Setting the Right Price Key Concepts

How to Set a Price on a Product or Service Chapter 18 Setting the Right Price Fine tune with pricing tactics Choose a price strategy Estimate demand, costs, and profits Establish pricing goals Results lead to the right price Notes: Setting the right price is a four-step process as shown in Exhibit 18.1.

Establish Pricing Goals Chapter 18 Setting the Right Price Profit-Oriented Sales-Oriented Status Quo Notes: The first step in setting the right price is to establish pricing goals. In Chapter 17, we learned that pricing objectives fall into three categories—profit oriented, sales-oriented, and status quo. These pricing goals are derived from the firm’s overall objectives. For example, a company wanting to be the dominant sales leader will pursue a sales-oriented pricing goal. A conservative organization may establish a status quo goal. A company wanting to maximize shareholder value will establish aggressive profit-oriented goals. A good understanding of the marketplace and of the consumer can tell a manager if a goal is realistic. All pricing objectives have trade-offs. Reaching the desired market share often means sacrificing short-term profit, because without careful management, long-term profit goals may not be met. Meeting the competition is the easiest pricing goal to implement. But demands and costs, the lifecycle stage, and other considerations can not be ignored when creating pricing objectives.

Choose a Price Strategy Chapter 18 Setting the Right Price Status Quo Pricing Price Skimming Penetration Pricing Charging a price identical to or very close to the competition’s price. A firm charges a high introductory price, often coupled with heavy promotion. A firm charges a relatively low price for a product initially as a way to reach the mass market. Notes: Companies that plan for creating a price strategy can select from three basic approaches: price skimming, penetration pricing, and status quo pricing. A discussion of each type follows.

Why & When Price Skimming ? Chapter 18 Setting the Right Price Situations When Price Skimming Is Successful Unique Advantages/Superior Legal Protection of Product Blocked Entry to Competitors Technological Breakthrough Inelastic Demand Notes: Price skimming is a pricing policy whereby a firm charges a high introductory price, often coupled with heavy promotion. The term is derived from the phrase “skimming the cream off the top.” Companies often use price skimming for new products when the product is perceived as having unique advantages. As a product enters different stages of its life cycle, the price may decrease to reach larger market segments. Additional situations when price skimming is successful are listed on this slide. Firms often feel it is better to test the market at high prices and then lower the price if sales are too slow. A price skimming strategy will encourage competitors to enter the market. Discussion/Team Activity: List companies and/or products that utilize a price skimming strategy.

Penetration Pricing Advantages Disadvantages Chapter 18 Setting the Right Price Advantages Disadvantages Discourages or blocks competition from market entry PRICE AS BARRIER Boosts sales and provides large profit increases Can justify production expansion Requires gear up for mass production Have to sell large volumes at low prices Strategy to gain market share may fail On Line Southwest Airlines It’s no secret that Southwest Airlines has some of the cheapest fares around the nation. But just how much cheaper are they? The next time you travel, take the time to compare Southwest’s prices with another carrier’s. Has your regular airline met the challenge of Southwest’s penetration pricing strategy? If so, how? Notes: Penetration pricing is at the opposite end of the spectrum from price skimming. By charging a low price for a product, a larger share of the market is captured, resulting in lower production costs. It does, however, mean lower profit per unit, and a higher volume of sales is required to reach the break-even point. Penetration pricing does tend to discourage competition and is effective in a price-sensitive market.

Status Quo Pricing Advantages Disadvantages Simplicity Chapter 18 Setting the Right Price Advantages Disadvantages Simplicity Safest route to long-term survival for small firms Fly under the radar Strategy may ignore demand and/or cost Notes: Status quo pricing means meeting the competition’s prices by charging an identical price or very close to the competition’s price. It is a simple method of pricing, but the strategy may ignore demand and/or cost. However, if the firm is small, meeting the competition’s prices may be the safest route to long-term survival.

