signal high quality, to limit demand, to test consumers’ price sensitivity o To be successful, competitors must not be able to enter easily o Face potential drawback from high unit costs associated with producing small volumes of products o Can cause discontent for consumers who pay the initial high price, then realize a price drop
Market Penetration Pricing
Market Penetration: Set initial price low for the intro of the new P/S, with objective of building sales, market share, & profit more quickly o Profits flow through volume o Experience Curve Effect refers to drop in unit cost as volume sold increases; as sales continue to grow, the costs continue to drop, allowing even further reductions in the price Discourages competitors from entering the market b/c the profit margin is relatively low Drawbacks: firm must have the capacity to satisfy a rapid rise in demand, low price does not signal high quality, and firms can lose profit if there are some segments willing to pay more for the product
Psychological Factors Affecting Value-Based Strategies Consumers’ Use of Reference Prices
Reference Price price against which buyers compare actual selling price of P/S & that facilitates evaluation process External Reference Price a higher price to which the consumer can compare selling price to evaluate the deal Internal Reference Price price info stored in consumers’ memory that’s used to assess current price offering External reference prices influence internal reference prices
Everyday Low Pricing (EDLP) Versus High/Low Pricing
EDLP = emphasize continuity of their retail prices at a level somewhere between the regular, non-sale pricing & the deep-discount pricing their competitors offer High/low pricing = relies on the promotion of sales, during which prices are reduced to encourage purchases Some don’t want to put time/effort in and patronize EDLP stores Other consumers are price sensitive & will search out the lowest price every time Some consumers perceive EDLP store are less quality; high/low stores carry higher quality items
Odd Prices
Prices that end in odd numbers (usually 9) – e.g. $3.99 Firms fear rounding prices will have a negative effect Firms believe consumers truncate the actual price, making perceived price appear cheaper than it really is Odd prices signal to consumers that the price is low
The Price Quality Relationship
Not all consumers use price to judge quality If they know the brand, had experience with P/S price becomes less important Consumers also judge quality via brand name, store, warranties/guarantees, etc
Pricing Tactics
Offer short-term methods to focus on certain components of 5 Cs Represents short-term response to competitive threat OR broadly accepted method of calculating final price
B2B
Customers
Seasonal Discounts – additional reduction as incentive to retailers to order much in advance of normal buying season; trade-off for dealers between cost savings and cost of carrying inventory for long period of time.
Price Lining = establish price floor & price ceiling fir entire line of similar product & setting price points in between to represent distinct differences in quality.
Cash Discounts – additional discount that reduces invoice cost if buyer pays prior to end of discount period (2/10 n30). This allows firms to take advantage of the time value of money.
Price Bundling = pricing of more than 1 product for single, lower price than what the items would cost separately
Allowances: Advertising = offered to retailers if they agree to feature manufacturer’s product in their advertising/promotions Listing = offered to get new product into store &/or gain better shelf space
Leader Pricing = building store traffic by aggressively pricing & advertising a regularly purchased item, often priced at or just above the store’s cost. The store prices other items at higher price to make up for the markdown on the product. (e.g. milk)
Quantity Discounts = providing a reduced price according to amount purchased. The more the buyer purchases the higher the discount and the higher the value. Cumulative quantity discount = discount on the amount purchased over a specified period of time, involving several transactions. Vs. Noncumulative quantity discount = discount based on only the amount purchased in a single order
Markdowns are reductions retailers take on the initial selling price of the product or service. Allows retailers to move slow moving or obsolete items or increase sales. Size Discount – the larger the quantity bought the less the cost per unit Seasonal Discounts – price reductions on products to stimulate demand during off-peak seasons.
Uniform Delivered Pricing – the shipper charges one rate, no matter where the buyer is located Geographic Pricing – the setting of different prices depending on a geographical division of the delivery areas.
Coupons – provide a stated discount to consumers on the final selling prices of a specific item. Rebates – consumer discount in which a portion of the purchase price is returned to the buyer in cash.
Legal Aspects and Ethics of Pricing Deceptive or Illegal Price Advertising
Deceptive reference prices – external reference prices cannot be inflated (e.g. regular price) Loss leader pricing – takes the tactic of leader pricing one step further by lowering the price below the store’s cost. Bait and switch – practice of luring customers into the store with a very low advertised price on an item (the bait), only to aggressively pressure them into purchasing a higher-priced item (the switch) by disparaging the
low-priced item, comparing it unfavourably with the higher priced model, or professing an inadequate supply of the lower-priced item.
Predatory Pricing
Practice of setting a very low price for one or more of its products with the intent to drive its competition out of business Illegal under the Competition Act b/c it constrains free trade and represents a form of unfair competition
Price Discrimination
Selling the same product to different resellers or to the ultimate consumer at different prices; some but not all forms of price discrimination are illegal.
Price Fixing
The practice of colluding with other firms to control prices. 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. Vertical price fixing: occurs when parties at different levels of the same marketing channel collude to control the prices on to customers (e.g. manufacturers and retailers).
