1. 17 MKTG CHAPTER Lamb, Hair, McDaniel 2007-2008 Pricing Concepts
Chapter 17 Pricing Concepts
MKTG
Lamb, Hair, McDaniel 17
CHAPTER
Pricing Concepts
Designed by
Amy McGuire, B-books, Ltd.
Prepared by
Deborah Baker, Texas Christian University

2. Learning Outcomes LO1 LO2 LO3
Chapter 17 Pricing Concepts
Learning Outcomes
Discuss the importance of pricing decisions to the economy and to the individual firm
List and explain a variety of pricing objectives
Explain the role of demand in price determination
LO1
LO2
LO3

3. Learning Outcomes LO4 LO5 LO6
Chapter 17 Pricing Concepts
Learning Outcomes
Understand the concept of yield management systems
Describe cost-oriented pricing strategies
Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet and extranets, and perceptions of quality can affect price
LO4
LO5
LO6

4. The Importance of Price
Chapter 17 Pricing Concepts
The Importance of Price
LO1
Discuss the importance of pricing decisions to the economy and to the individual firm

5. The Importance of Price
Chapter 17 Pricing Concepts
The Importance of Price
To the consumer... Price is the cost of something
To the seller... Price is revenue
Notes:
Marketing has the broadest perspective on pricing because it is the function that looks at both internal cost issues and external pressure demands.
Price means one thing to the consumer and another to the seller. To the consumer, the price is the cost of something; to the seller, price is the source of profits. Marketing mangers find the task of setting prices a challenge.
Price allocates resources in a free-market economy
LO1

6. Chapter 17 Pricing Concepts
What Is Price?
Price
Price is that which is given up in an exchange to acquire a good or service.
Notes:
Price is typically money exchanged for a good or service; however, it may also be time lost while waiting to acquire the good or service.
Consumers are interested in obtaining a “reasonable price,” which means a perceived reasonable value at the time of the transaction. The price paid is based on the satisfaction consumers expect to receive from a product and not necessarily the satisfaction they actually receive.
Price can relate to anything with perceived value, not just money. When goods or services are exchanged, the trade is called barter.
LO1

7. The Importance of Price to Marketing Managers
Chapter 17 Pricing Concepts
The Importance of Price to Marketing Managers
Revenue
The price charged to customers multiplied by the number of units sold.
Profit
Revenue minus expenses.
Notes:
Prices are the key to revenues, which are the key to profits for an organization.
Revenue is what pays for every activity of the company. What’s left over is profit. The price is set to earn a profit for the company.
Managers strive to charge a price that will earn a fair profit. The price must not be too high or too low, and must equal a perceived value to consumers.
Lost sales mean lost revenue; on the other hand, if a price is too low, the company loses revenue. Additionally, setting prices too low may not attract as many buyers as managers might think.
LO1

8. Trends Influencing Price
Chapter 17 Pricing Concepts
Trends Influencing Price
Flood of new products
Increased availability of bargain-priced private and generic brands
Price cutting as a strategy to maintain or regain market share
Internet used for comparison shopping
Notes:
Setting the right price can be a stressful task of marketing managers, as demonstrated by the above trends in the consumer market.
Consumers are using the Internet to make wiser and more informed purchasing decisions.
Competition in general is increasing, and consequently many installations, accessories, and parts are being marketed like indistinguishable commodities.
LO1

9. REVIEW LEARNING OUTCOME
Chapter 17 Pricing Concepts
REVIEW LEARNING OUTCOME
LO1
The Importance of Pricing Decisions
Price X Sales Unit = Revenue
Revenue – Costs = Profit
Profit drives growth, salary increases, and corporate investment

10. List and explain a variety of pricing objectives
Chapter 17 Pricing Concepts
Pricing Objectives
LO2
List and explain a variety of pricing objectives

11. Pricing Objectives LO2 Profit-Oriented Sales-Oriented Status Quo
Chapter 17 Pricing Concepts
Pricing Objectives
Profit-Oriented
Sales-Oriented
Status Quo
Notes:
Pricing objectives must be specific, attainable, and measurable to survive in today’s competitive market.
Pricing objectives can be divided into three categories as shown above and described in the following slides.
LO2