Setting the Right Price Chapter 18 Setting the Right Price Setting the Right Price Establish price goals Estimate demand, costs, and profits Choose a price strategy Fine-tune base price Set price $x.yy Evaluate results Skimming Status quo Penetration Low $ High $

The Legality and Ethics of Price Strategy Chapter 18 Setting the Right Price The Legality and Ethics of Price Strategy Unfair Trade Practices Price Fixing Price Discrimination Notes: The issues that limit pricing decisions are unfair trade practices, price fixing, price discrimination, and predatory pricing. Predatory Pricing

The Legality and Ethics of Price Strategy Chapter 18 Setting the Right Price The Legality and Ethics of Price Strategy Unfair Trade Practices Laws that prohibit wholesalers and retailers from selling below cost. Price Fixing An agreement between two or more firms on the price they will charge for a product. Notes: In over half the states, unfair trade practice acts put a floor under wholesale and retail prices, and selling below cost is illegal. Wholesalers and retailers must take a certain minimum percentage markup on their combined merchandise cost and transportation cost. The most common markup figures are 6 percent at the retail level and 2 percent at the wholesale level. If a specific wholesaler or retailer can provide conclusive proof that operating costs are lower than the minimum required figure, lower prices may be allowed. The intent of unfair trade practice acts is to protect small firms from retail giants like Wal-Mart and Target, which operate efficiently on razor-thin margins. State enforcement of unfair trade practice laws has generally been lax, because low prices benefit local consumers. ------------------------------------------------------ Price fixing is illegal under the Sherman Act and the Federal Trade Commission Act. Cases involving price fixing include: * ISK Japan, for conspiring to fix prices for video magnetic iron oxide particles * Gemstar-TV Guide International *Hoechst AG, for suppressing competition for an industrial chemical used in production * Uniroyal, for fixing prices on neoprene *Hoffman-LaRoche for price fixing in the vitamin industry

Price Discrimination There must be price discrimination. Chapter 18 Setting the Right Price Price Discrimination The Robinson-Patman Act of 1936: There must be price discrimination. Transaction must occur in interstate commerce. Seller must discriminate by price among two or more purchasers. Products sold must be commodities or tangible goods. Products sold must be of like grade and quality. There must be significant competitive injury.

Price Discrimination The Robinson-Patman Act of 1936: Seller Defenses Chapter 18 Setting the Right Price Price Discrimination The Robinson-Patman Act of 1936: Seller Defenses Cost Market Conditions Competition Notes: The Robinson-Patman Act provides three defenses for the seller charged with price discrimination. In each case the burden is on the defendant to prove the defense. Cost: A firm can charge different prices to different customers if the prices represent manufacturing or quantity discount savings. Market conditions: Price variations are justified if designed to meet fluid product or market conditions. Examples include the deterioration of perishable goods, the obsolescence of seasonal products, a distress sale under court order, or a legitimate going-out-of-business sale. Competition: A reduction in price may be necessary to stay even with the competition.

Predatory Pricing Predatory Pricing Chapter 18 Setting the Right Price Predatory Pricing Predatory Pricing The practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market. Notes: Predatory pricing is illegal under the Sherman Act and the Federal Trade Commission. However, proving the use of this practice is difficult and expensive. The Justice Department must show that the predator explicitly tried to ruin a competitor and that the predatory price was below the predator’s average variable cost.

Tactics for Fine-Tuning the Base Price Chapter 18 Setting the Right Price Special pricing tactics Discounts Geographic pricing Notes: The base price is the general price level at which the company expects to sell a good or service. The general price level is correlated with the pricing policy: above the market, at the market, or below the market. The final step is to fine-tune the base price. Fine tuning techniques include discounts, geographic pricing, and special pricing tactics.

Discounts, Allowances, Rebates, and Value-Based Pricing Chapter 18 Setting the Right Price Quantity Discounts Cash Discounts Functional Discounts Seasonal Discounts Promotional Allowances Rebates Zero Percent Financing Value-Based Pricing Notes: A base price can be lowered through the use of discounts and the related tactics of allowances, rebates, low or zero percent financing, and value-based pricing. Discounts are used to encourage customers to do what they would not ordinarily do, such as pay cash, take delivery out of season, or perform certain functions with a distribution channel. The most common tactics are: Quantity discounts with lower prices for buying in multiple units of above a specified dollar amount. Cash discounts offered for prompt payment of a bill Functional discounts (trade discounts) are offered when channel intermediaries perform a service for the manufacturer. Seasonal discounts are lower prices for buying merchandise out of season. Promotional allowances (or trade allowance) are payments to dealers for promoting the manufacturer’s products. Rebates are cash refunds given for purchasing a product within a specified period. Zero percent financing offers no interest charge to increase sales. However, it does cost the manufacturers. Value-based pricing sets the price at a level that seems to the customer to be a good price compared to other prices.

