Marketing Concepts Price MKTG 3110-004 Spring 2014 Mrs. Tamara L. Cohen Marketing Concepts Price Classes #18-19

KEY TERMS price barter value total revenue average revenue marginal revenue total cost fixed cost variable cost marginal cost price fixing price discrimination predatory pricing price = money or other negotiable instrument exchanged for the ownership or use of a product or service barter = exchange of products/services for products/services; money is not used in the exchange value = consumer’s perceived benefit from product/service, e.g. quality, durability total revenue = total money received from sale of product average revenue = average amount of money received from selling one unit of product = price marginal revenue = change in total revenue from producing & marketing one additional unit of that product total cost = total expense incurred by a company to produce & market a product fixed cost = overhead = company’s expenses that are stable, and do not change with quantities of product produced & sold variable cost = company’s expenses that change directly with the quantity of product produced & sold marginal cost = change in total cost from producing one more unit of product price fixing = conspiracy among companies to set prices for a product; illegal in the US price discrimination = charging different prices to different buyers for the same products predatory pricing = charging a very low price in order to drive competitors out of business

KEY CONCEPTS demand curve price elasticity of demand break-even analysis discounts allowances FOB pricing uniform delivered pricing demand curve = curve on a graph showing number of units consumers will buy in a given time period, at different prices that might be charged price elasticity of demand = a measure of the sensitivity of demand to changes in price break-even analysis = analysis of relationship between total cost and total revenue to determine profitability at various levels of production discount = straight reduction in price on purchases during stated period of time allowance = promotional money paid by manufacturers to retailers in return for featuring manufacturer’s products FOB pricing = geographical pricing strategy where goods are placed Free On Board (FOB) a carrier; customer pays freight from factory to destination uniform delivered pricing = geographical pricing strategy where company charges same price plus freight to all customers, regardless of location

PRICING STRATEGIES Skimming pricing Penetration pricing Prestige pricing Price lining Odd-even pricing Target pricing Bundle pricing Yield-management pricing Standard mark-up pricing Cost-plus pricing Experience curve pricing Target profit pricing Target return-on-sales pricing Target return-on-investment pricing Customary pricing Above-, at-, or below-market pricing Loss-leader pricing One-price policy Flexible-price policy Skimming pricing = setting a very high initial price for a new or innovative product Penetration pricing = setting a low initial price on a new product to appeal quickly to the mass market Prestige pricing = setting a high price to attract quality- or status-conscious consumers Price lining = setting prices for a line of products at a number of different price points Odd-even pricing = pricing a few cents or dollars below an even number, e.g. $11.99 rather than $12.00 Target pricing = working backwards from price consumers are thought to be willing to pay Bundle pricing = marketing 2 or more products or services in a single package price Yield-management pricing = pricing in differentiated categories to maximize revenue for finite capacity; commonly used by airlines Standard mark-up pricing = adding a fixed percentage to the cost of all items in a specific product category Cost-plus pricing = markup pricing = adding a specific amount to the cost of providing a product or service; common in some professions and in construction Experience curve pricing = pricing based on experience that unit cost of particular product/service declines 10 – 30 % each time a company’s experience at producing and selling them doubles; used in electronics industry Target profit pricing = pricing to achieve a target of a specific $ volume of profit Target return-on-sales pricing = pricing to return a profit of a specified percentage of sales; used by some supermarket chains Target return-on-investment pricing = pricing to meet a target of a particular return on investment; commonly used by public utilities Target return pricing is also known as break-even pricing. Customary pricing = pricing levels set by tradition, a standardized channel of distribution, or some other competitive factor Above-, at-, or below-market pricing = pricing strategy in relation to competitors or market leaders Loss-leader pricing = intentionally pricing below customary price, in order to entice customers into sales venue, where they will be tempted to buy other goods, in addition to the loss-leader One-price policy = fixed pricing = setting one price for all buyers of a product/service Flexible-price policy = dynamic pricing = setting different prices for products/services depending on individual buyers and purchase situations

What is PRICE? = amount of money charged for a product or service = sum of all values the consumer exchanges for the benefits of owning or using a product or service ≠ cost PRICE is the only element in the marketing mix that produces revenue; all other elements represent costs one of the most flexible elements of marketing mix: price can be changed quickly the biggest problem for many marketing executives historically the major factor affecting buyer choice (but this has waned in recent years) price = money or other negotiable instrument exchanged for the ownership or use of a product or service (Assigned reading p.318)

“PRICE” has many names Tuition Rent Interest Premium Fee Dues Fare $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ Tuition Rent Interest Premium Fee $1 Dues Fare Salary Wage Commission barter = exchange of products/services for products/services; money is not used in the exchange

The PRICE you see is not the PRICE you pay PRICE = LIST PRICE – DISCOUNTS + FEES What about TAXES? LIST PRICE = advertised/published price DISCOUNTS include incentives and allowances, e.g. rebate, cash discount, trade-in, scholarship, financial aid, quantity discount, seasonal discount FEES include charges required to process sale, e.g. financing, shipment TAXES are not usually included in quoted prices, unless explicitly stated. $ ?