12. Profit-Oriented Pricing Objectives
Chapter 17 Pricing Concepts
Profit-Oriented Pricing Objectives
Profit-Oriented Pricing Objectives
Profit
Maximization
Satisfactory Profits
Target Return on
Investment
Notes:
Profit-oriented pricing objectives include profit maximization, satisfactory profits, and target return on investment. A discussion of each of these follows.
LO2

13. Profit Maximization LO2 Profit Maximization
Chapter 17 Pricing Concepts
Profit Maximization
Profit Maximization
Setting prices so that total revenue is as large as possible relative to total costs.
Notes:
Although profit maximization aims at setting prices for a large total revenue, it does not always signify unreasonably high prices. Both price and profits depend on the competitive environment and the product’s perceived value. Remember, too, that a firm cannot charge a price higher than the product’s perceived value.
Satisfactory profits represent a reasonable level of profits that is consistent with the level of risk an organization faces.
LO2

14. ROI = Net Profit after taxes
Chapter 17 Pricing Concepts
Return on Investment
Return on Investment
ROI = Net Profit after taxes
Total assets
Net profit after taxes divided by total assets.
Notes:
The most common profit objective is a target ROI, or the return on total assets. It represents a firm’s effectiveness in generating profits with the available assets. The higher the firm’s ROI, the better off the firm is. ROI puts a firm’s profits into perspective by showing profits relative to investment.
ROI needs to be evaluated in terms of the competitive environment, risks in the industry, and economic conditions. In general, firms seek ROIs in the 10 to 30 percent range, depending on the industry. For example GE seeks a 25 percent ROI, while grocery chains obtain a return under 5 percent.
LO2

15. Sales-Oriented Pricing Objectives
Chapter 17 Pricing Concepts
Sales-Oriented Pricing Objectives
Market
Share
Sales
Maximization
Sales-Oriented Pricing Objectives
Online
Target
Wal-Mart
JC Penney
Shop for some kind of electronic device (DVD player, digital camera, MP3 player, etc.) on the Target, Wal-Mart, and JCPenney Web sites. How do the prices for the same product compare at the three retailers? Do they all even carry the same product? Compare the price on the Web with the price offered at the physical store and explain any discrepancies.
Online
LO2

16. Market Share LO2 Market Share
Chapter 17 Pricing Concepts
Market Share
Market Share
A company’s product sales as a percentage of total sales for that industry.
Notes:
Market share can be reported in dollars or units of product, and the results may be different.
Many companies believe that maintaining or increasing market share is an indicator of the effectiveness of their marketing mix. Larger shares often mean higher profits, thanks to economies of scale, market power, and ability to compensate top-quality management. However, this conventional wisdom is not always reliable.
Many companies with low market share survive if they are in a slow growth industry and experience few product changes.
LO2

17. Sales Maximization LO2 Short-term objective to maximize sales
Chapter 17 Pricing Concepts
Sales Maximization
Short-term objective to maximize sales
Ignores profits, competition, and the marketing environment
May be used to sell off excess inventory
Notes:
Maximization of cash should never be a long-run objective because cash maximization may mean little or no profitability. Without profits, a company cannot survive.
LO2

18. Status Quo Pricing Objectives
Chapter 17 Pricing Concepts
Status Quo Pricing Objectives
Maintain
existing
prices
Meet
competition’s
Status Quo Pricing Objectives
Notes:
Status quo pricing seeks to maintain existing prices or to meet the competition’s prices.
This category requires little planning, and is essentially a passive policy.
LO2

19. REVIEW LEARNING OUTCOME
Chapter 17 Pricing Concepts
REVIEW LEARNING OUTCOME
LO2
Pricing Objectives
Profit
Maximization
Satisfactory
Profits
Target
ROI
Profit-Oriented
Status Quo
Maintain
Existing Price
Sales-Oriented
Market
Share
Sales Maximization

20. The Demand Determinant of Price
Chapter 17 Pricing Concepts
The Demand Determinant of Price
LO3
Explain the role of demand in price determination
Notes:
After pricing goals are established, specific prices are set.
The price set for products depend on two factors: the demand for the good and the cost to the seller for that good.

