Kent 31 BAD 67051 Marketing Management Lecture 3 Pricing

Managing Pricing

I. Pricing Programs A. What is Price? Price is the VALUE of a bundle of attributes to the customer.

I. Pricing Programs A. What is Price? B. Importance of Price?

Price as a Marketing Mix Variable Target Market Product: Engineering Excellence High Status High Quality Components Desired Attributes Promotion: “Classy & Upscale” Media? Style? Distribution: Exclusive What Price Fits the Mix: Premium? Market? Discount? QUESTION

Possible Range of Prices VARIABLE COST = Absolute Minimum VALUE to Customer = Absolute Maximum

Pricing Strategy Fundamentals 1. Determine the Strategic Pricing Objectives 2. Know the Importance of Pricing to Your Target Audience e.g., Perceived Value 3. Know the Demand for Your Product (how will price affect it?) e.g., price elasticity

Pricing Strategy Fundamentals 4. Understand Your Costs 5. Determine Your Pricing Strategy What are competitors’ prices? What method will you use? Set the price. Plan for needed adaptations.

Income Oriented Objectives A. Target Return on Investment (ROI) Achieve high turnover Drop product lines that cannot reach required RO B. Maximize Profits Control costs and adjust price Some items in a mix may achieve this goal C. Increase cash flow Adjust prices and discounts Encourage purchases and rapid payment

Income Oriented Objectives D. Keep a Going Concern Adapt prices to "hold on" Going concern is easier to sell E. Survive Set prices to "scrape by" Survive economic storm or achieve owner retirement

Sales Oriented Objectives A. Maintain Market Share Keep sales in roughly the same position relative to those of competitors Firms want to keep leadership positions B. Encourage Sales Growth Adjust price and discounts Encourage more purchases by existing buyers and attract new buyers

Competition-Oriented Objectives A. Meet Competition: Set prices and discounts about equal to those of competitors Avoid price competition; price stabilization B. Avoid Competition: Set prices at a level that will discourage competition in the firm's market Develop a distinctive image or use as a defensive move

Competition-Oriented Objectives C. Undercut Competition: Set prices lower than the competition's Project bargain image or increase share

Objectives of Social Concern A. Behave Ethically Due to special considerations, set prices at levels lower than they could have been Avoid government regulations; long-term view B. Maintain Employment Set prices at levels that will maintain production and employment of workers Support community commitment; increase attraction for a buyer

II. Details of Two Approaches to Pricing

A. Cost Driven Pricing 1. Mark-up or Cost-plus

1. Mark-up or Cost-plus Total Cost = Fixed Cost + Variable Cost OR Total Cost = Fixed Cost + (Estimated Quantity x Unit Variable Cost) Unit Cost = Variable Cost + Fixed Cost/Expected Unit Sales

1. Mark-up or Cost-plus TO SET PRICE: 1) Estimate Total Cost Per Unit 2) Apply the “Formula” e.g., TOTAL COST + 50% Problem IGNORES price sensitivity of demand Advantage SIMPLE

A. Cost Driven Pricing 2. Target Return on Investment or 1. Mark-up or Cost-plus 2. Target Return on Investment or Target Pricing

Review Break Even Break Even Point FC (in Units) = (SP-VC) $5,000,000

Review Break Even Break Even Point FC (in Dollars) = 1-(VC/SP) $5,000,000 1-($6.25/$15) = $8,571,429

“The Plan” We plan to sell 800,000 units at a total cost of $12.50 each. So, our total costs are 800,000 x $12.50 or $10,000,000. We want a 20% return on our investment. Profit is ? Total Revenue needs to be ? What do we need to charge per unit?

2. Target Return on Investment or Target Pricing Total Revenue Target Return a. Estimated Unit Cost = $12.50 b. Estimated Sales Volume = 800,000 units c. TOTAL COST = $10,000,000 d. Target ROI = 20% .20 x $10,000,000 = $2,000,000 Needed Profit $ Costs & Revenue Break even Total Cost Fixed Costs Expected Sales 571 800 Sales Volume in Units (000’s)

2. Target Return on Investment or Target Pricing d. Target ROI = 20% .20 x $10,000,000 = $2,000,000 Needed Profit e. Needed (Target) Revenue = Total Cost + Profit = $10,000,000 + $2,000,000 = $12,000,000 f. Unit Price = REVENUE / VOLUME = $12,000,000 / 800,000 =$15.00 / Unit Price

2. Target Return on Investment or Target Pricing g. Problems --Must be able to forecast the demand --Will the customer pay the price?