Value-Based Pricing Value-Based Pricing Chapter 18 Setting the Right Price Value-Based Pricing Setting the price at a level that seems to the customer to be a good price compared to the prices of other options. Notes: The basic assumption with value-based pricing is that the firm is customer driven, seeking to understand the attributes customers want in the goods and services they buy and the value of that bundle of attributes to customers.

Pricing Products Too Low Chapter 18 Setting the Right Price Managers attempt to buy market share through aggressive pricing. Managers tend to make pricing decisions based on current costs, current competitor prices, and short-term share gains rather than on long-term profitability. Notes: Pricing products too low reduces company profits. This happens for two reasons: The company is attempting to buy market share through aggressive pricing. Managers have a tendency to make decisions that can be justified objectively. As a result, pricing decisions are made based on current costs, projected short-term share gains, or current competitive prices rather than on long-term profitability.

Geographic Pricing FOB origin pricing Uniform delivered Zone pricing Chapter 18 Setting the Right Price Basing-point pricing Freight absorption Zone pricing Uniform delivered FOB origin pricing On Line United Parcel Service Go to UPS’s Web site and do some quick cost comparison on sending the same package to a friend in town and to a friend out-of-state. Does the difference in cost surprise you? Do you think it is justified? Why or why not? Notes: The cost of freight can greatly affect the total cost of a product. The common methods of geographic pricing are listed on this slide. Online http://www.ups.com

Geographic Pricing FOB Origin Pricing Uniform Delivered Zone Pricing Chapter 18 Setting the Right Price FOB Origin Pricing Uniform Delivered Zone Pricing Freight Absorption Basing-Point The buyer absorbs the freight costs from the shipping point (“free on board”). The seller pays the freight charges and bills the purchaser an identical, flat freight charge. The U.S. is divided into zones, and a flat freight rate is charged to customers in a given zone. The seller pays for all or part of the freight charges and does not pass them on to the buyer. The seller designates a location as a basing point and charges all buyers the freight costs from that point.

Other Pricing Tactics Single-Price Tactic Chapter 18 Setting the Right Price Single-Price Tactic All goods offered at the same price Flexible Pricing Different customers pay different price Professional Services Pricing Used by professionals with experience, training or certification Price Lining Several line items at specific price points Leader Pricing Sell product at near or below cost Bait Pricing Lure customers through false or misleading price advertising Odd-Even Pricing Odd-number prices imply bargain Even-number prices imply quality Price Bundling Combining two or more products in a single package Two-Part Pricing Two separate charges to consume a single good Notes: Other pricing tactics are unique and defy neat categorization. Managers use these tactics to stimulate demand for specific products, to increase store patronage, and to offer a wider variety of merchandise at a specific price point. These pricing tactics are described on this slide. Discussion/Team Activity: Discuss products and/or businesses that utilize these pricing tactics.

Fine-Tuning the Base Price Chapter 18 Setting the Right Price Fine-Tuning the Base Price

Product Line Pricing Product Line Pricing Chapter 18 Setting the Right Price Product Line Pricing Product Line Pricing Setting prices for an entire line of products. On Line Beauty.com Does Beauty.com use a product line pricing strategy? Choose a brand and view the product list and pricing sheet. What evidence do you see of product line pricing? Of other pricing strategies? Notes: In product line pricing, the manager tries to achieve maximum profits for the entire line rather than for a single component of the line.

Relationships among Products Chapter 18 Setting the Right Price Relationships among Products Complementary Substitutes Neutral Notes: In setting product line prices, the manager first determines the relationship among the products in the line: Complementary: An increase in the sale of one good causes an increase in demand for the complementary product. Substitutes: Two products in a line can be substitutes for each other. If buyers buy one item in the line, they are less likely to buy a second item in the line. Neutral: A neutral relationship can exist between two products. Demand for one of the products is unrelated to demand for the other.