21. The Demand Determinant of Price
Chapter 17 Pricing Concepts
LO3
Demand
The quantity of a product that will be sold in the market at various
prices for a specified period.
Supply
The quantity of a product that will
be offered to the market by a supplier
at various prices for a specific period.
Online
uBid
See how demand and supply establish prices by checking out the offerings at uBid.com. See a variety of products and identify the price and the number of items in the lot. Can you see a correlation between the price and the number of, say, printers uBid has on hand?
Online

22. The Demand Curve LO3 Chapter 17 Pricing Concepts Notes:
The quantity of a product that people will buy depends on its price. The higher the price, the fewer goods or services consumers will demand, and vice versa.

23. The Supply Curve LO3 Chapter 17 Pricing Concepts Notes:
Exhibit 17.3 demonstrates the supply curve. At higher prices, manufacturers will obtain more resources and produce more product to sell.

24. Beyond the Book Tyson’s Meat Glut LO3
Chapter 17 Pricing Concepts
LO3
Tyson’s Meat Glut
Tyson Foods, the world’s largest processor, has an oversupply of meat:
Lower chicken consumption due to avian flu fears
Export restrictions to Japan and South Korea due to mad cow disease
Mismatch between oversupply and reduced demand has created tremendous financial losses for the company.
Tyson produces 25% of meats that Americans eat, and small price changes impact company profit significantly.
To reverse trend, company is taking a commodity approach to the primary business, while marketing more value-added products.
Beyond the Book
SOURCE: Richard Gibson, “Tyson Looks for Way Out of Meat Glut,” Wall Street Journal, June 28, 2006, B9A.

25. How Demand and Supply Establish Price
Chapter 17 Pricing Concepts
LO3
Price
Equilibrium
The price at which demand and
supply are equal.
Elasticity of Demand
Consumers’ responsiveness or
sensitivity to changes in price.
Notes:
The concepts of supply and demand are combined to see how competitive market prices are determined.

26. Price Equilibrium LO3 Chapter 17 Pricing Concepts Notes:
Exhibit 17.4 shows how an equilibrium price is reached when supply and demand are equal.
A price below equilibrium results in a shortage because the demand is greater than the available supply. A shortage puts upward pressure on price.
At a price above equilibrium, the demand is less than the available supply, and a surplus is created. A surplus lowers the price.
Establishing an equilibrium price may not be possible all at once. Prices may fluctuate as the market for a good moves toward equilibrium; however, demand and supply will settle into the proper balance.

27. Elasticity of Demand LO3 Elastic Demand
Chapter 17 Pricing Concepts
LO3
Elastic Demand
Consumers buy more or less of a product when the price changes.
Inelastic Demand
An increase or decrease in price will not significantly affect demand.
Notes:
1. To appreciate demand analysis, the concept of elasticity should be understood.
Unitary Elasticity
An increase in sales exactly offsets a decrease in prices, and revenue is unchanged.

28. Elasticity of Demand LO3 Elasticity (E) =
Chapter 17 Pricing Concepts
LO3
Elasticity (E) =
Percentage change in quantity demanded of good A
Percentage change in price of good A
If E is greater than 1, demand is elastic.
If E is less than 1, demand is inelastic.
If E is equal to 1, demand is unitary.

29. Elasticity of Demand LO3 Price Goes... Revenue Goes... Demand is...
Chapter 17 Pricing Concepts
LO3
Price Goes...
Revenue Goes...
Demand is...
Down Up
Elastic
Inelastic
Up or Down
Stays the Same
Unitary Elasticity
Discussion/Team Activity:
Identify products and/or services which illustrate the elasticity of demand.

30. Chapter 17 Pricing Concepts
Biz Flix
The
Money Pit
LO3

31. Elasticity of Demand LO3 Chapter 17 Pricing Concepts Notes:
This example shows a very elastic demand curve. Decreasing the price of the good increases sales and revenue substantially.

