Pricing products: Approaches and strategies

Factors to Consider When Setting Prices Factors that Affect Pricing Decisions Internal Factors External Factors Internal and external company factors affect a company’s pricing decisions Internal factors include the company’s marketing objectives, marketing mix strategy, costs, and organizational considerations (See Slide 6) External factors include the nature of the market, demand competition, and other environmental elements (See Slide 7)

Internal Factors affecting pricing decisions Marketing objectives Marketing Mix Strategies Internal factors Costs Organizational considerations Internal factors include the company’s marketing objectives, marketing mix strategy, costs, and organizational considerations Marketing Objectives Before establishing price, a company must select a product strategy If the company has selected a target market and positioned itself carefully, its marketing mix strategy, including price, will be more precise Marketing Mix Strategy Price is only one of many marketing mix tools that a company uses to achieve its marketing objectives Price must be coordinated with product design, distribution, and promotion decisions to form a consistent and effective marketing program Decisions made for other marketing mix variables may affect pricing decisions A firm’s promotional mix also influences price Companies often make pricing decisions first Other marketing mix decisions are based on the price a company chooses to charge Costs Costs set the floor for the price a company can charge for its product A company wants to charge a price that covers its costs for producing, distributing, and promoting the product Beyond covering these costs, the price has to be high enough to deliver a fair rate of return to investors Total costs are the sum of the fixed and variable costs for any given level of production In the long run, management must charge a price that will at least cover total costs at a given level of sales Organizational Considerations Management must decide who within the organization should set prices Companies handle pricing in a variety of ways In small companies, top management, rather than the marketing or sales department, often sets the prices In large companies, pricing is typically handled by a corporate department or by regional or unit managers, under guidelines established by corporate management Many corporations within the hospitality industry now have a revenue management department with responsibility for pricing and coordinating with other departments that influence price

Internal Factors affecting pricing decisions: Marketing Objectives Survival Current Profit Maximization Market-Share Leadership Product-Quality Leadership Other Objectives Before establishing price, a company must select a product strategy Pricing may play an important role in helping accomplish the company’s objective at many levels Survival Companies troubled by too much capacity, heavy compensation, or changing consumer wants set survival as their objective In the short run, survival is more important than profit This strategy directly affects immediate competitors and sometimes the entire industry Current profit maximization Many companies want to set a price that will maximize current profits They estimate what demand and costs will be at different prices and choose the price that will produce the maximum current profit, cash flow, or return on investment, seeking current financial outcomes rather than long-run performance Market-share leadership Some companies want to obtain a dominant market-share position They believe that a company with the largest market share will eventually enjoy low costs and high long-run profit Thus prices are set as low as possible Product-quality leadership For example: Groen, a manufacturer of food-service equipment, is known for its high-quality steam-jacketed kettles Kitchen designers specify Groen equipment because of its known quality, enabling the company to demand a high price for its equipment To maintain its quality, Groen must have a well-engineered product comprised of high-quality materials It also must have the budget to ensure that it maintains its position as a quality leader Other objectives A company also might use price to attain other, more specific objectives For example, a restaurant may set low prices to prevent competition from entering the market or set prices at the same level as its competition to stabilize the market

Internal factors: marketing objectives Survival Suffering from too much capacity, slumping economy, changing consumer wants Characterized by discounting and attempting to salvage cash flow Profit less important

Internal factors: marketing objectives Current Profit Maximization Internal factors: marketing objectives Still focused on short run Purchase distressed hotel and flip it Chipotle and McDonalds

Internal factors: marketing objectives Market Share Leadership Internal factors: marketing objectives Go after dominant share of the market Eventually achieve low costs and high long-term profit Marriott and Australia Gold coast

Internal factors: marketing objectives Product – Quality Leadership Internal factors: marketing objectives Charge high prices because of high inherent quality Constant reinvestment in quality Paying for a lot more than core product (highly augmented products)

