McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 14 Pricing Over the Product Life Cycle

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Product Life Cycles- The Conceptual Model Development Stage- the product concept is engineered from idea to actual design –The accumulated cash investment grows to a substantial amount before the product is introduced for sale Introduction- the period of initial success or failure for new products –The firm’s marketing efforts are geared towards stimulating primary demand (demand for the product itself)

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Product Life Cycles- The Conceptual Model Growth- the product begins to make rapid sales gains as the rate of market acceptance accelerates –Competitor’s marketing strategies focus on stimulating secondary demand with emphasis on product differentiation Maturity- the rate of the market acceptance decreases as the number of new potential customers diminishes –Marketing strategies are designed to create customer preference and loyalty, and continued growth requires an increase in market share

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Product Life Cycles- The Conceptual Model Saturation- products and production methods have become standardized, and buyers are generally well aware of similarities and differences in products –Competition for market share intensifies Shakeout- prices tend to decline faster than do costs –High-cost sellers tend to be forced out of the market

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Product Life Cycles- The Conceptual Model Decline- Sales begin to diminish as customers turn to new or better products

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Price Elasticity Over the Product Life Cycle How price elasticity might change over a product’s life cycle depends on: –How the product is initially priced –Whether the product’s price follows a decreasing or increasing trend over time –The degree to which sellers make quality improvements over time –The degree that buyers perceive real benefits and therefore value-in-use in the product

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Strategy Implications It is important to recognize:  Products have a limited life  Accelerating technological changes, changing income levels, and increased global competition may decrease a product’s life span  There is some correspondence between the industry experience curve and the product life cycle

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. More Strategy Implications  Sales and profits tend to follow a predictable trend  Products require different marketing strategies at each stage of the life cycle  Pricing strategy is vitally important at each stage of the life cycle, but particularly at the introduction stage

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Throughout the cycle, changes occur in promotional and price elasticity and in costs of production and distribution Pricing over the cycle depends on: –Technical maturity –Market maturity –Competitive maturity

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Value analysis- increasing perceived value by increasing performance relative to customer needs and willingness to pay for that performance Rate-of-Return Pricing- reveals a price for a given product that makes it an irresistibly good investment to customers in view of their alternatives and at the same time extracts from the customers all that can safely be demanded

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Systematic approach- 1. Estimate demand at different prices over expected life cycle. 2. Estimate costs over expected life cycle. 3. Estimate price-volume-profit relationship. 4. Determine likely competitors.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing 5. Determine competitors’ entry capabilities. 6. Estimate competitors’ likely entry dates. 7. Determine a marketing strategy. 8. Estimate marketing requirements over life cycle. 9. Select an entry price.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Estimating demand for a New Product- –Will the product fill a need or want and, therefore, will sell if the price is right? –At what range of prices will the product be acceptable to potential buyers? –What is the expected sales volumes at feasible price points in the acceptable price range? –What is the extent of potential competitive response? Information can be translated into a buy-response curve

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Buyer’s Analysis Selecting Probable Prices Buyer’s Alternatives- An analysis of demand can be made: –1. Determine the major uses for the product, and then the product’s performance characteristics for these uses –2. Specify the products that are the buyers’ best alternatives

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Buyer’s Analysis Continued –3. For each use, determine how well the product’s performance characteristics meet the requirements of customers compared to alternative products –4. Forecast prices of alternative products –5. Estimate the superiority premium –6. Determine a “parity price” for the product relative to the buyers’ best alternative (Parity is a price that encompasses the premium a customer would be willing to pay for comparative superiority)

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Pricing the Superiority Differential- Determine the price premium that the new product’s superiority will most profitably warrant –Depends on uncertainties for buyer, future costs, and the dynamic demand schedule Estimating Costs- A value-oriented approach to pricing begins with determining what the target market would be willing to pay, and then design a product using this target cost

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Estimated Costs To get maximum practical use from costs in new product pricing, three questions must be answered: –1. Whose cost? –2. Which cost? –3. What role?