32. Factors that Affect Elasticity of Demand
Chapter 17 Pricing Concepts
LO3
Availability of substitutes
Price relative to purchasing power
Product durability
A product’s other uses
Online
Columbia House
How can Columbia House offer so many CDs, videos, or DVDs for one cent? Go to the Web site to see what kind of deals Columbia House is offering right now. Compare the introductory offers to the pricing for subsequent purchases. What conclusions can you draw about Columbia House and about the elasticity of demand for CDs based on the posted pricing for the initial sign-up and for subsequent purchases?
Notes:
Factors that affect elasticity of demand are:
Availability of substitutes: When many substitutes are available, it is easy to switch products, making demand elastic. The same is true in reverse, if no substitutes are available.
Price relative to purchasing power: If a price is so low that it is an inconsequential part of an individual’s budget, demand will be inelastic and people are not sensitive to the price increase.
Product durability: Repairing durable products rather than replacing them prolongs their useful life. If the cost of a new product increases, people might elect to repair the old product. Thus, people are sensitive to the price increase, and the demand is elastic.
A product’s other uses: The greater the number of uses for a product, the more elastic demand tends to be. If a product has only one use, the quantity purchased probably will not vary as price varies.
Discussion/Team Activity:
Discuss examples of price inelasticity and elasticity. Include zero percent automobile financing, the price of vehicle models, cell phone rates, prestige watches, cigarettes, health care, etc.
Rate of inflation
Online

33. The Power of Yield Management Systems
Chapter 17 Pricing Concepts
The Power of Yield Management Systems
LO4
Understand the concept of yield management
systems

34. Yield Management Systems
Chapter 17 Pricing Concepts
Yield Management Systems
Yield Management Systems
A technique for adjusting prices that uses complex mathematical software to profitably fill unused capacity.
Notes:
When competitive pressures are high, a company must know when it can raise prices to maximize its revenues.
Yield management systems, which were first developed by the airline industry, utilize complex mathematical software to profitably fill unused capacity.
Yield management systems have spread beyond the service industries, and used by companies to set prices based on a number of variables.
LO4

35. Yield Management Systems
Chapter 17 Pricing Concepts
Yield Management Systems
Discounting early purchases
Limiting early sales at discounted prices
Overbooking capacity
Notes:
The software employs techniques such as discounting early purchases, limiting early sales at these discounted prices, and overbooking capacity.
LO4

36. Beyond the Book Yield Management Systems LO4
Chapter 17 Pricing Concepts
LO4
Yield Management Systems
Rental property landlords use
yield management systems to
raise rents at a faster pace.
The M/PF Yield-Star Price
Optimizer is similar to pricing
systems used by airlines and car-rental companies.
It uses data such as number of vacancies and forecasted market conditions to determine the optimal rent.
Tenants can also take advantage of the technology.
Beyond the Book
SOURCE: Kemba J.Dunham, “Technology Proves a Boon for Some Landlords,” Wall Street Journal, June 28, 2006, B10.

37. REVIEW LEARNING OUTCOME
Chapter 17 Pricing Concepts
REVIEW LEARNING OUTCOME
LO4
Yield Management Systems

38. The Cost Determinant of Price
Chapter 17 Pricing Concepts
The Cost Determinant of Price
LO5
Describe cost-oriented pricing strategies

39. The Cost Determinant of Price
Chapter 17 Pricing Concepts
Varies with changes
in level of output
Types of Costs
Variable
Cost
Fixed Cost
Does not change
as level of output changes
Notes:
Sometimes the importance of demand is ignored when prices are decided, based largely or solely on the basis of costs.
Prices set on the basis of cost may be too high for the target market. On the other hand, if prices are set too low, the firm will earn a lower return than it should.
Costs should be determined as part of any price determination, in part to determine the floor below which a good or service must not be priced in the long run.
4. Variable and fixed costs are important aspects of price determination.
LO5

40. The Cost Determinant of Price
Chapter 17 Pricing Concepts
Break-Even
Pricing
Profit Maximization Pricing
Keystoning
Markup pricing
Methods
Used to
Set Prices
Notes:
Costs can be used to set prices in a variety of ways. Markup pricing is fairly simple. The others—profit maximization pricing and break-even pricing--use more complicated concepts of costs. A description of these methods is shown on the following slides.
LO5