Marketing Mix Strategies Internal Factors affecting pricing decisions Internal Factors Marketing objectives Marketing Mix Strategies Internal factors Costs Organizational considerations Internal factors include the company’s marketing objectives, marketing mix strategy, costs, and organizational considerations Marketing Objectives Before establishing price, a company must select a product strategy If the company has selected a target market and positioned itself carefully, its marketing mix strategy, including price, will be more precise Marketing Mix Strategy Price is only one of many marketing mix tools that a company uses to achieve its marketing objectives Price must be coordinated with product design, distribution, and promotion decisions to form a consistent and effective marketing program Decisions made for other marketing mix variables may affect pricing decisions A firm’s promotional mix also influences price Companies often make pricing decisions first Other marketing mix decisions are based on the price a company chooses to charge Costs Costs set the floor for the price a company can charge for its product A company wants to charge a price that covers its costs for producing, distributing, and promoting the product Beyond covering these costs, the price has to be high enough to deliver a fair rate of return to investors Total costs are the sum of the fixed and variable costs for any given level of production In the long run, management must charge a price that will at least cover total costs at a given level of sales Organizational Considerations Management must decide who within the organization should set prices Companies handle pricing in a variety of ways In small companies, top management, rather than the marketing or sales department, often sets the prices In large companies, pricing is typically handled by a corporate department or by regional or unit managers, under guidelines established by corporate management Many corporations within the hospitality industry now have a revenue management department with responsibility for pricing and coordinating with other departments that influence price

Internal factors affecting pricing decisions: marketing mix Strategies Align with Product, Place, Promotion elements in consistent way Place: If most rooms at your resort are sold through a wholesaler… Product: Plan to renovate rooms every few years…

Marketing Mix Strategies Internal Factors affecting pricing decisions Internal Factors Marketing objectives Marketing Mix Strategies Internal factors Costs Organizational considerations Internal factors include the company’s marketing objectives, marketing mix strategy, costs, and organizational considerations Marketing Objectives Before establishing price, a company must select a product strategy If the company has selected a target market and positioned itself carefully, its marketing mix strategy, including price, will be more precise Marketing Mix Strategy Price is only one of many marketing mix tools that a company uses to achieve its marketing objectives Price must be coordinated with product design, distribution, and promotion decisions to form a consistent and effective marketing program Decisions made for other marketing mix variables may affect pricing decisions A firm’s promotional mix also influences price Companies often make pricing decisions first Other marketing mix decisions are based on the price a company chooses to charge Costs Costs set the floor for the price a company can charge for its product A company wants to charge a price that covers its costs for producing, distributing, and promoting the product Beyond covering these costs, the price has to be high enough to deliver a fair rate of return to investors Total costs are the sum of the fixed and variable costs for any given level of production In the long run, management must charge a price that will at least cover total costs at a given level of sales Organizational Considerations Management must decide who within the organization should set prices Companies handle pricing in a variety of ways In small companies, top management, rather than the marketing or sales department, often sets the prices In large companies, pricing is typically handled by a corporate department or by regional or unit managers, under guidelines established by corporate management Many corporations within the hospitality industry now have a revenue management department with responsibility for pricing and coordinating with other departments that influence price

Internal factors: Costs Set the floor Fixed costs Variable costs Cost subsidization Seasonal ski resorts

Marketing Mix Strategies Internal Factors affecting pricing decisions Internal Factors Marketing objectives Marketing Mix Strategies Internal factors Costs Organizational considerations Internal factors include the company’s marketing objectives, marketing mix strategy, costs, and organizational considerations Marketing Objectives Before establishing price, a company must select a product strategy If the company has selected a target market and positioned itself carefully, its marketing mix strategy, including price, will be more precise Marketing Mix Strategy Price is only one of many marketing mix tools that a company uses to achieve its marketing objectives Price must be coordinated with product design, distribution, and promotion decisions to form a consistent and effective marketing program Decisions made for other marketing mix variables may affect pricing decisions A firm’s promotional mix also influences price Companies often make pricing decisions first Other marketing mix decisions are based on the price a company chooses to charge Costs Costs set the floor for the price a company can charge for its product A company wants to charge a price that covers its costs for producing, distributing, and promoting the product Beyond covering these costs, the price has to be high enough to deliver a fair rate of return to investors Total costs are the sum of the fixed and variable costs for any given level of production In the long run, management must charge a price that will at least cover total costs at a given level of sales Organizational Considerations Management must decide who within the organization should set prices Companies handle pricing in a variety of ways In small companies, top management, rather than the marketing or sales department, often sets the prices In large companies, pricing is typically handled by a corporate department or by regional or unit managers, under guidelines established by corporate management Many corporations within the hospitality industry now have a revenue management department with responsibility for pricing and coordinating with other departments that influence price