B. Market or Demand Driven Pricing 1. Perceived Value Pricing

1. Perceived Value Pricing Scripto --Weak with teens and young adults --Found 42% of Eraser Mate bought by 11 - 14 year olds --Established “Value” in Focus Group Research --Verified in Placement Tests --Market Success

B. Market or Demand Driven Pricing 1. Perceived Value Pricing 2. Demand and Elasticity --Kinked Demand Curves

III. Pricing By Market Leaders

A. Price Skimming involves setting the highest initial price that customers really desiring the product are willing to pay. used when introducing a new or innovative product; so it is seen in the early stage of the PLC

Price / Cost Cost Curve Time/Experience In Price Skimming, we set the price HIGH relative to our costs. Price / Cost We create significant PROFITS as we drop our price in steps over time As we discussed before, costs go down over time, with longer production runs and more experience Cost Curve Time/Experience

Price Skimming issues Used to rapidly recover investments in developing a new product Works because: consumers WANT the product, there are no competitors (yet) We have a protection on the product (copyright; patents; unique process) As a result, there are no (easy) substitutes And SO we have an INELASTIC demand curve.

7. Advantages of Price Skimming Allows us to recover development costs quickly IF the price is perceived as “too high” by the market, we can easily lower it (RAISING a price is much harder to do) Apple QUICKLY dropped the price of its iPhones, as initial sales were less than expected (from $599 to $399).

8. Disadvantage of Price Skimming The major disadvantage is that the large profit margins will ATTRACT competition

B. Umbrella Pricing 1. Umbrella Pricing Defined

B. Umbrella Pricing Skim Price / Cost Umbrella Cost Curve Time/Experience

B. Umbrella Pricing 1. Umbrella Pricing Defined 2. Relationship to Product Life Cycle (PLC) 3. Advantage 4. Disadvantage

C. Slide Down the Demand Curve Involves starting with a Price Skimming approach and then REDUCING price as our costs decline This is done to appeal to a wider market once the “premium price” buyers are satisfied or To react to an influx of competitors

Price / Cost Skim Time/Experience “Slide down the demand curve” Pricing Begin with a high price relative to our costs Price / Cost And then we reduce our price as the premium market is satisfied and as competition enters Skim Which produces a significant profit initially Price Cost Curve Time/Experience

Advantages of “slide down the demand curve” Allows us to recover development costs early in the PLC Helps to discourage competition as we drop price (note that OUR costs should be lower than those of the “late entrant” competitors). (assumes a reasonably LONG PLC)

Disadvantages of “slide down the demand curve” It is very hard to know just when to begin dropping prices Drop too soon, and we give up profits, Drop too late and we let competition in

D. Penetration Pricing 1. Penetration Pricing : involves setting a low initial price on a new product It is used to appeal immediately to the mass market And so to capture a large share of the market quickly

D. Penetration Pricing This is used when there are few barriers to competition entering the market, When we expect the PLC to be long When we expect demand to be ELASTIC (so there is a market response to our lower price).

D. Penetration Pricing Price / Cost Small Margin Price Cost Curve Time/Experience

Advantages of Penetration Pricing The small margin is likely to discourage competition Because we get a large share of the market quickly: i. our volume is larger and our production costs (per unit) drop more quickly ii. And with high volume we still generate good profit

Disadvantages of Penetration Pricing A risky strategy We must be able to do a good job of forecasting the demand, because we will need to gear up FAST for mass production and distribution/marketing. IF demand does not develop, our production costs stay high and we do not make a profit!

E. Prestige Pricing Prestige Pricing involves setting a high price to attract quality- or status-conscious consumers This should appeal to high-end consumers and limit it appeal to “others” (which ENHANCES the product’s image)

Prestige Pricing Price / Cost Cost Curve Time/Experience We set our price high and keep it high Cost Curve Time/Experience

Advantages and Disadvantages of Prestige Pricing Because of the high price, we are unlikely to sell in large volume, however, This is not a problem as significant profit can be made with the large markup on each item sold

IV. Follower Pricing A. Meet Competition (Parity Pricing) B. Build Share (Penetration Pricing)

V. Pre-emptive or Extinction Pricing 1. Defined 2. Not Recommended (Illegal)

About the Remote Day 1. READ: Chapter 8 Integrated Marketing Communications Chapter 9 Personal Selling, Relationship Building, and Sales Management 2. View the lecture from Vista 8 or CD (CD provided in Week 3 ) -- RESPOND to lecture questions using Vista 8. 3. DO: MINI-CASE 3—via Vista 8 discussion board. 4. Turn in 4th simulation decision – via e-mail to lmarks@kent.edu by the end of class time.

GOT MILK?