Inflation High Inflation Cost-Oriented Tactics Demand-Oriented Tactics Chapter 18 Setting the Right Price Cost-Oriented Tactics High Inflation Demand-Oriented Tactics

Cost-Oriented Tactics Chapter 18 Setting the Right Price Increased Production Costs Decreased Demand Increase Price Maintaining a Fixed Gross Margin Notes: Any cost-oriented pricing policy that tries to maintain a fixed gross margin under all conditions can lead to a vicious circle, as shown in the diagram on this slide. A price increase will result in decreased demand, which in turn increases production costs because of lost economies of scale. Increased production costs require a further price increase, etc.

Cost-Oriented Tactics Chapter 18 Setting the Right Price Delayed-quotation pricing Escalator pricing Hold prices constant, but add new fees Notes: Cost-oriented tactics include delayed-quotation pricing, which is used for industrial installations and accessory items. Price is not set until the item is either finished or delivered. Examples: Builders of nuclear power plants, ships, airports, and office towers. Escalator pricing is similar to delayed-quotation pricing in that the final selling price reflects costs increases incurred between the time an order is placed and the time delivery is made. Examples: with new customers or with extremely complex products that take a long to produce. Another tactic is to hold prices constant but add new fees.

Cost-Oriented Tactics Chapter 18 Setting the Right Price Problems with Cost-Oriented Tactics A high volume of sales on an item with a low profit margin may still make the item highly profitable. Eliminating a product may reduce economies of scale. Eliminating a product may affect the price-quality image of the entire line. Notes: One common cost-oriented tactic is culling products with a low profit margin. However this tactic may backfire for the three reasons listed on this slide.

Demand-Oriented Tactics Chapter 18 Setting the Right Price Price Shading The use of discounts by salespeople to increase demand for one or more products in a line. Notes: Demand-oriented tactics use price to reflect changing patterns of demand caused by inflation or high interest rates. Often price shading becomes habitual and is done routinely without much forethought.

Demand-Oriented Tactics Chapter 18 Setting the Right Price Strategies to Make Demand More Inelastic Cultivate selected demand Create unique offerings Change the package design Heighten buyer dependence Notes: To make the demand for a good or service more inelastic and to create buyer dependency, a company can use the strategies as shown on this slide: Cultivate selected demand: Target prosperous customers who will pay extra for convenience or service. Example: Neiman Marcus Create unique offerings: By studying buyers’ needs, the seller can design distinctive products to fit a buyers’ needs and establish a beneficial relationship. Example: Value-added or multi-ingredient cereals Change the package design: Companies pass on higher costs by shrinking the product sizes but keep prices the same. Heighten buyer dependence: Provide additional value-added services and training with product offerings to freeze out competition and support higher prices. Example: Owens-Corning Fiberglas integrated insulation service (from feasibility studies to installation)

Bundling or Unbundling Recession Chapter 18 Setting the Right Price Value-Based Pricing Bundling or Unbundling Notes: Effective pricing tactics during recession are value-based pricing and bundling. Value-based pricing stresses to customers that they are getting a good value for their money. Bundling or unbundling of features or services gives a perception of higher value. Bundling can be demonstrated in vacation packages that include lodging, meals, massages, etc.

Supplier Strategies during Recession Renegotiating contracts Chapter 18 Setting the Right Price Renegotiating contracts Offering help Keeping the pressure on Paring down suppliers Notes: In a recession, prices often fall so that companies can maintain demand for their products. Falling prices are an incentive to lower costs since falling prices mean lower profits or no profits. Suppliers can be excellent sources of cost savings. Some ways companies can use cost-saving strategies with suppliers are listed on this slide. Renegotiating contracts: Demanding lower prices or rebidding the contracts. Offering help: Help suppliers’ plants reorganize and increase productivity. Keeping the pressure on: Set annual, across-the-board cost-reduction targets. Paring down suppliers: Reduce the number of suppliers and boost purchases from those that remain.

Pricing During Inflation and Recession Chapter 18 Setting the Right Price Pricing During Inflation and Recession