12 Pricing Fundamentals

Chapter Learning Objectives Understand the role of price Identify the characteristics of price and non price competition Be familiar with demand curves and the price elasticity of demand Understand the relationships among demand, costs, and profits Describe key factors that may influence marketers’ pricing decisions Be familiar with the major issues that affect the pricing of products for business markets Copyright © Houghton Mifflin Company. All rights reserved.

Chapter Outline The Role of Price Price and Nonprice Competition Price competition - Nonprice competition Analysis of Demand The Demand Curve - Demand fluctuations Assessing price elasticity of demand Demand, Cost, and Profit Relationships Marginal analysis - Breakeven analysis Copyright © Houghton Mifflin Company. All rights reserved.

Chapter Outline Factors Affecting Pricing Decisions Organizational and marketing objectives Types of pricing objectives Costs - Other marketing mix variables Channel member expectations Customers’ interpretation and response Competition - Legal and regulatory issues Pricing for Business Markets Price discounting - Geographic pricing Transfer pricing Copyright © Houghton Mifflin Company. All rights reserved.

The Role of Price Price The value exchanged for products in a marketing exchange Barter The trading of products; the oldest form of exchange Copyright © Houghton Mifflin Company. All rights reserved.

The Nature of Price = Costs Total - Revenues Profit Sold) Quantity x It is the most readily changeable characteristic (under favorable circumstances) of a product. It is a key element in the marketing mix because it relates directly to generation of revenues and quantities sold. It is a key component of the profit equation, having strong effect on the firm’s profitability. It has symbolic value to customers—prestige pricing. Costs Total - Revenues Profit = Sold) Quantity x (Price Profits Copyright © Houghton Mifflin Company. All rights reserved.

Price Competition Price Competition Emphasizing price and matching or beating competitors’ prices An effective strategy in markets with standardized products Lowest-cost competitor (seller) will be most profitable. Allows marketers to respond quickly to competitors Price wars can weaken competing organizations. Copyright © Houghton Mifflin Company. All rights reserved.

Nonprice Competition Nonprice Competition Emphasizing factors other than price to distinguish a product from competing brands Distinctive product features • Service Product quality • Promotion • Packaging Advantage is in increasing brand’s unit sales without changing price. Is effective when a product or service’s features are difficult to imitate by competitors and customers perceive their value Builds customer loyalty by focusing on nonprice features Copyright © Houghton Mifflin Company. All rights reserved.

Analysis of Demand The Demand Curve A graph of the quantity of products expected to be sold at various prices Decreases in price create increases in quantities demanded. Increased demand means larger quantities sold at the same price. Prestige items sell best in higher price ranges. Copyright © Houghton Mifflin Company. All rights reserved.

Demand Curve Illustrating the Price/ Quantity Relationship and Increase in Demand FIGURE 12.1 Copyright © Houghton Mifflin Company. All rights reserved.

Demand Curve Illustrating the Relationship Between Price and Quantity for Prestige Products FIGURE 12.2 Copyright © Houghton Mifflin Company. All rights reserved.

Elasticity of Demand FIGURE 12.3 Copyright © Houghton Mifflin Company. All rights reserved.

Analysis of Demand = Demand Fluctuations Changes in buyers’ needs Variations in the effectiveness of the marketing mix The presence of substitutes Dynamic environmental/market factors Assessing Price Elasticity of Demand Price elasticity A measure of the sensitivity of demand to changes in price—the greater the change in demand for a specific change in price, the more elastic demand is Price in Change % Demanded Quantity Demand of Elasticity = Copyright © Houghton Mifflin Company. All rights reserved.

Demand, Cost, and Profit Relationships Marginal Analysis Examines what happens to a firm’s costs and revenues when product changes by one unit Marginal Revenue The change in total revenue resulting from the sale of an additional unit of product Profit is maximized where marginal costs (MC) are equal to marginal revenue (MR). Copyright © Houghton Mifflin Company. All rights reserved.

Types of Costs Copyright © Houghton Mifflin Company. All rights reserved.

Costs and Their Relationships Quantity Fixed Cost Average Fixed Cost (2) Average Fixed Cost (2) ÷ (1) Average Total Cost (3) + (4) Total Cost (5) × (1) Marginal Cost 1 $40 $40.00 $20.00 $60.00 $60 $10 2 40 20.00 $15.00 35.00 70 3 13.33 $10.67 24.00 72 18 4 10.00 $12.50 22.50 90 20 5 8.00 $14.00 22.00 110 30 6 6.67 $16.67 23.33 140 7 5.71 25.71 180 TABLE 12.1 Copyright © Houghton Mifflin Company. All rights reserved.

Marginal Analysis Method for Determining the Most Profitable Price 1 2 3 4 5 6 7 Price Quantity Sold Total Revenue (1) × (2) Marginal Revenue Marginal Cost Total Cost Profit (3) – (6) $57.00 $ 57 $ 60 -$3 $50.00 100 43 10 70 30 $38.00 114 14 72 42 $33.00* 132 18 90 $30.00 150 20 110 40 $27.00 162 12 140 22 $25.00 175 13 180 -5 *Boldface indicates the best price-profit combination. TABLE 12.2 Copyright © Houghton Mifflin Company. All rights reserved.