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Whose Cost? Buyer’s costs- can be determined by applying value analysis techniques and performance of alternative products to find the superiority premium

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Whose Cost? Competitor’s costs- –can be determined for products in the market by estimating: Their staying power The floor of retaliation pricing –can be determined for unborn competitive products by: Forecasting the relationship between unit direct costs and cumulative experience

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Whose Cost? Seller’s costs- –1. A new product must be pre-priced in the R&D stage and then periodically as it progresses toward market –2. Establish a price floor –3. Estimate total costs with and without the new product

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Estimating the Price-Volume-Profit Relationship- allows the manager to trace the implications of different introductory pricing strategies

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. When To Use A Skimming Price Strategy 1. Demand is likely to be inelastic during introduction 2. Market can be separated into distinct price segments 3. Skimming is safer when elasticity is unknown (it is easier to reduce price) 4. Cash is needed to fund expansion (caution: sufficient volume must be obtained)

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. When To Use A Skimming Price Strategy 5. A capacity constraint exists 6. There is realistic perceived value in product 7. A high introductory price provides room for future price decreases 8. A high introductory price may be used to signal quality 9. A high introductory price may be used to signal low experience effects on costs

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. When To Use A Penetration Price Strategy 1. Demand is likely to be elastic during introduction 2. Product quality and benefits can be easily determined after trial and use 3. Possible economies of scale through accumulated volume 4. Product faces strong potential competition soon after introduction

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. When To Use A Penetration Price Strategy 5. There is no segment of buyers willing to pay a higher price 6. There is high available capacity in production and distribution 7. A low introductory price may be used to signal large experience effects on costs

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Skimming vs. Penetration The speed with which a new product loses its uniqueness and sinks to the level of just another competitive product depends on: –1. Its total sales potential –2. The investment required for rivals to manufacture and distribute the product –3. The strength of the patent and know-how protection –4. The alertness and power of competitors

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Guidelines For Pricing New Products 1. Clearly define corporate goals 2. Begin pricing during development stage 3. Use process of successive approximations –(Rough estimates of relevant concepts are preferable to precise knowledge of historical irrelevancies.) 4. Cost information about the seller, buyers’ and seller’s rivals can provide useful guidance 5. The only relevant costs are the incremental costs of going ahead; Costs of R&D and market testing are irrelevant

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Guidelines For Pricing New Products 6. Consider the changing economic and competitive environment of the product throughout its life cycle. 7. Price the product through the eyes of customers. Price it just low enough to make it irresistible relative to buyers’ alternatives. 8. Buyers’ cost savings (or revenues gained) as a rate of return on their investment is key to predicting price sensitivity for business customers. 9. Choosing between skimming and penetration should be based on a careful analysis of the market.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Pricing During Growth Objective is to select a price that will help generate a sales volume that enables the firm to realize its target contribution –3 essential points for pricing during growth: 1. Range of feasible prices has narrowed 2. Unit variable costs have decreased due to experience factor 3. Fixed expenses have increased due to increased capitalization and period marketing costs

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Pricing During Growth Responding to Lower-Priced Competitive Offerings- The firm should introduce a lower-priced version of the product before competitors enter Prolonging the Growth Stage- The firm can revitalize the product with “new and improved” versions Pricing Next Generation Products

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Pricing During Maturity Pricing objective is to choose the price alternative leading to maximum contribution –Follow competition’s reduced prices –Try to reduce costs by using cheaper materials, eliminating several labor operations, or reducing period marketing costs

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Pricing A Declining Product Pricing objective is to maximize contributions per sales dollar generated –Most firms eliminate all period marketing costs and remain in the market as long as price exceeds direct variable costs

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Dynamic Pricing Models Diffusion effect refers to the increased likelihood of purchase as market penetration increases Saturation effect refers to the reduction in the unfulfilled demand as market penetration increases

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Focused Price Reductions  Base product vs. option prices  Many customers will make their purchase decision using the base price alone, and then become less price sensitive to additional options or accessories that can be purchased separately  Channel specific pricing  Offer lower prices on high-quality products by identifying distribution channels that serve price sensitive customers and offering the lower prices through these channels only

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Focused Price Reductions  Pricing according to customers’ perceived values  Offering similar services to customers at different prices shifts demand and enhances volume from price sensitive segments  Price bundling  Offering two or more products or services at a price that usually is lower than the sum of the individual prices

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Focused Price Reductions  Product redesign  Unbundling the base product from the options by changing it in some way (fewer features, lower grade material, different brand name) and then selling it as a separate, lower-priced product  The objective is to appeal to price sensitive customers who would normally not buy the original product at its regular price