PRICE as an indicator of VALUE value = consumer’s perceived benefit from product/service value = consumer’s perceived benefit from product/service, e.g. quality, durability “Give people something of value, and they’ll happily pay for it.” Ronald Shaich, CEO of Panera Bread Company “Give people something of value, and they’ll happily pay for it.”

concentrated soap powder Value Pricing McDonald’s began its Supersize program in the 1990s. Other fast foods followed. All were discontinued by 2006. concentrated soap powder Value pricing = increasing product and/or service benefits + maintaining or decreasing price Supersize = very large portion of fast food

Profit equation PROFIT = TOTAL REVENUE – TOTAL COST unit price fixed cost x + quantity sold variable cost (Assigned reading p.322)

6 steps in setting price Kerin, Hartley, Rudelius

6 steps in setting price Kerin, Hartley, Rudelius

6 steps in setting price Kerin, Hartley, Rudelius

6 steps in setting price Kerin, Hartley, Rudelius

6 steps in setting price Kerin, Hartley, Rudelius

6 steps in setting price Kerin, Hartley, Rudelius

Step 1: Identify pricing objectives & constraints Profit - long-run and/or short-run or not at all Sales Market share Unit volume Survival Social responsibility This list of pricing objectives includes criteria commonly used by organizations.

Step 1: Identify pricing objectives & constraints Market size / demand Newness / life cycle Strength / status versus competition Cover costs of production & marketing Lag time Type of competitive market This list of pricing constraints includes criteria commonly used by organizations.

Pricing, product, & advertising strategies available to firms in 4 types of competitive markets Kerin, Hartley, Rudelius (Assigned reading p.327 Marketing Matters) Walmart’s EDLP strategy affects all its competitors Walmart and Target form an oligopoly with regard to the broad range of products they both sell. Competitors are keenly aware of each other’s prices, and want to avoid price wars in which they lose big time.

Step 2: Estimate demand & revenue The demand curve shows us that for most products and services: When prices are high, few consumers are willing to buy. When prices drop, more consumers are willing to buy. When prices are low, many consumers are willing to buy. demand curve = curve on a graph showing number of units consumers will buy in a given time period, at different prices that might be charged What affects demand? These are demand factors: (The first 2 factors are what consumers WANT to buy; the 3rd is what they CAN buy.) Consumer tastes Price & availability of similar (competitive) products Consumer income Kerin, Hartley, Rudelius: Demand curves for Newsweek showing the effect on annual sales (quantity demanded per year) by a change in price caused by a movement along the demand curve

Step 2: Estimate demand & revenue Total Revenue (TR) = total money received from sale of product TR = P x Q where P = unit price of product and Q = quantity of product sold Average Revenue (AR) = average amount of money received for selling one unit of a product = PRICE of that unit AR = TR ÷ Q = P Marginal Revenue (MR) = change in total revenue from producing & marketing one additional unit of product MR = change in TR ÷ 1 unit increase in Q = ΔTR ÷ ΔQ = slope of TR curve Fundamental revenue concepts

Price Elasticity of Demand measures sensitivity of consumer demand to changes in product’s price Price elasticity of demand = E = % change in quantity demanded % change in price INELASTIC demand: A slight change in price has very little effect on demand. ELASTIC demand: A slight change in price has a big effect on demand. price elasticity of demand = a measure of the sensitivity of demand to changes in price Unitary demand exists when % change in price causes exactly the same % change in quantity demanded. Graphs: http://www.marketingmo.com/how-to-articles/pricing/will-lowering-your-prices-increase-profits/

INELASTIC ELASTIC Elasticity examples Necessities Luxuries e.g. toothpaste; open-heart surgery Gasoline price strategy e.g. Gas prices tend to rise in summer, but this doesn’t stop many people from driving extensively Luxuries e.g. yacht; skiing vacation Public policy implications e.g. Increase price of cigarettes in NY via higher excise tax causes less smoking by teens, who often have limited spending money, i.e. price elastic re cigarettes Fundamental revenue concepts