Internal factors: organizational considerations Not always the same person or department setting prices Top management in small company, sales dept, marketing dept Pricing dept, regional manager, unit manager… Hotel corporate team establishes pricing and occupancy goals regional management approves  individual GMs and Sales manager responsible for achieving them Revenue Management Dept

Factors to Consider When Setting Prices Factors that Affect Pricing Decisions Internal Factors External Factors Internal and external company factors affect a company’s pricing decisions Internal factors include the company’s marketing objectives, marketing mix strategy, costs, and organizational considerations (See Slide 6) External factors include the nature of the market, demand competition, and other environmental elements (See Slide 7)

External Factors affecting pricing decisions The Nature of Market & Demand Consumer Perceptions of Price & Value Competition External factors that affect pricing decisions include: The Nature of the Market and Demand Competition Other environmental elements Market and Demand Although costs set the lower limits of prices, the market and demand set the upper limit Both consumer and channel buyers such as tour wholesalers balance the product’s price against the benefits it provides Thus, before setting prices, a marketer must understand the relationship between price and demand for a product Cross-Selling and Upselling Cross-selling opportunities abound in the hospitality industry For example, a hotel can cross-sell food and beverage (F&B), exercise room services, and executive support services, and it can even sell retail products ranging from hand-dipped chocolates to terry-cloth bathrobes Upselling involves training sales and reservations employees to continuously offer a higher-priced product, rather than settling for the lowest price Consumer Perceptions of Price and Value In the end, it is the consumer who decides whether a product’s price is right When setting prices, management must consider how consumers perceive price and the ways that these perceptions affect consumers’ buying decisions Like other marketing decisions, pricing decisions must be buyer oriented Consumers tend to look at the final price and then decide whether they received a good value

Price-Demand Relationship The Nature of Market & Demand Each price a company can charge leads to a different level of demand The demand curve illustrates the relationship between price charged and the resulting demand It shows the number of units the market will buy in a given period at different prices that might be charged In the normal case, demand and price are inversely related: The higher the price, the lower the demand Most demand curves slope downward in either a straight or a curved line For prestige goods, the demand curve sometimes slopes upward

External factors Relationship between Price and Demand The Nature of Market & Demand Relationship between Price and Demand

Demand shifts

Supply shifts

External factors affecting price Consumer Perceptions of Price & Value Perceived value is a function of brand image, product attributes, and price Awareness of target market and purchase motivation affect price

Price Elasticity Measures how responsive demand will be to a change in price % Change in price = % change in Q demanded / price elasticity of demand Elasticity = % Change Qd / % Change in Price 1 = perfectly elastic -1 = perfectly ineleastic

Income Availability of substitutes Time

Determinants of Price Elasticity Buyers are Less Price Sensitive When: The Product is Unique The Product is High in Quality, Prestige or Exclusiveness Substitute Products are Hard to Find Marketers also need to understand the concept of price elasticity, how responsive demand will be to a change in price If demand hardly varies with a small change in price, we say that the demand is inelastic If demand changes greatly, we say the demand is elastic % Change in Quantity Demand = % Change in Price Price Elasticity of Demand What determines the price elasticity of demand? Buyers are less price-sensitive when: The product is unique The product is high in quality, prestige, or exclusiveness Substitute products are hard to find

