Pricing Products: Pricing Considerations, Approaches, and Strategy Marketing for Hospitality and Tourism Kotler, Bowen and Makens Pricing Products: Pricing Considerations, Approaches, and Strategy Chapter 11

Learning Objectives Outline the internal factors affecting pricing decisions, especially marketing objectives, marketing mix strategy, costs, and organizational considerations. Identify and define the external factors affecting pricing decisions, including the effects of the market and demand, competition, and other environmental elements. Contrast the differences in general pricing approaches, and be able to distinguish among cost-plus, target profit pricing, value-based pricing, and going rate.

Learning Objectives (cont.) Identify the new product pricing strategies of market-skimming pricing and market-penetration pricing. Understand how to apply pricing strategies for existing products, such as price bundling and price adjustment strategies. Understand and be able to implement a revenue management system. Discuss the key issues related to price changes, including initiating price cuts and price increases, buyer and competitor reactions to price changes, and responding to price changes.

Price Simply defined: Price is the amount of money charged for a product or service Broadly defined: Price is the sum of values consumers exchange for the benefits of having or using the product or service Price is the only marketing mix element that produces revenue All others represent cost Simply defined, price is the amount of money charged for a good or service More broadly, price is the sum of the values consumers exchange for the benefits of having or using the product or service

Common Pricing Mistakes Mistakes Include Pricing That: Is Too Cost-Oriented Fails to Reflect Market Changes Does Not Account for the Marketing Mix Is Not Varied Enough The most common mistakes include pricing that: Is too cost oriented Fails to reflect market changes Does not take the rest of the marketing mix into account Is not varied enough for different product items and market segments

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 Organizational Considerations Marketing Mix Marketing Objectives Marketing Mix Strategies Organizational Considerations Costs Internal Factors 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

Marketing Objectives Current Profit Maximization 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

External Factors 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 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

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

Competition-Based Pricing Approaches to Pricing Cost-Base 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

New Product Pricing Strategies 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 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)

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

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)

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

Key Terms Cost-plus pricing Adding a standard markup to the cost of the product. Cross-selling The company’s other products that are sold to the guest. Discriminatory pricing Refers to segmentation of the market and pricing differences based on price elasticity characteristics of the segments. Fixed costs Costs that do not vary with production or sales level. Going-rate pricing Setting price based largely on following competitors’ prices rather than on company costs or demand. Price The amount of money charged for a product or ser-vice, or the sum of the values that consumers exchange for the benefits of having or using the product or service. Revenue management Forecasting demand to optimize profit. Demand is managed by adjusting price. Fences are often built to keep all customers from taking advantage of lower prices. For example, typical fences include making a reservation at least two weeks in advance or staying over a Saturday night.

Key Terms (cont.) Survival A technique used when a company’s or business unit’s sales slump, creating a loss that threatens its existence. Because the capacity of a hotel or restaurant is fixed, survival often involves cutting prices to increase demand and cash flow. This can disrupt the market until the firm goes out of business or the economy improves. Upselling Training sales and reservation employees to offer continuously a higher-priced product that will better meet the customers’ needs, rather than settling for the lowest price. Value-based pricing Uses the buyer’s perceptions of value, not the seller’s cost, as the key to pricing.