41. Markup Pricing LO5 Markup Pricing Keystoning
Chapter 17 Pricing Concepts
Markup
Pricing
The cost of buying the product
from the producer plus amounts
for profit and for expenses not otherwise accounted for.
Keystoning
The practice of marking up prices
by 100%, or doubling the cost.
Notes:
Markup pricing is the most popular method to establish a selling price. Instead of using the costs of production to set price, it uses the costs of buying the product from the producer, plus amounts for profit and expenses. The total determines the selling price.
Keystoning is a method based on experience, with many small retailers doubling the cost. Other factors that influence markups are the merchandise’s appeal to customers, past response to the markup, the item’s promotional value, the seasonality of the goods, their fashion appeal, the product’s traditional selling price, and competition.
The biggest advantage of markup pricing is its simplicity. The primary disadvantage is that it ignores demand and may result in overpricing or underpricing the merchandise.
LO5

42. Profit Maximization LO5 Profit Maximization Marginal Revenue
Chapter 17 Pricing Concepts
Profit
Maximization
A method of setting prices that
occurs when marginal revenue
equals marginal cost.
Marginal
Revenue
The extra revenue associated with selling an extra unit of output,
or the change in total revenue with
a one-unit change in output.
Notes:
Profit maximization occurs when marginal revenue equals marginal cost.
Marginal cost is the change in total costs associated with a one-unit change in output. Marginal revenue is the extra revenue associated with selling an extra unit of output. As long as the revenue of the last unit produced and sold is greater than the cost of the last unit produced and sold, the firm should continue manufacturing and selling the product.
LO5

43. Break-Even Pricing LO5 Chapter 17 Pricing Concepts Notes:
Break-even analysis determines what sales volume must be reached before the company breaks even and no profits are earned. (Its total costs equal total revenue.)
LO5

44. Fixed cost contribution Price - Avg. Variable Cost
Break-Even Pricing
Chapter 17 Pricing Concepts
Break-Even
Quantity =
Total fixed costs
Fixed cost contribution
Fixed cost
Contribution
Price - Avg. Variable Cost
Notes:
Break-even analysis provides a quick estimate of how much the firm must sell to break even and how much profit can be earned if a higher sales volume is obtained. It is useful to see what can be done to reduce costs or increase sales. However, it has limitations such as the difficulty in determining whether a cost is fixed or variable. Additionally, break-even analysis ignores demand.
LO5

45. REVIEW LEARNING OUTCOME
Chapter 17 Pricing Concepts
REVIEW LEARNING OUTCOME
LO5
Cost-Oriented Pricing Strategies

46. Other Determinants of Price
Chapter 17 Pricing Concepts
Other Determinants of Price
LO6
Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet and extranets, and perceptions of quality can affect price
Notes:
Other factors besides demand and costs can influence price. A description of these determinants follows.

47. Other Determinants of Price
Chapter 17 Pricing Concepts
Other Determinants of Price
Perceived Quality
Promotion Strategy
Distribution Strategy
Competition
Stages of the
Product Life Cycle
LO6

48. Stages in the Product Life Cycle
Chapter 17 Pricing Concepts
Stages in the Product Life Cycle
Introductory
Stage
Growth
Decline $
High
Stable
Decrease
Maturity
Notes:
As a product moves through its life cycle, the demand for the product and the competitive conditions change:
During the introductory stage, prices are set high to recover development costs. Demand originates in the core of the market and is relatively inelastic.
As the product enters the growth stage, prices tend to stabilize due to the increased product supply as new competitors enter the market. Second, the product begins to appeal to a broader market, often lower income groups. Last, economies of scale are lowering costs, and the savings can be passed on to the consumer.
Maturity brings about further decreases in price, as competition increases and high-cost firms are eliminated. However, distribution channels become a significant cost factor because of the need to offer wide product lines. Usually, only the most efficient manufacturers remain.
The decline stage may see further price decreases until only one firm is left in the market. At that time, prices begin to stabilize and may even increase as the product moves into the specialty goods category.
Discussion/Team Activity:
Identify and discuss products in various stages of the product life cycle. Relate the pricing of these products to the product life cycle shown above.
LO6