Step 3: Determine cost, volume & profit relationships Total Cost (TC) = total expense to produce & market a product Fixed Cost (FC) = company’s expenses that are stable, and do not change with quantities of product produced & sold Variable Cost (VC) = company’s expenses that change directly with the quantity of product produced & sold TC = FC + VC Marginal Cost (MC) = change in total cost from producing one more unit of product MC = change in TC ÷ 1 unit increase in Q = ΔTC ÷ ΔQ = slope of TC curve total cost = total expense incurred by a company to produce & market a product fixed cost = company’s expenses that are stable, and do not change with quantities of product produced & sold; e.g. rent of building, executive salaries, insurance, costs of business permits & licenses variable cost = company’s expenses that change directly with the quantity of product produced & sold; e.g. direct labor, direct materials, sales commissions based on quantities sold marginal cost = change in total cost from producing one more unit of product Everyone wants to reduce costs & increase revenues. If Total Costs > Total Revenues for too long, the company can no longer remain in business.

Break-Even Analysis = analysis of relationship between total cost and total revenue to determine profitability at various levels of production Break-Even Point = quantity where TC = TR (i.e. Total Cost = Total Revenue) Profit will come from units sold AFTER Break-Even Point. Profit is maximized where MC = MR (i.e. Marginal Cost = Marginal Revenue) Break-even analysis is used in marketing to study the effects of price changes, fixed costs and variable costs on profits. “What if” questions are well handled by spreadsheets like Excel. e.g. Automation - increases fixed costs, which raises break-even point; after this point, potential profit increases much more rapidly than without automation Profit is a maximum at the quantity at which marginal revenue and marginal cost are equal

Break-even analysis chart for a picture frame store shows the break-even point at 400 pictures Kerin, Hartley, Rudelius

4 approaches for selecting approximate price level 4.1 4.2 4.3 4.4 Kerin, Hartley, Rudelius

Step 4: Select an approximate price level Demand-oriented approaches to pricing: Skimming Penetration Prestige Price lining Odd-even Target Bundle Yield management There are 4 basic approaches to figuring out an approximate starting price, and each of these includes several strategies: Demand-orientation - focus on expected customer preferences & tastes Cost-orientation - focus on production & marketing costs Profit-orientation - balance revenues & costs Competition-orientation - focus on what “the market” (i.e. competitors) is (are) doing Skimming pricing = setting a very high initial price for a new or innovative product Penetration pricing = setting a low initial price on a new product to appeal quickly to the mass market Prestige pricing = setting a high price to attract quality- or status-conscious consumers Price lining = setting prices for a line of products at a number of different price points Odd-even pricing = pricing a few cents or dollars below an even number, e.g. $11.99 rather than $12.00 Target pricing = working backwards from price consumers are thought to be willing to pay Bundle pricing = marketing 2 or more products or services in a single package price Yield-management pricing = pricing in differentiated categories to maximize revenue for finite capacity; commonly used by airlines