Factors Affecting Price Sensitivity Unique Value Effect Substitute Awareness Effect Business Expenditure Effect End-Benefit Effect Total Expenditure Effect Price Quality Effect Factors that affect price sensitivity: Unique value effect Creating the perception that your offering is different from those of your competitors avoids price competition. In this way the firm lets the customer know it’s providing more benefits and offering a value that is superior to that of competitors, one that will either attract a higher price or more customers at the same price Substitute awareness effect The existence of alternatives of which buyers are unaware cannot affect their purchase behavior When consumers discover products offering a better value, they switch to those products Business expenditure effect When someone else pays the bill, the customer is less price-sensitive When setting rates, management needs to know what the market is willing to pay End-benefit effect Customers are more price-sensitive when the price of the product accounts for a large share of the total cost of the end benefit The end-benefit price identifies price-sensitive markets and provides opportunities to overcome pricing objections when the product being sold is a small cost of the end benefit Total expenditure effect The more someone spends on a product, the more sensitive they are to the product’s price The total expenditure effect is useful in selling lower-price products or products that offer cost savings to volume users Price quality effect Consumers tend to equate price with quality, especially when they lack any prior experience with the product If charge less then less customers Shared cost effect The more people sharing the cost, the less price sensitive Inventory effect The more perishable, the less price sensitive

Competition-Based Pricing Approaches to Pricing Cost-Based Pricing Break-Even Pricing Value-Based Pricing Competition-Based Pricing The price the company charges is somewhere between one that is too low to produce a profit and one that is too high to produce sufficient demand Product costs set a floor for the price, while consumer perceptions of the product’s value set the ceiling The company must consider competitors’ prices and other external and internal factors to find the best price between these two extremes. Companies set prices by selecting a general pricing approach that includes one or more of these sets of factors Cost-Based Pricing The simplest pricing method is cost-plus pricing, which is adding a standard markup to the cost of the product Markup pricing remains popular for many reasons Sellers are more certain about costs than about demand Tying the price to cost simplifies pricing Managers do not have to adjust prices as demand changes Break-Even Pricing The firm tries to determine the price at which it will break even Target Profit Pricing A variation of break-even pricing Targets a certain return on investment Value-Based Pricing An increasing number of companies are basing their prices on the products’ perceived value Value-based pricing uses the buyers’ perceptions of value, not the seller’s cost, as the key to pricing Value-based pricing means that the marketer cannot design a product and marketing program and then set the price Price is considered along with other marketing mix variables before the marketing program is set The company uses the non-price variables in the marketing mix to build perceived value in the buyers’ minds, setting price to match the perceived value Competition-Based Pricing A strategy of going-rate pricing is the establishment of price based largely on those of competitors, with less attention paid to costs or demand The firm might charge the same, more, or less than its major competitors The price the company charges is somewhere between one that is too low to produce a profit and one that is too high to produce sufficient demand Product costs set a floor for the price, while consumer perceptions of the product’s value set the ceiling

General Approaches to Pricing Cost-Based Pricing General Approaches to Pricing Cost-Plus markup Wine on menu sold at 300% purchase cost Cost as a percentage of selling price 40% food cost means menu item sold at 2.5 times cost 30% food cost means menu item sold at 3.33 times cost Prime Cost = Labor + Food Making dessert from scratch may have lower food cost, but labor is high, often not worth it

General Approaches to Pricing Cost-Based Pricing General Approaches to Pricing Lower the markup as cost increases, dollar value still increases Wine Sellers more certain about cost than demand Simple, common method so less price competition with rivals Not most effective price because takes little account of Demand

General Approaches to Pricing Break-Even Pricing General Approaches to Pricing

BEP The volume of output at which total cost and total revenue are equal Profit (P) = TR – TC = R x Q – (FC +v x Q) = Q (R-V) – FC Example A buffet restaurant wants to make a profit of $200,000. Its Fixed Costs are $300,000, Variable cost per meal are $10, and its current Sales price is $20 per meal. What is the Break Even Quantity? How many meals do they need to sell at the current price to reach desired profit? How many meals at $25 selling price? BEP is 30000 50000 33333 92 per day