Typical Marginal Cost and Average Total Cost Relationship FIGURE 12.4 Copyright © Houghton Mifflin Company. All rights reserved.

Typical Marginal Revenue and Average Revenue Relationship FIGURE 12.5 Copyright © Houghton Mifflin Company. All rights reserved.

Combining the Marginal Cost and Marginal Revenue Concepts for Optimal Profit FIGURE 12.6 Copyright © Houghton Mifflin Company. All rights reserved.

Breakeven Analysis Breakeven Point The point at which the costs of producing a product equal the revenue made from selling the product The point after which profitability begins Costs Fixed to Contribution Unit - Per Breakeven Point = Costs Unit Variable – Price Unit Fixed Total Breakeven Point = Copyright © Houghton Mifflin Company. All rights reserved.

Determining the Breakeven Point FIGURE 12.7 Copyright © Houghton Mifflin Company. All rights reserved.

Factors That Affect Pricing Decisions FIGURE 12.8 Copyright © Houghton Mifflin Company. All rights reserved.

Factors Affecting Pricing Decisions Organizational and Marketing Objectives Prices should be set that are consistent with the organization’s goals and mission. Prices must be compatible with marketing objectives (e.g., setting premium prices to enhance a product’s quality image). Types of Pricing Objectives Setting prices low to increase market share Using temporary price reductions to gain market share Lowering prices to raise cash quickly Copyright © Houghton Mifflin Company. All rights reserved.

Factors Affecting Pricing Decisions (cont’d) Costs Set a floor price—products must be sold above their costs if the firm is to remain in business. Reducing costs increases productivity and profitability. Using labor-saving technologies Focusing on quality Establishing efficient manufacturing processes Other Marketing Mix Variables Price/quality image of the product or brand Selective or intensive product distribution Product pricing used as a promotional tool Copyright © Houghton Mifflin Company. All rights reserved.

Factors Affecting Pricing Decisions (cont’d) Channel Member Expectations To make a profit at least equivalent to the potential profit from handling a competitor’s brand To earn a profit commiserate with the effort and resources the channel member expends on the product To receive discounts for volume purchases and prompt payment To be supported by the producer with training, advertising, sales promotion, and return policies Copyright © Houghton Mifflin Company. All rights reserved.

Factors Affecting Pricing Decisions (cont’d) Customers’ Interpretation and Response What meaning does the product’s price have to the customer? Does the customer respond to the price by moving closer to or farther away from making a purchase? Internal reference price A price developed in the buyer’s mind through experience with the product External reference price A comparison price provided by others Copyright © Houghton Mifflin Company. All rights reserved.

Factors Affecting Pricing Decisions (cont’d) Buyers’ Responses to Price Value consciousness Concern about price and quality Price consciousness Striving to pay low prices Prestige sensitivity Being drawn to products that signify prominence and status Copyright © Houghton Mifflin Company. All rights reserved.

Factors Affecting Pricing Decisions (cont’d) Competition Pricing to match competitors’ prices Judging competitors’ responses to adjusting prices Changes in an industry’s market structure cause and create pricing opportunities. Legal and Regulatory Issues Price controls intended to curb inflation Controls that set/regulate prices for specific products Regulations and laws to prohibit price fixing, and deceptive and discriminatory pricing Copyright © Houghton Mifflin Company. All rights reserved.

Pricing for Business Markets Price Discounting Trade (Functional) Discounts A reduction off the list price given by a producer to an intermediary for performing for performing certain functions Quantity Discounts Deductions from list price for purchasing large quantities Cumulative Discounts Quantity discounts aggregated over a stated period Noncumulative Discounts One-time reductions in price based on specific factors Copyright © Houghton Mifflin Company. All rights reserved.

Pricing for Business Markets (cont’d) Price Discounting (cont’d) Cash Discount A price reduction given to buyers for prompt payment or cash payment Seasonal Discount A price reduction given to buyers for purchasing goods or services out of season Allowance A concession in price to achieve a desired goal Copyright © Houghton Mifflin Company. All rights reserved.

Table 12.3 Copyright © Houghton Mifflin Company. All rights reserved.

Pricing for Business Markets (cont’d) Geographic Pricing Reductions for transportation costs and other costs related to the physical distance between buyer and seller Copyright © Houghton Mifflin Company. All rights reserved.

Pricing for Business Markets (cont’d) Transfer Pricing The price of products that one organizational unit charges when selling to another unit in the same organization Actual full cost All fixed and variable costs divided by the number of units produced Standard full cost Pricing based on what it would cost to produce the goods at full plant capacity. Cost plus investment Full cost plus internal cost of assets used in production Copyright © Houghton Mifflin Company. All rights reserved.

Pricing for Business Markets (cont’d) Transfer Pricing (cont’d) Market-based pricing Market price less marketing and selling costs Copyright © Houghton Mifflin Company. All rights reserved.

After reviewing this chapter you should: Understand the role of price. Be aware of the characteristics of price and nonprice competition. Be familiar with demand curves and the price elasticity of demand. Be aware of the relationships among demand, costs, and profits. Be able to describe the key factors that may influence marketers’ pricing decisions. Have considered the issues affecting the pricing of products for organizational markets. Copyright © Houghton Mifflin Company. All rights reserved.