4.1 DEMAND-oriented pricing approach Skimming Penetration Prestige pricing Price lining Skimming pricing = setting a very high initial price for a new or innovative product Effective strategy when: enough customers will pay initial high price so as to make sales profitable high initial price acts as barrier to entry (to deter competitors) elastic demand customers correlate high price with high quality Sony Sony introduced first HDTV in Japan: $43,000 Price reduced over next few years to attract new buyers $6,000 for 40-inch HDTV in Japan $2,000 for 40-inch HDTV in Japan $500 for 40-inch HDTV in USA Apple iPhone Initial price (2010) was $599 per phone - purchased by customers who really wanted the cool new gadget and could afford the high price. 6 months later, prices dropped to $399 (8GB model), $499 (16GB model) 1 year later (2011), prices dropped to $199 & $299. 2013, you could buy an 8GB model for $49. In this way, Apple skimmed maximum revenue from its market segments. Penetration pricing = setting a low initial price on a new product to appeal quickly to the mass market many segments of market are price sensitive low initial price discourages competitors unit production & marketing costs fall dramatically as production volume increases; high sales volume reduces unit costs, allowing further price reductions Dell used penetration pricing to enter personal computer market, selling high quality computer products through lower-cost direct distribution channels. IBM, Apple and others selling through retail stores could not match Dell’s prices. IKEA used penetration pricing since it first opened in China in 2002. Shoppers came for freebies (a/c, toilets, even decorating ideas). IKEA in China stocks many more Chinese-made products at dramatically discounted prices (up to 70%), compared to IKEAs elsewhere in the world. This has worked remarkably well. IKEA commands 43% of China’s growing home-wares market; sales grew 23% last year (2012). The Beijing store attracts nearly 6 million visitors a year. The Chinese name for IKEA is Yi Jia Jia Ju (宜家家具); most people just call it yíjiā” (宜家), pronounced ee-gee-ah; roughly translates as ‘affordable home’. Prestige pricing = setting a high price to attract quality- or status-conscious consumers (also called psychological pricing) e.g. Rolls Royce cars, TAG Heuer watches, Rolex watches, Breitling “high end watch manufacturer of the highest quality and precision” (‘Blackbird’ model, above, $5,000), Tiffany luxury jewelry, silver & crystal, Chanel No.5 Price lining = setting prices for a line of products at a number of different price points Companies with a range of products may find it simpler to adhere to selected price ‘lines’, rather than pricing every product individually. Price lines = price points Price steps are set between the products in a line, based on cost differences between those products, customer evaluations of features, and competitors’ prices. A limited number of price points (like 3 or 4) is best; too many (8-10) confuses customers Snapper makes a range of lawnmowers, ranging from simple push-mowers (priced at $259.95, $299.95, $399.95) to fancy, ride-on lawn tractors (priced at $1,000 and up). Each lawnmower in the line offers more distinguishable features. Car washes typically offer a variety of ‘packages’, e.g. ‘basic’ wash costs $5, ‘premium’ costs $6, ‘superior’ costs $7, etc. Each increment adds one or two extra services. USPS has aggressively adopted price lining. All domestic letters weighing up to 1 oz cost 46 cents to mail anywhere in the contiguous USA. Flat rate package services charge a single price for specified ranges of weights and sizes.

4.1 DEMAND-oriented pricing approach (cont.) Odd-even pricing Target pricing Bundle pricing Yield-management pricing Odd-even pricing = pricing a few cents or dollars below an even number, e.g. $11.99 rather than $12.00 Consumers see the initial number and perceive the price as being lower. They round DOWN. This becomes significant when $299 is seen as $200 rather than $300. The perception of the consumer is that anything odd-priced is a bargain price. Gas stations do this all over the US. Target pricing = working backwards from price consumers are thought to be willing to pay Manufacturers who are very familiar with their markets will identify a price point they believe consumers will be willing to pay. They then work backwards through standard retail and wholesale margins, to work out what features and quality they can afford to build into this particular product. This is typical in many categories of products sold through mass retailers. Bundle pricing = marketing 2 or more products or services in a single package price Several products/services are offered for sale as one combined product. This is very common in the software business (e.g. bundle a word processor, a spreadsheet, and a database into one office ‘suite’) in the cable TV industry (e.g. basic cable service comes with several channels at one price, with the option of adding other channels that are bundled together), in the fast food industry, where multiple items are combined into a ‘meal’, and in the travel business, where flights are bundled with accommodations, car rentals, and tours. Bundling is effective when: there are economies of scale in production and/or distribution consumers appreciate a simplified purchase decision consumers perceive the superior value of the bundle as a sort of synergy Yield-management pricing = pricing in differentiated categories to maximize revenue for finite capacity; initiated and still commonly used by airlines, also by hotels. This method blends marketing, operations and financial principles. 3 essential conditions for yield management to be applicable: that there is a fixed amount of resources available for sale that the resources sold are perishable that different customers are willing to pay different prices for using the same amount of resources

4.2 COST-oriented pricing approach Standard mark-up pricing Cost-plus pricing Experience curve pricing Standard mark-up pricing = adding a fixed percentage to the cost of all items in a specific product category Supermarkets and some retail stores have so many products (SKUs), that individual pricing is impractical. They depend on their buyers to obtain a good price up front, then they add on a fixed percentage to the cost of all items in a specific product class. This percentage must cover all fixed costs, and sometimes some variable costs too. Rules of thumb: high volume items usually have low % markups; low volume items usually have high % markups Basic items in supermarkets: 10 – 23%; discretionary items 27 – 47% Movie theaters: 87% (soft drinks), 65% (candy), 90% (popcorn) Costco policy ≤ 14%; most around 10% Department stores: around 50% Cost-plus pricing = adding a specific amount to the cost of providing a product or service; common in some professions and in construction, also in large contract work where it’s difficult to predict all costs ahead of time Experience curve pricing = pricing based on experience that unit cost of particular product/service declines 10 – 30 % each time a company’s experience at producing and selling them doubles; used in electronics industry