General Approaches to Pricing Value-Based Pricing General Approaches to Pricing Willingness to pay Uses buyers’ perceptions of value as they key to pricing, NOT sellers’ cost Why a coffee and a piece of pie cost $5 at a family restaurant, $6 at a hotel coffee shop, $10 for room service, $15 at an elegant restaurant Tradeoff analysis How much would you pay for a hotel room with and without certain amenities Helps determine which features add more value than the cost Holiday Inn designed with this in mind. No frills, no extras

General Approaches to Pricing Competition-Based Pricing General Approaches to Pricing “Going rate pricing” based on what competitors are charging Thought to reflect the collective wisdom of the industry Might decide to be the same, little higher, little lwer than others

New Product Pricing Strategies Setting a high price when the market is price-insensitive Make sense when lowering the price will create less revenue Effective short-term policy However, competition will notice the high prices consumers are willing to pay and enter the market, creating more supply and eventually reducing prices Set a low initial price to penetrate market quickly and attracting buyers and market share Market must be highly price-sensitive Economies of scale to reduce cost and profit comes with volume Low price bars competition Prestige Pricing Market- Penetration Pricing Market- Skimming Pricing Several options exist for pricing new products: prestige pricing, market-skimming pricing, and market-penetration pricing Prestige Pricing For example, hotels or restaurants seeking to position themselves as luxurious and elegant enter the market with a high price to support this position Night clubs charge high cover Market-Skimming Pricing Price skimming is setting a high price when the market is price-insensitive Price skimming can make sense when lowering the price will create less revenue Price skimming can be an effective short-term policy However, one danger is that competition will notice the high prices that consumers are willing to pay and enter the market, creating more supply and eventually reducing prices Market-Penetration Pricing Rather than setting a high initial price to skim off small but profitable market segments, other companies set a low initial price to penetrate the market quickly and deeply, attracting many buyers and winning a large market share Several conditions favor setting a low price The market must be highly price-sensitive so that a low price produces more market growth There should be economics that reduce costs as sales volume increases The low price must help keep out competition

Existing Product Pricing Strategies Product-Bundle Pricing Price-Adjustment Strategies Product-Bundle Pricing Sellers who use product-bundle pricing combine several of their products and offer the bundle at a reduced price Price bundling has two major benefits to hospitality and travel organizations Customers have different maximum prices or reservation prices they will pay for a product The price of the core product can be hidden to avoid price wars or the perception of having a low-quality product Price-Adjustment Strategies Companies usually adjust their basic prices to account for various customer differences and changing situations (See Slide 15)

Product-Bundle Pricing Room + meal + entertainment + transportation+… Promote sale of products customer might not normally buy Benefit 1: Customers have different max prices they are willing to pay, so we can shift the surplus between components Example: Customer A is willing to pay $280/night for a hotel near Disneyland and $350 for two 3-day passes. Customer B willing to pay $325 /night and $300 for the passes. If the hotel wants $160/per night, but can get a bulk discount on tickets and offer at $620 package, both customers will buy it even though room price is $20 more than what customer A is willing to pay

Product-Bundle Pricing Benefit 2: price of core product can be hidden form competition Avoid price wars Avoid cheap perception A Las Vegas Hotel that needs to fill room discounts from $100 to $50 and sells the rooms to an airline The airline can package the hotel with its airfare from Los Angeles for $299 and the hotel does not appear as cheap

Price-Adjustment Strategies Discount Pricing and Allowances Discriminatory Pricing Revenue Management Companies usually adjust their basic prices to account for various customer differences and changing situations Discount pricing and allowances Volume discounts Most hotels have special rates to attract customers who are likely to purchase a large quantity of hotel rooms, either for a single period or throughout the year Discounts based on time of purchase Seasonal discounts allow the hotel to keep demand steady throughout the year Discriminatory pricing Discriminatory pricing refers to segmentation of the market and pricing differences based on price elasticity characteristics of these segments Price discrimination as used in this chapter is legal and viewed by many as highly beneficial to the consumer In discriminatory pricing, the company sells a product or service at two or more prices, although the difference in price is not based on differences in cost Price discrimination works to maximize the amount that each customer pays Revenue Management One application of discriminatory pricing is revenue management Revenue management involves upselling, cross-selling, and analysis of profit margins and sales volume for each product line Revenue management system is used to maximize a hospitality company’s yield or contribution margin An effective revenue management system establishes fences to prohibit customers from one segment receiving prices intended for another

