CHAPTER 11 Pricing The Product M A R K E T I N G Real People, Real Choices Fourth Edition CHAPTER 11 Pricing The Product

Yes, But What Does It Cost? Price is the value that customers give up or exchange to obtain a desired product Payment may be in the form of money, goods, services, favors, votes, or anything else that has value to the other party

Opportunity Costs The value of something that is given up to obtain something else also affects the “price” of a decision. Example: the cost of going to college is charged in tuition and fees but also includes the opportunity cost of what a student cannot earn by working instead.

Steps in Price Planning Develop pricing objectives Estimate demand Determine costs Evaluate the pricing environment Choose a pricing strategy Develop pricing tactics

Types of Pricing Objectives Sales or market share objectives (e.g. long distance telephone services) Profit objectives Work back from a desired profit level Competitive effect objectives (e.g. Jet Blue and Delta) Customer satisfaction objectives (e.g. Saturn and firm pricing) Image enhancement objectives – prestige products like Rolex, Rolls Royce, etc.

Estimating Demand Demand refers to customers’ desire for products How much of a product do consumers want? How will this change as the price goes up or down?

Demand Curves Shows the quantity of a product that customers will buy in a market during a period of time at various prices if all other factors remain the same Vertical axis represents the different prices a firm might charge Horizontal axis shows the number of units demanded Upward and downward shifts in demand curves

The Price Elasticity of Demand How sensitive are customers to changes in the price of a product? Price elasticity of demand is a measure of the sensitivity of customers to changes in price Price elasticity of demand = Percentage change in quantity demanded / Percentage change in price Elastic / Inelastic demand / Unit Elasticity

Other types of demand elasticities Income elasticity of demand Percentage change in demand as a result of percentage change in incomes Cross elasticity of demand Percentage in demand for a product as a result of percentage change in price of a substitute (e.g. if price of Pepsi goes up the demand for Coke will increase) OR Percentage in demand for a product as a result of percentage change in price of a complementary product (e.g. if price of gas goes up demand for tires may come down)

Estimating Demand Identify demand for an entire product category in markets the company serves Predict what the company’s market share is likely to be Marketing research to find out price elasticity of demand

Types of Costs_1 Variable costs – per-unit costs of production that will fluctuate, depending on how many units or individual products a firm produces Fixed costs – do not vary with the number of units produced. Costs remain the same regardless of amount produced

Types of Costs_2 Average fixed cost is the fixed cost per unit produced (total fixed costs / number of units produced) Total costs = variable costs plus fixed costs

Break-Even Analysis Technique used to examine the relationship between cost and price and to determine what sales volume must be reached at a given price at which company will completely cover its total costs Sales – Variable Costs = Contribution Losses < BE point < Profits Angle of incidence, Margin of Safety BE sales in units = Total Fixed Costs / Contribution per unit

Evaluating the Pricing Environment The Economy Pricing in a Recession: Consumers pull back on their spending Pricing in inflation: Consumers desensitized to rising prices The Competition: Perfect, Oligopoly, Monopolistic competition Consumer Trends: Affluent people hunt for bargains

Cost-Plus Pricing Most common cost-based approach Marketer figures all costs for the product and then adds desired profit per unit Straight markup pricing is the most frequently used type of cost-plus pricing price is calculated by adding a pre-determined percentage to the cost

Pricing Strategies Based on Cost Advantages Simple to calculate Relatively risk free Disadvantages Fail to consider several factors target market demand competition product life cycle product’s image Difficult to accurately estimate costs

Steps in Cost-Plus Pricing Estimate unit cost Calculate markup Markup on cost Markup on selling price

Pricing Strategies Based on Demand_1 Demand-based pricing means that the selling price is based on an estimate of volume or quantity that a firm can sell in different markets at different prices Target costing: find out what customers will be willing to pay and work backwards to design a product within that cost Yield management pricing: services use this method to fill capacity

Pricing strategies Price leadership: the biggest firm in the industry announces a new price and all other firms fall in line - oligopoly ELDP – Every Day Low Pricing: prices based on customer perceptions of value. No further discounts given e.g. Walmart, P&G, etc.

New Product Pricing Skimming price – firm charges a high, premium price for its new product with the intention of reducing it in future response to market pressures Penetration pricing – new product is introduced at a very low price Trial pricing – product carries a low price for a limited time period

Pricing Tactics Pricing for Individual Products two-part pricing (e.g., country clubs, cell phone services) payment pricing (e.g., easy payments for new cars) Pricing for Multiple Products Price bundling (e.g., monitor, keyboard, CPU in a computer package) Captive pricing (e.g., razors and razor blades)

More Pricing Tactics Distribution-based pricing FOB pricing CIF pricing Basing-point pricing Uniform delivered pricing Freight absorption pricing

Discounting for Channel Members Trade or functional discounts Quantity discounts Cash discounts Seasonal discounts

Trade Discounts Pricing structure built around list price List price, also called suggested retail price, is the price that the manufacturer sets as the appropriate price for the end consumer Manufacturers offer discounts because channel members perform selling, credit, storage, and transportation services

Pricing with Electronic Commerce Dynamic pricing strategies price can be adjusted to meet changes in the marketplace online price changes can occur quickly, easily, and at virtually no cost Auctions sites offer chance to bid on items sites offer reverse-price auctions

Price Discrimination Means that marketers classify customers based on some characteristic that indicates what they are willing or able to pay Acceptable when price differences are in response to: changes in cost of product changes in competitive activity changes in marketplace

Psychological Issues in Pricing Internal Reference Prices – consumers have a set price or price range in mind If the actual price is higher, consumers will feel the product is overpriced If it is too low below the internal reference price, consumers may assume its quality is inferior Competition as Reference Price – If the price is close, the assimilation effect will encourage the customer to think the products are similar enough and choose the lower-priced product

Price-Quality Inferences If consumers are unable to judge the quality of a product through examination or prior experience, they usually will assume that the higher-priced product is the higher-quality product

Psychological Pricing Strategies Odd-even pricing Price lining

Legal and Ethical Considerations Deceptive pricing practices Unfair sales act Price discrimination

Deceptive Pricing Practices Retailers must not claim prices are lower than competitors unless it is true A going out-of-business sale should be the last sale before going out of business Bait-and-switch – consumers are lured into store for a very low price, but then the item is not available. A more expensive product is offered instead Trading up is acceptable

Unfair Sales Acts Laws or regulations prohibiting selling products below cost loss leader pricing many regulations even set a percentage markup below which the distributor may not sell the products

Regulated by Robinson-Patman Act Price Discrimination Means selling the same product to different wholesalers and retailers at different prices if practices lessen competition Regulated by Robinson-Patman Act only applies to resellers discounts are legal if based on established policy and offered to any customer who chooses to buy under those conditions

Price Fixing Occurs when two or more companies conspire to keep prices at a certain level Horizontal price fixing occurs when competitors making the same product jointly determine what price they each will charge Vertical price fixing occurs when manufacturers attempt to force the retailer to charge the suggested retail price

Predatory Pricing Means that a company sets a very low price for the purpose of driving competitors out of business