4.3 PROFIT-oriented pricing approach Target profit pricing Target return-on-sales pricing Target return-on-investment pricing Target profit pricing = pricing to achieve a target of a specific $ volume of profit Target return-on-sales pricing = pricing to return a profit of a specified percentage of sales; used by some supermarket chains Target return-on-investment pricing = pricing to meet a target of a particular return on investment; commonly used by public utilities

4.4 COMPETITION-oriented pricing approach Customary pricing Above-, at-, or below-market pricing Loss-leader pricing Customary pricing = pricing levels set by tradition, a standardized channel of distribution, or some other competitive factor e.g. Swatch watches are customarily priced at $40; specific price point traditional for some candy bars, especially for vending machine trade. Change content of candy bar rather than change price point. Above-, at-, or below-market pricing = pricing strategy in relation to competitors or market leaders. Neiman Marcus likes its image of above-market pricing, arguing that the customer receives above-market service and products to match their premium prices. Private brands typically are priced 8-10% below national brands like Skippy peanut butter. Loss-leader pricing = intentionally pricing below customary price, in order to entice customers into sales venue, where they will be tempted to buy other goods, in addition to the loss-leader Prior to 2012 holiday season, Overstock Auction advertised iPhone 5s at dramatically low prices. Walmart and some electronics stores advertised the iPhone 5 at competitively low prices too at that time, but assigned stocks are usually very low for these loss leader prices. Apple's iPhone 5 as loss leader by Philip Elmer-DeWitt, FORTUNE, December 19, 2012: 8:03 AM ET

Step 5: Set the List or Quoted Price One-price policy = fixed pricing Flexible-price policy = dynamic pricing One-price policy = fixed pricing = setting one price for all buyers of a product/service Flexible-price policy = dynamic pricing = setting different prices for products/services depending on individual buyers and purchase situations. Some sophisticated companies monitor customers’ ‘click streams’. Dynamic pricing includes different prices charged such as off-peak pricing for utilities and tourism, futures contracts on commodities, seats in some sports stadiums (e.g. San Francisco Giants, Oakland A’s, St Louis Cardinals)

Effects on Pricing Company effects Customer effects product substitutes & complementary products product line pricing Customer effects beware of setting different kinds of middlemen against one another Competitive effects price war (successive price cutting by competitors)

Step 6: Adjust the List or Quoted Price Discount = straight reduction in price on purchases during stated period of time Allowance = promotional money paid by manufacturers to retailers in return for featuring manufacturer’s products FOB pricing = geographical pricing strategy where goods are placed Free On Board (FOB) a carrier; customer pays freight from factory to destination Delivered pricing = geographical pricing strategy where company charges same price plus freight to all customers, regardless of location CIF pricing = geographical pricing strategy where price includes Cost + Insurance + Freight (CIF) discount = straight reduction in price on purchases during stated period of time allowance = promotional money paid by manufacturers to retailers in return for featuring manufacturer’s products FOB pricing = geographical pricing strategy where goods are placed Free On Board (FOB) a carrier; customer pays freight from factory to destination delivered pricing = geographical pricing strategy where company charges same price plus freight to all customers, regardless of location

3 special adjustments to list or quoted price include discounts, allowances, & geographical adjustments Kerin, Hartley, Rudelius

Several pricing practices are affected by legal & regulatory restrictions, which benefit both consumers & firms Kerin, Hartley, Rudelius

Laws & Regulations in Pricing price fixing = conspiracy among companies to set prices for a product; illegal in the US (Sherman Act & Consumer Goods Pricing Act) price discrimination = charging different prices to different buyers for the same products; illegal in the US (Robinson-Patman Act) predatory pricing = charging a very low price in order to drive competitors out of business; illegal in the US (Sherman Act & Federal Trade Commission Act)

5 most common deceptive pricing practices Kerin, Hartley, Rudelius

Next class March 26 & 31 : Place Homework Assignment #7 DUE Mar.26: Retailer Comparison Go into two different retail stores and compare the following features: lighting, flooring, shelf fixtures, signage, help/service, image, ambiance. Next class March 26 & 31 : Place Preparation: Read ch.15 pp.378-9; pp.392-3; p.395 ch.16 pp.404-5; pp.423 Homework #7: Retailer Comparison