Discount pricing and allowances Volume discounts: groups, conventions, corporate rates Time of Purchase discounts: seasonal, off-peak, early bird, happy hour, late night

Discriminatory pricing Segmentation of the market and pricing differences based on price elasticity characteristics Works to maximize the amount that each customer pays Steak dinner menu price $20 x 100 people - ($20 x $8) = $1200 profit Steak dinner menu price $14 x 200 people – VC = $1200 profit If there are some of the 200 who were willing to pay $20, then losing out on revenue

Discriminatory pricing Early birds Time sensitive and price sensitive Coupon Supersaver: advance purchase and Saturday stayover Eliminates less price-sensitive business traveler Geared towards leisure traveler Fencing Geography, age, length of stay, corporate, group, loyalty status, usage rate

Discriminatory pricing Revenue Management Involves upselling, cross-selling, and analysis of profit margins and sales volume for each product line Maximize yield or contribution margin Rates a hotel will charge and the number of rooms available at each rate based on projected occupancies for a given period Manage revenue and inventory effectively by pricing differences based on the elasticity of demand for selected segments

Discriminatory pricing Revenue Management (𝑟𝑜𝑜𝑚 𝑛𝑖𝑔ℎ𝑡𝑠 𝑠𝑜𝑙𝑑÷𝑟𝑜𝑜𝑚 𝑛𝑖𝑔ℎ𝑡𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒)×(actual avg room rate÷𝑟𝑜𝑜𝑚 𝑟𝑎𝑡𝑒 𝑝𝑜𝑡𝑒𝑛𝑡𝑖𝑎𝑙)=𝑦𝑖𝑒𝑙𝑑 Requires very good data Ability to segment markets Perishable inventory Ability to sell products in advance Fluctuating demand Low-marginal sales costs High marginal production costs -Booking pattern data -Market segment demand patterns -Overbooking policy -Internal and external information systems -Ability to fence segments

Discriminatory pricing Revenue Management RevPAR Revenue Per Available Room Considers occupancy and average rate 100-room hotel that sold 60 rooms at avg rate of $200 60/100 x $200 = $120 Useful for gauging performance across brands, competition RevPASH Revenue Per Available Seat Hour Maximizing table seating configurations

Psychological Pricing Promotional Pricing Value Pricing Psychological pricing considers the psychology of prices, not simply the economics Prestige can be created by selling products and services at a high price. Another aspect of psychological pricing is reference prices Reference Prices are prices that buyers carry in their minds and refer to when they look at a given product A buyer’s reference price might be formed by noting current prices, remembering past prices, or assessing the buying situation Promotional Pricing When companies use promotional pricing, they temporarily price their products below list price and sometimes even below cost Value Pricing Value pricing means offering a price below competitors permanently, which differs from promotional pricing, in which price may be temporarily lowered during a special promotion Value pricing is risky if a company does not have the ability to cut costs significantly It is usually most appropriate for companies able to increase long-run market share through low prices (Taco Bell) or niche players with a lower-cost operating basis who use price to differentiate their product (Southwest Airlines) Temporary Permanent EDLP

Initiating Price Changes Price Increases Price Cuts Initiating Price Changes After developing their price structures and strategies, companies may face occasions when they want to cut or raise prices Initiating Price Cuts Several situations may lead a company to cut prices – one is excess capacity Companies may also cut prices in a drive to dominate the market or increase market share through lower costs Either the company starts with lower costs than its competitors, or it cuts prices in the hope of gaining market share through larger volume Initiating Price Increases Inevitably many companies must eventually raise prices They do this knowing that price increases may be resented by customers, dealers, and their own sales force However, a successful price increase can greatly increase profits In passing price increases on to customers, the company should avoid the image of price gouger It is best to increase prices when customers perceive the price increase to be justified Price increases should be supported with a company communication program informing customers and employees why prices are being increased