Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Chapter 18 Pricing Concepts

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Objectives 1.Outline the legal constraints on pricing. 2.Identify the major categories of pricing objectives. 3.Explain price elasticity and its determinants. 4.List the practical problems involved in applying price theory concepts to actual pricing decisions. 5.Explain the major cost-plus approaches to price setting. 6.List the chief advantages and shortcomings of using breakeven analysis in pricing decisions. 7.Explain the superiority of modified breakeven analysis over the basic breakeven model and the role of yield management in pricing decisions. 8.Identify the major pricing challenges facing online and international marketers.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Legal Constraints on Pricing The Robinson-Patman Act –Known as the Anti-A&P Act. –Was technically an amendment to the Clayton Act. –Prohibits price discrimination in sales to wholesalers, retailers, and others producers. –Differences in price must reflect cost differentials. –Prohibits selling at unreasonably low prices in order to drive competitors out of business.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Legal Constraints on Pricing Unfair-Trade Laws –Require sellers to maintain minimum prices for comparable merchandise. These laws were intended to protect small specialty shops. –Typical state laws set retail price floors at cost plus some modest markup.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Legal Constraints on Pricing Fair-Trade Laws –Allow manufacturers to stipulate minimum retail prices. –Assert that a product’s image, determined in part by its price, is a property right of the manufacturer. –Exclusivity is one method manufacturers use to maintain minimum price. –Has its roots in the Depression era. –California became the first state to enact fair-trade legislation. –These laws became invalid with the passage of the Consumer Goods Pricing Act (1975).

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Four Major Groups of Pricing Objectives 1.Profitability 2.Volume 3.Meeting Competition 4.Prestige

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Pricing Objectives High prices for tobacco and alcohol to reduce consumption  Profit maximization  Cost recovery  Market incentives  Market suppression High-priced luxury autos such as Ferrari and watches by Rolex  Lifestyle  Image Price wars among major airlines  Value pricing Dell’s low-priced PCs increase market share and sales of service  Sales maximization  Market share Low introductory interest rates on credit cards with high standard rates after 6 months  Profit maximization  Target return ExamplePurpose Not-for-profit objectives Prestige objectives Meeting competition objectives Volume objectives Profitability objectives Objective

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Pricing For many consumers high price indicates quality. –When viewing Gucci timepieces consumers see quality.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Profit Impact of Market Strategies (PIMS) Project Study conducted by the Marketing Science Institute. Analyzed more than 2,000 firms. Revealed that two important factors influencing profitability were: 1.Product quality 2.Market share The leading brand typically generates after- tax ROI of 18 percent.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Pricing of the Not-For-Profit Organizations Goals 1.Profit maximization. 2.Cost recovery. Recover only the actual cost of operating the unit. 3.Market incentives. Lower-than-average pricing policy or offer a free service. 4.Market suppression. High prices help to accomplish social objectives.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Elasticity in Pricing Strategy Elasticity is the measure of responsiveness of purchasers and suppliers to price changes. –The elasticity of demand is the percentage change in the quantity of a good or service demanded  the percentage change in its price. –The price elasticity of supply of a product is the percentage change in the quantity of a good or service supplied  the percentage change in its price.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Problems of Price Theory 1.Many firms do not attempt to maximize profits. 2.It is difficult to estimate demand curves.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Cost-Plus Approaches to Price Setting Cost-plus pricing, the most popular method, uses a base-cost figure per unit and adds a markup to cover unassigned costs and to provide a profit. Works well for a business that keeps its costs low. Two most common cost-oriented pricing procedures: –Full-cost pricing uses all relevant variable costs and allocates fixed costs. Allows the marketer to recover all costs plus the amount added as a profit margin. The full-cost deficiencies. –First, there is no consideration of competition or demand for the item. –Second, any method for allocating overhead is arbitrary. –One way to overcome the arbitrary allocation of fixed expenses is: –2.Incremental-cost pricing, which attempts to use only those costs directly attributable to specific output in setting prices.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Breakeven Chart Breakeven Analysis is a means of determining the number of goods or services that must be sold at a given price to generate sufficient revenue to cover total costs. The breakeven point is the point at which total revenue just equals total cost.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Calculating Breakeven Breakeven Analysis is a means of determining the number of goods or services that must be sold at a given price to generate sufficient revenue to cover total costs. BEP = fixed costs\contribution* *Contribution = selling price less variable cost

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Shortcomings of Breakeven Analysis First, the model assumes that costs can be divided into fixed and variable categories. The model assumes that per-unit variable costs do not change at different levels of operation. Finally, the basic breakeven model does not consider demand.

Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Pricing Challenges Facing Online and International Marketers Five pricing objectives: 1.Profitability 2.Volume 3.Meeting competition 4.Prestige 5.Price stability