49. The Competition LO6 High prices may induce firms to enter the market
Chapter 17 Pricing Concepts
The Competition
High prices may induce firms to enter the market
Competition can lead to price wars
Global competition
may force firms to
lower prices
Notes:
Competition varies during the product life cycle. Although a firm may not have competition at first, the high prices obtained may induce other firms to enter the market.
Sometimes competition can lead to price wars.
Global competition has often forced firms to lower prices. Even Wal-mart has seen price cutting by the second largest world-wide competitor Carrefour.
LO6

50. Distribution Strategy
Chapter 17 Pricing Concepts
Distribution Strategy
Manufacturers
Wholesalers/Retailers
Offer a larger profit margin or trade allowance
Use exclusive distribution
Franchising
Avoid business with price-cutting discounters
Develop brand loyalty
Sell against the brand
Buy gray-market goods
Notes:
Adequate distribution for a new product can be obtained by offering a larger-than-usual profit margin to distributors, or by offering a large trade allowance to defray the costs of promotion.
However, some distributors use “selling against the brand” strategies to promote their own private-label brands. They place well-known brands at high prices while offering other brands at higher prices.
Distributors may also go outside traditional channels and buy “gray-market goods” at lower prices so they can sell the goods with a large markup or at a reduced price.
LO6

51. Distribution Strategy
Chapter 17 Pricing Concepts
Distribution Strategy
Selling against the brand
Stocking well-known branded items at high prices in order to sell store brands at discounted prices.
LO6

52. The Impact of the Internet
Chapter 17 Pricing Concepts
The Impact of the Internet
Internet auctions
Shopping bots
Second opinions from expert sites
Product selection
Notes:
The Internet connects sellers and buyers quickly, and allows product and price comparison, putting them in a better bargaining position.
Numerous Web sites provide information regarding product selection, and a second opinion for brand selection. However, quality of reviews vary.
Shopping bots search the Web for the best price. The two types of shopping bots are broad-based types and niche-oriented types. Most shopping bots give preferential listings to e-tailers who pay for the privilege, and not necessarily the lowest-priced retailer.
Internet auctions, such as eBay, are huge. Business-to-business auctions are likely to be the dominant form in the future.
LO6

53. The Relationship of Price to Quality
Chapter 17 Pricing Concepts
The Relationship of Price to Quality
Prestige Pricing
Charging a high price to help promote a high-quality image.
Online
Vivre
Ashford
Vivre is a luxury lifestyle catalog and Web site. Visit Vivre.com and review the product offerings. Pick a product and then see if you can get it cheaper at Ashford.com, a luxury brand discounter. What luxury brands are offered on both sites? How do the prices compare? Can you identify tiers of luxury brands?
Notes:
When a purchase decision involves uncertainty, consumers tend to rely on a high price as a predictor of good quality. Consumers assume that “you get what you pay for.”
Prestige pricing takes these consumer attitudes into account when devising price strategies. A successful prestige pricing strategy requires a retail price that is reasonably consistent with consumers’ expectations.
Online
LO6

54. Beyond the Book The $100,000 Family Car LO6
Chapter 17 Pricing Concepts
LO6
The $100,000 Family Car
The auto industry has a new sticker price on luxury: $100,000.
These cars are powerful mass market sedans, targeting households with incomes of $300,000 or more.
With sales of 9,000 cars sold last year, and 17,000
being built, it looks like
massive oversupply.
The expensive models
could lure buyers into
the showroom.
Beyond the Book
SOURCE: “The $100,000 Family Car,” Wall Street Journal, March 12, 2006, W1.

55. Dimensions of Quality LO6 Ease of use Versatility Durability
Chapter 17 Pricing Concepts
Dimensions of Quality
Ease of use
Versatility
Durability
Serviceability
Performance
Prestige
Notes:
In a recent study to ascertain the dimensions of quality revealed the factors shown on this slide, in order of importance, beginning with ease of use.
When consumers focused on prestige and/or durability to assess quality, price was a strong indicator of perceived quality. Price was less important as an indicator of quality if the consumer was focused on the other four dimensions of quality.
LO6

56. REVIEW LEARNING OUTCOME
Chapter 17 Pricing Concepts
REVIEW LEARNING OUTCOME
LO6
Factors Affecting Price